The most important date on Europe’s political calendar is only a few days away: Italy’s election on March 4, with a Eurosceptic party leading the polls. And after years of austerity and migration waves, European politics further splinters over another development.

This is the development of a resurgent Southern Europe. With €2.3 trillion in debt, or 135% of its GDP and 20% of the Eurozone’s total debt, Italy’s upcoming elections next month will be crucial to the Eurozone’s survival. Currently, the ECB’s expansive monetary policy keeps Italy’s debt sustainable while hurting frugal consumers in Northwestern Europe. However, for the first time in a decade, and after years of recession and fierce austerity, Portugal, Italy, Spain and Greece – previously dubbed the Eurozone’s ‘PIGS’ – now post accelerating growth. Paradoxically, a stronger Southern Europe could mean the internal cohesion in the Eurozone might deteriorate: although price, wage and income levels will converge across the Eurozone, Southern European member states might find themselves in a stronger bargaining position concerning the Eurozone’s financial future (i.e. less stringent budget rules and/or extending the ECB’s QE program). As a result, disagreement between Northwestern and Southern member states about the Eurozone’s financial future might increase in the medium-term. And since Italy is ‘too big to fail’ for the Eurozone, a victory by a Eurosceptic party would accelerate political rifts within the Eurozone.
Meanwhile, The Italian election will be on the same day as the announcement of the outcome of Germany’s Social Democrats (SPD) vote on whether to enter a new coalition with Angela Merkel’s conservatives. The prize of a renewed “grand coalition” comes at a cost. Merkel loses key ministries to her junior coalition partner. In turn, Merkel receives critique from her own party. For example, the position for finance minister, a key role for the future direction of the Eurozone, could be taken by the SPD mayor of Hamburg, Olaf Scholz, thereby succeeding the powerful Wolfgang Schäuble. Merkel’s weakened position comes at a time when Europe is in transition from a Germany-led model to a Europe with Germany leading Central and Northern Europe, France leading Southern Europe, and Poland leading Eastern Europe, as we wrote in our Macroscope.

The internal regional tensions are accompanied by a difficult expansion in the southeast. In February, Brussels presented its Western Balkans strategy. Following this plan, the EU will encourage reform in Serbia, Montenegro, Bosnia-Herzegovina, Kosovo, Macedonia and Albania, by renewing the prospect of membership. However, the Balkan states feel they have already been waiting for a long time, since the EU first promised membership in 2003. And for the reforms to be successful, the EU has to realize that the geopolitical situation has changed since then. Russia’s influence has grown. Turkey’s role in the region is different and the country is gaining influence among Muslim communities in the Balkans. China takes the stage as the biggest foreign investor in Serbia this year, as a high-speed railway between the Greek port of Piraeus and Budapest, via Belgrade, is part of the Belt and Road Initiative. Europe has to act more effectively in the Balkans in order to face these geopolitical changes. How the above described developments play out will be significant to the direction the EU takes in the following years. At the same time, Europe is confronted with new geopolitical realities.

RISK MARKED ON THE RISK RADAR AS NUMBER 2: Unrest and regime change in periphery of EU, policy uncertainty