17Capital International Analysis

Introduction

Business (including private equity) it is often said “hates uncertainty”. Yet the reality of life especially in our recent turbulent times is that uncertainty itself is one of the few comparative certainties. The challenge for private equity (and for the broader business community) is to anticipate what form of political uncertainty might occur where and then to make a proportionate assessment as to whether this is or is not a reason to think differently about investments. The rarely stated truth is that most of the time strong economic fundamentals will matter more than which person or party is in power.

Uncertainty itself is one of the few comparative certainties

This has been valid for both the United States and Europe. It is relatively unusual for the same party to control the presidency, the House of Representatives, and the Senate in Washington and when this does occur the alignment rarely lasts for more than two years (as has been shown once more with the Republicans, albeit narrowly and with deep internal acrimony, retaking the House after the November 2022 ballot). In a similar spirit, it is uncommon for what, since Brexit, are the five largest countries within the European Union (Germany, France, Italy, Spain and Poland) to have seemingly stable governments all at the same time and all but unheard of for them all to be predictable in their duration and to be uniformly composed of either centre-left or central right political administrations.

The landscape entering 2023

Uncertainty is particularly predictable for the major countries of the EU in 2023. They might not all see uncertainty at exactly the same time and even if they did then the nature of that uncertainty will be different. The leading five nations start with an atypical degree of diversity between them. There is Germany with an ideologically challenging combination of the Social Democrats, the Greens and the Free Democrats (supporters of both free markets and liberal social values). France has a centrist President who as of June last year has lost his majority in the National Assembly. Italy held elections last year in which a previously very small and fringe political force – Brothers of Italy – surged to such an extent that it is the most significant player in the new and very distinctly right-of-centre Cabinet.

Spain has a coalition between the Socialists, Podemos (a party to the left of the Socialists and a rival to them) and a collection of smaller and regional centre-left parliamentarians which have allowed it a wafer-thin majority since the last election there in 2019. In Poland, the United Right, dominated by the Law and Justice Party, currently hold a secure majority but has had several disputes with the EU. There is not much of a meeting of minds here and that restricts the EU as a political actor, as a result.

What are likely to be the catalysts for uncertainty in 2023 in the five most populous EU countries?

Germany

On the face of it, Germany would appear to be the least likely location for uncertainty. The October 2021 election has led to a three-party coalition between the Social Democrats, the Greens and the Free Democrats with the SDP’s Olaf Scholz replacing the long-serving Angela Merkel as Chancellor. Put together, these three parties control 416 of the 736 seats in the Bundestag, a clear majority.

Appearances can be deceptive. The instinctively anti-capitalist Greens and the pro-business FDP are far from comfortable with each other. The more established SDP and the CDU, now in opposition for the first time since 2005, have been shaken to the core by the Russian invasion of Ukraine as the leadership of both of them had mostly taken a “softly, softly” approach towards Vladimir Putin. The country has been forced to undertake a dramatic review of energy supplies and of defence spending. These have not been easy exercises either within the ruling coalition or for public opinion at large.

As a consequence, the fortunes of the three parties in government have varied considerably. The SPD has fallen back in popularity, while the Greens have increased their share in the opinion polls. The most important development, though, is that the FDP has slid sharply from its 2021 showing.

This could be the main cause for uncertainty within German politics. The FDP is haunted by the memory of the 2009-2013 administration in which it participated. It had done especially well in the 2009 elections and entered a coalition with the Christian Democrats/Christian Social Union. It would enjoy the trappings of power but with a brutal sting in the tail. When the votes were cast in 2013, the CDU/CSU saw a surge in its support, but the FDP fell below the 5% of the national vote that it needed to have parliamentary representation. It went, in one fell swoop, from 93 seats to nothing.

The FDP will not want history to repeat itself. There is, nonetheless, the real risk that it might. It will be watching nervously at four key state elections this year where it could fall below the 5% barrier. These are Berlin (where it obtained 7.1% last time), Bremen (5.9%), Hesse (7.5%) and Bavaria (5.1%).

If in some, conceivably all, of these elections, the FDP is wiped out at the local level then pressure on its leader, Christian Lindner, to find a pretext before the end of 2023 to leave the coalition and build his party up again from opposition would be intense. If that happened, the impact on the numbers in the legislature would be seismic. The SPD and Greens alone would only hold 324 out of 736 seats in the lower house of Parliament. Even with the tacit support of the hard left Linke with 39 seats (and relying on them even implicitly would be very controversial given their roots in the old East German Communist Party), they would only be able to assemble 363 seats to the 373 held by the CDU/CSU, Alliance for Deutschland and FPD combined. Germany would either have to endure a minority Red-Green administration (an unprecedented situation) or an early election would enter the equation.

