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While much of the world’s attention was focused on the earthquake that devastated the towns of Amatrice, Arquata del Tronto, and Accumoli, a political quake rocked the resurgent Five-Star Movement. This may have given PM Matteo Renzi a better chance to win his critical constitutional referendum. Economic improvements may follow. But this is the best-case scenario. In the worst case the government will fall, economic reforms will remain a pipe dream and talk of a possible departure of Italy from the Eurozone will gain momentum.

Only a few months ago the populist Five Star Movement of the comedian Beppe Grillo was riding high, having just emerged as Italy’s leading political party. Four public opinion polls had given it the edge over the ruling Democratic Party, or PD, of Matteo Renzi and had set alarm bells ringing about a Fall referendum on which the Prime Minister has staked his career. Mr. Grillo’s party had already won victories in important municipal elections in Rome and Turin. Rumors had begun circulating about a possible government collapse while the parliamentary leader of the Five Star Movement, Luigi Di Maio, demanded that Brussels allow public money to be pumped into the country’s ailing banks without any hit to private investors. The Movement was calling for a plebiscite to be held on ditching the euro and re-establishing a national currency.

But then along came a scandal revolving around Rome’s administrator for refuse, Paola Muraro, who was appointed by Mayor Virginia Raggi of the Five Star Movement only a short while ago to get the city cleaned up. The problem grew out of links she is said to have had with “Eco-Mafia” crime rings that feed off lucrative waste disposal contracts. The revelation quickly grew into a political threat not only to Ms. Raggi but to the whole Five Star party, especially as it followed hard on the heels of the exit of five technocrats in Rome, including the city’s respected finance chief, complaining about the “incompetence” of Rome’s newly installed administration.

If the Five Star Movement’s fortunes decline this strengthens the odds of PM Renzi winning the crucial referendum on far-reaching constitutional reforms that he plans to hold in November and on which he has staked his political future. The reforms aim to make Italy more governable, inter alia by stripping the Senate of much of its legislative powers and reducing the number of lawmakers, and to boost the ailing economy. His government is weighing the merits and costs of increases in pensions for low-income retirees, directing some 500 million euros supposedly created by the constitutional reform to the “fight against poverty,” and bringing forward to next year an income tax cut originally planned for 2018. The trouble is, he has very little fiscal leeway and will, in fact, have to find spending cuts or extra revenues to offset the automatic VAT rises that are scheduled to hit next year.

He also wants to rescue the ailing banking sector, which is beset by multiple ills including exposure to peripheral government debt, mountains of bad loans, weak profitability and a fragmented structure. The country has 600 separate banks with a vast number of branches. As much as 17% of the loan volume is said to be sour, which is ten times the level in the US. Currently most at risk is Monte dei Paschi di Siena, the world’s oldest bank and Italy’s third-largest by assets, but it is far from being the only one with headaches. It is estimated that UniCredit, for instance, which is Italy’s only globally important bank, needs to be recapitalized with up to 10 billion euros while smaller, local banks such as Rimini, Vicenza and Veneto Bank need hundreds of millions.

It is doubtful that they will be able to raise those funds. Collateral offered up by borrowers is often questionable, inter alia because under a bankruptcy law dating back to Mussolini’s times it can take as long as 15 years to foreclose on a defaulted mortgage. Also, according to point 44 of the 2013 rules on state aid being provided to banks, European Union regulations require that first “subordinated debt must be converted into equity.” In Italy, retail investors own about 60 billion euros of such bonds and conversion would not only cause a political upheaval. Such a “bail-in,” wiping out the holdings of investors, could also threaten confidence in the banks that sold the paper.

To go ahead with a multi-billion euro injection of state money, PM Renzi needs a waiver from European Commission state aid rules and a legal path through the bail-in regulations of the EU’s Bank Resolution and Recovery Directive. Italy has tried and failed to secure this in the past, and a renewed failure on this score could doom the Prime Minister’s chances to win the constitutional referendum. Defeat on this score would indeed do grave damage to his career and risk pushing Italy into prolonged political and economic instability. If the voters reject his reforms, Mr. Renzi has said he would resign. In such an event, he would likely be replaced by a caretaker PM before national elections that would lead to another weak administration.

The background to all this is formed by a very soft economy, which stalled in the second quarter with zero growth and a real GDP just 0.7% ahead of a year earlier. The Finance Ministry was quick to blame the setback on external factors including the Brexit vote, the European migration crisis and terrorism. But, clearly, domestic weaknesses bear much of the responsibility. This includes the fact that the country has too many small, unproductive businesses that are not growing. Banks have contributed to the difficulties with cozy links to selected borrowers. Faster economic growth would alleviate many problems afflicting the country, from the non-performing loans that weigh down banks to a public debt that stands at 135% of GDP. Without it, Italy will stay in a rut and the voices calling for it to leave the Eurozone will get louder.

Italy is today arguably worse off than it was when it joined the monetary union. Its real gross domestic product was last year almost 4% lower than in 1998, while that of Germany has grown by 17%. Unemployment has declined in the past year, but only to 11.6% from 12.2%, while the Eurozone average is 10.1%. Youth unemployment in Italy, at 36.5%, is far above the Eurozone rate of 20.8%. Inflation is higher and productivity growth lower than in Germany. Capital is leaving the country. So long as these ills prevail, the view will grow among the people that Italy is getting little or no benefit from the supposed pooling of risks across the Eurozone, while it is being punished by the many fiscal, monetary and regulatory constraints membership implies and by the inability to devalue its currency. It is hard to see how this dilemma can be resolved and it would not come as a great surprise if Italians lost confidence in the euro. The question then will be whether they can be persuaded to worry more about the staggering costs of leaving the Zone than about the difficulties of staying in it...