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05/12/2016

Italy and Commission on collision course over budget

Euro & Finance

Italy and Commission on collision course over budget

Barroso and Renzi. 4 July, Rome. [Daniela Vincenti]

Italy and the European Commission are on a collision course over Rome’s 2015 budget plan, which Brussels says flouts EU recommendations but Rome says it has no intention of changing, ahead of today’s (15 October) deadline.

Italian Prime Minister Matteo Renzi, faced with a recession-bound economy, has set out an expansionary 2015 budget framework which funds tax cuts with new borrowing and targets only a marginal reduction in the budget deficit.

The Commission says Italy must cut the deficit more in order to rein in a public debt of more than 130% of gross domestic product, the highest in the eurozone after Greece. Renzi says the debt has risen because of persistent recession which is only exacerbated by fiscal tightening.

The Italian government is forecasting economic output to fall 0.3% this year, the third consecutive year of contraction, before rising by a meagre 0.6% in 2015.

The dispute revolves around the so-called “structural” budget deficit – adjusted for the business cycle and one-off factors – which Italy is proposing to reduce by just 0.1% of GDP. The Commission wants a much bigger cut of “at least 0.7%,” an EU source told Reuters on Tuesday.

Weeks of skirmishing have left the two sides far apart, just a day before the Italian cabinet has to sign off on the budget and send it to Brussels.

The big shortfall in what Italy is proposing constitutes “a serious violation” of Commission recommendations, the EU source said, and could mean the budget is rejected and Rome is put on the Commission’s blacklist of countries out of line with EU fiscal rules.

Italian Economy Minister Pier Carlo Padoan confirmed the budget would correct the structural deficit by just 0.1%.

39 year-old Renzi is pushing for the EU to relax its rules to allow extra spending to help revive faltering growth in the region. He points out that Italy’s headline deficit is inside the EU’s ceiling of 3% of GDP, even though he views the limit as “anachronistic.”

If Italy confirms its budget blueprint as it stands on Wednesday then Renzi, the Commission, and eurozone governments are likely to enter into prolonged negotiations before the Commission delivers its final verdict later this year.

The Commission will also examine the budget of France, which has reneged on previous promises to cut its deficit and is considered in a weaker position than Italy because its fiscal shortfall already exceeds the 3% ceiling.

Italy’s economy, the most chronically sluggish in the eurozone, has been slipping in and out of recession for the last six years, during which the country has consistently failed to meet its growth and public finances targets.

Tax cuts

The EU source said Italy’s position was weakened by the fact that its cut to the structural deficit this year had also fallen short of the Commission’s recommendation.

Far from toughening the budget, Renzi this week announced an extra €6.5 billion of tax cuts for companies which, on top of an extension of income tax cuts for low earners would be “the biggest tax reduction ever attempted” in Italy.

His announcement of €11.5 billion of extra borrowing ran counter to previous pledges that tax cuts would be funded entirely by lower spending and the details of the budget are still foggy just a day ahead of its presentation.

Renzi recently discarded a series of proposals on spending cuts from the Spending Review Commissioner Carlo Cottarelli, who later announced his resignation.

He said last month the budget would cut spending by €20 billion, but lowered that to €16 billion in a speech on Monday. Reports in Italian media yesterday said spending cuts would amount to no more than €13 billion. 

Background

The European Union has set up a yearly cycle of economic policy coordination called the European Semester. Each year, the Commission undertakes a detailed analysis of EU member states' plans of budgetary, macroeconomic and structural reforms and provides them with recommendations for the next 12-18 months.

In October, member states submit their draft budgetary plans for the following year. The Commission issues an opinion on each of them in November. In particular, the Commission assesses whether the draft budgetary plans comply with the requirements under the Stability and Growth Pact.

Similarly, the Commission examines the economic partnership programmes submitted in October by those members subject to an Excessive Deficit Procedure.

The Spring meeting of the European Council in March takes stock of the overall macroeconomic situation and progress towards the Europe 2020 targets and provides policy orientations covering fiscal, macroeconomic and structural reforms.

Also in March, the Commission publishes in-depth reviews for the member states identified in the Alert Mechanism Report. These in-depth reviews can conclude that: (i) the country is not experiencing imbalances in the sense of the Macroeconomic Imbalance Procedure; or (ii) the country is experiencing imbalances, which are, however, not excessive; or (iii) the country is experiencing excessive imbalances.

In April, member states present their plans for sound public finances (stability or convergence programmes) and their reforms and measures to make progress towards smart, sustainable and inclusive growth in areas such as employment, education, research, innovation, energy or social inclusion (national reform programmes).

In May-June, the Commission assesses these programmes and proposes country-specific recommendations as appropriate.

Finally, end of June or in early July, the Council formally adopts the country-specific recommendations. [more]