France

France also has an apparent stability that might prove to be misleading. Emmanuel Macron won a second term comfortably last year (and cannot constitutionally seek a third spell as President) but less because of his own appeal than the perceived extremism of his main opponents. That harsh truth was exposed in the National Assembly elections which followed after his own victory. His LREM supporters lost their overall majority but remained the largest party with 244 out of 577 seats. Both the hard left in the form of NUPES (created by veteran presidential contender Jean-Luc Mélenchon) and the far-right RN (headed by Marine Le Pen) hugely outperformed expectations with 131 seats and 89 seats respectively. Add to these groups (who have virtually nothing in common bar the wish to make life as difficult as possible for the President) a further 22 left-of-centre individuals who are not formally part of NUPES but not far from it, and the strongly pro and staunchly anti-Macron sides in the Assembly are essentially even, with the traditional centre-right Republicans (not that inclined to help the President out) holding the balance of power. Over the past seven months, therefore, the National Assembly has systematically sought to tie Elisabeth Borne, the President’s latest choice to be his Prime Minister, in knots and emergency powers had to be used to enact the national budget.

This battle will be the cause of considerable instability in 2023. The distribution of seats within the National Assembly means that majorities have to be found on an ad hoc basis (if they can occur at all) on each individual item of legislation. The Assembly (or sizeable factions of it) will continue to seek the Prime Minister’s proverbial head on a plate. There will be another bust-up on the budget.

In theory, the President has a means to end this paralysis. Once a year has elapsed since the last National Assembly elections, he has the right to dismiss that Assembly and call fresh elections. The difficulty for the President is that his own approval rating remains stubbornly below 40% and there is no evidence from the polls that his backers would win a majority if a new round of elections is called.

Indeed, there is the serious danger that if the President went for a mandate through the National Assembly his gambit could backfire spectacularly. His team could be depleted heavily, and he would have no choice but to pick a Prime Minister of whom a majority in the National Assembly approved, even if that individual were not remotely of his choosing. He would render himself for his remaining time in office suffering from the same constraint of cohabitation that both Francois Mitterrand and Jacques Chirac also had to put up with during parts of their presidency. In which case, the President would be compelled to withdraw from domestic politics to a substantial extent. That prospect may prompt M. Macron to decide that he would rather live with his current uncertainty than roll the dice.

Italy

In one sense, Italy should be the least likely centre of uncertainty in 2023 in that it only held its last elections in October 2022, and it returned a political alliance with a robust majority in the Chamber of Deputies (237 out of 400 seats) and the Senate (115 seats out of 200 seats) which seems stable.

Yet this could well be illusory. The winning right-of-centre group is composed of three main blocs. The largest is Brothers of Italy, a movement with historical links to Mussolini, which shot from 4% of the overall vote in 2018 to 26% in 2022, an astonishing rise in share. Hence its leader in the form of Giorgia Meloni (Brothers of Italy, paradoxically, has a woman at its helm) has been sworn in as Prime Minister. Her allies are the League (led by Matteo Salvini) and Forza Italia (which remains under the personal sway of Silvio Berlusconi). The opposition is headed by the centre-left Democratic Party.

The EU institutionally and many individual member states were absolutely horrified at this result as Brothers of Italy are not that apologetic about their background as a political party. There are some who think that Italy should be treated as a semi-pariah within the EU (as Hungary sort of is) but Italy is a much more important actor within the EU than Hungary so to side-line it would be far harder.

The working assumption of many in Brussels, Berlin and Paris is that Italy will revert to its instability and uncertainty of old and that to ostracise the Prime Minister and her administration would be an error. The thinking is that either the realities of office will force the incumbent coalition to moderate its outlook, or that one of the League or Forza Italia (possibly both) will undermine the government in an attempt to reassert themselves as the most significant party on the right when a chance comes or that the entire administration will just implode (plenty of examples of that in post-1945 Italy) and then the government will disappear completely and be replaced (once again) by career technocrats.

This assessment could well be accurate, but it has an ironic quality to it. The European (and probably the Italian) establishment is in this instance actively in favour of uncertainty and would prefer that to the certainty and stability which would come from a government which holds a legislative majority then implementing the agenda on which it was elected. Recent constitutional reforms in Italy may also mean that it is turns out to be harder to eject a Cabinet in mid-term that it has been in the past.

So, if the Prime Minister can outwit any effort by the Salvini-Berlusconi axis to contain her politically and can overcome the expectation that she will not last in office through 2023 and continue beyond that point then Rome may be a lasting headache for others. That will be even more true if elections held in 2023 in the two remaining major EU states – Spain and Poland – come out in a certain way.

