Investors are turning bullish on Italy as Draghi prepares new reforms

A man wears a protective mask as he sits near the Colosseum, as the spread of the coronavirus disease (COVID-19) continues, in Rome, Italy November 12, 2020.

Guglielmo Mangiapane | Reuters

LONDON — Mario Draghi's new government could be good for financials and consumer recovery plays, an analyst told CNBC, as investors turn more bullish on Italian stocks.

The former European Central Bank chief has ambitious plans to reform the country, including Italy's judiciary, public administration and tax system — an agenda welcomed by market players who have been tentative on Italy as multiple governments struggled to pass through any meaningful reforms in recent years.

"Accomplishing structural reform will be difficult. But after a long period of Italian underperformance, expectations are low. So any signs that Draghi may succeed in achieving growth-boosting structural reforms could lead to an upward rerating of Italian assets," analysts at investment research firm Gavekal Research said in a note. 

The FTSE MIB, Italy's main stock market index, has risen about 7% from a low on Jan. 29 on the back of Draghi's appointment. But experts believe there is further room to grow.

Strategists at UniCredit last week forecast that large and mid-cap segments of the Italian market could have "an absolute performance potential of about 10% from current level" in 2021.

Shifting the tax burden away from the workforce by reducing income taxes and employers' social security contributions would reduce employment costs, boosting corporate productivity.

Gavekal Research

Italy has taken measures to support firms and citizens in the wake of the Covid crisis, including through tax deferrals. However, it is also set to benefit from more than 200 billion euros ($243 billion) in European funds, which are due to start coming in later this year.

Financial stocks

Mislav Matejka, head of global and European equity strategy at JPMorgan, said that Draghi's policies are "bullish for the Italian equity market, through tighter peripheral spreads, greater policy credibility and the bottoming out in activity momentum, helped by the strong fiscal support."

"At sector level, this is especially positive for Financials, as well as for consumer recovery plays," Matejka said.

Financials  are the biggest sector among Italian large and mid-cap firms and consumer discretionary stocks make up the third-largest sector.

Draghi, who was called to take on the country's leadership after a political crisis emerged in January, told lawmakers that he will be dealing with some problems "that have been open for decades."

Analysts are particularly bullish about potential changes to the tax system.

"Shifting the tax burden away from the workforce by reducing income taxes and employers' social security contributions would reduce employment costs, boosting corporate productivity," Gavekal analysts said.

Draghi has also pledged to use the upcoming European funds to focus on digitalization, reskilling and to speed up plans for the country to transition away from fossil fuels.

"This reform agenda will find its counterpart in the selection of investment projects associated with the EU-wide facilities," Marco Protopapa, economist at JPMorgan, said in note.

Last year, "Draghi emphasized the importance of the Recovery Fund resources for Italy by distinguishing between good debt, linked to targeted, productivity-enhancing spending in the form of investment with a high social rate of return, versus bad debt resulting from scattered policy measures," Protopapa said.

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