Spain

The PSOE-Podemos led coalition administration has somewhat miraculously survived since 2019 despite very tight parliamentary numbers, the angst within Podemos about being in office at all and the bitter divisions over Catalonia that are a deep scar on Spanish politics. It looks as if the alliance will hold until elections have to be held at the end of this year, during which Spain as a country and Pedro Sanchez as Prime Minister will have a high profile holding the rotating presidency of the EU.

The prospect of that December election will overshadow everything else as the Government seeks to find means of boosting its standing predominantly through popular spending initiatives while the opposition PP moves in a more nationalist and populist direction to fire up its potential supporters.

The opinion polls have not been completely consistent in Spain and their record at predicting the final result is less than stellar. The balance of them, however, alongside regional election outcomes, suggests that the most likely administration to emerge is one which is headed by the PP (historically the main force on the centre-right) but which it is probable would require the overt or covert co-operation of Vox, a much more recent and considerably more right-wing entity, to obtain office. A formal coalition between the two may be unavoidable, a prospect that many in the EU will not like.

Poland

Poland also has to conduct parliamentary elections during 2023. The United Right bloc of which the Law and Justice Party is by some distance the most sizeable component has held power since 2015. Its attempts to exercise more influence over the judiciary has led to a disagreement with the EU with some in Brussels openly accusing the Polish Government of degrading the standing of its democracy. That the main political party within the opposition – Civic Coalition – is led by Donald Tusk, a former President of the European Commission, had added an extra dimension to this political dispute. That the Law and Justice Party is assertively socially conservative has aggrieved outsiders elsewhere too.

Neither the Polish Prime Minister Mateusz Morawiecki nor the administration that he leads is as popular as they once were, although there is broad national support for the very active support that Warsaw has offered to Ukraine after the Russian invasion of that country last February. It would be a surprise if the United Right coalition were to win another outright majority. It will face a competition from not only Civic Coalition but The Left and a completely novel entrant to politics, Poland 2050.

Despite this, the United Right could retain office through an agreement with the Polish Coalition (a more orthodox conservative movement) and, of necessity, Confederation, which is a far-right party which arguably outflanks any of those which have come to prominence elsewhere within the EU. If this comes to pass, then the stage will be set for more heat between Poland and EU institutions.

Uncertainty is a particular predictable for the major countries of the EU in 2023

Conclusion

It is very likely indeed that politics will be more polarised and look more uncertain in the EU in 2023. There will be many headlines which many international investors will find somewhat disturbing. The impression may well be of a continent in which what were once fringe parties seem to be advancing.

That perception has a degree of legitimacy, but it may mean far less for economics than social policy. The impact on the conduct of business, economic growth and profits in Europe could be negligible.

Consider all of the most disruptive scenarios in the five most significant nations within the EU. If the FDP were to withdraw from the German Cabinet, then that would remove a notable pro-business voice from it. The remaining SPD-Green administration would not, however, have a majority to push through measures which business would find harmful even if it had the ambition to do so. Stalemate would probably be resolved by early elections in which the CDU/CSU would be the favourites to be the largest political party in the Bundestag. President Macron has been an ally to many in the French business community and will continue to be so until he is obliged to retire in 2027. The absence of a majority in the National Assembly is a considerable inconvenience for him but it is equally the case that there is no majority for an anti-business agenda either. Matters would only become toxic in this regard if the President were to call fresh National Assembly elections which NUPES won outright. It is highly unlikely that the President will fall into this trap and will instead work around his enemies.

The new Italian administration is undoubtedly controversial on many fronts but can hardly be called anti-capitalist or insensitive to business interests. How long it will last anyway, being Italy, is unsure. A shift from PSOE/Podemos to PP/Vox in Madrid may have combustible elements to it but it would be welcomed by substantial sections of the business sector in Spain. If Poland were to witness the Law and Justice Party ally with Confederation (be it formally or informally) then that will cause some serious contention in its dealings with the EU, but the vast majority of its member states do not want to initiate a political conflict with Warsaw at a time when there is a military one right on its borders.

Economics, in short, will be calmer than politics in Europe in 2023

The short-term performance of the EU economy overall, and the extent to which a recession can either be avoided or limited, will depend rather more on the interest rate decisions made by the ECB, the Euro-Dollar exchange rate and whether the spectacular success of many countries in diversifying away from Russian gas can be maintained. Investors in, and practitioners of, private equity, and those in business generally, would be best advised to focus on these factors and not on what will be polarised politics which offers the appearance of uncertainty and upheaval but with far less impact on economic stability than it seems.