Italy on collision course with EU over budget deficit

Italian Minister of Economy and Financee Giovanni Tria attends during the conference XXX Villa Mondragone International Economic Seminar at Monte Porzio Catone, Italy, 25 June 2018. [Claudio Peri/EPA/EFE]

Party leaders in the Italian coalition government signalled they will seek leeway from the EU to increase next year’s budget deficit, heading on a collision course with the European Commission and investors who want it cut.

Following Fitch agency’s decision to lower the outlook on Italy’s debt rating on Friday (31 August), neither Matteo Salvini nor Luigi Di Maio – the heads of the League and 5-Star Movement respectively – backed away from promises to reduce taxes and boost welfare spending.

Italy sends mixed signals to jittery markets after debt downgrade

Italy’s new anti-establishment government sent contradictory signals to financial markets on Sunday (2 September) amid increasing concern Rome could breach EU spending limits as it comes under pressure to fulfil its anti-austerity electoral promises.

Salvini said on Monday (3 September) he wanted to increase spending, but not exceed the European Union’s deficit limit of 3% of gross domestic product. The previous day Di Maio stuck to 5-Star’s promise made during this year’s election campaign to introduce a universal income for the poor.

“We can’t think about listening to the ratings agencies and reassuring the markets, and then stab Italians in the back,” Di Maio said. “We’ll always choose Italians first.”.

Merely sticking to the EU’s upper deficit limit is unlikely to satisfy either Brussels or investors, who want Italy to reduce its huge debts rather than add to them. Italy’s debt currently stands at a whopping 132% of output.

Last year, the Commission gave the previous government spending leeway before the national election. But for 2019 the Commission expects Italy to lower its structural deficit, which is adjusted for the economic cycle and one-off measures, by 0.6 of a percentage point.

Moscovici: Italy, Portugal, Spain fiscal progress 'good news'

Portugal, Italy and Spain became yesterday (22 May) illustrative examples of the new period Europe enjoys. The executive congratulated Lisbon and Madrid for turning their economies upside down, just one year after they became the first countries that breached the fiscal rules, while it gave its blessing to Rome’s adjustments, one of the eurozone’s troublemakers.

Italy must disclose its economic growth and budget targets for next year by 27 September.

Economy Minister Giovanni Tria, an academic and not a member of either of the governing parties, has taken a more moderate line than the party leaders. He’s pushing to keep next year’s deficit below 2% of GDP, sources familiar with the government budget talks said on Monday.

Italy’s populist government took office in June after promising it would go on a spending spree to lift economic growth and create jobs. That has put the country’s debt, the third-biggest debt in the world, in the market spotlight.

Since mid-May, when the coalition published its programme, the gap between Italian benchmark 10-year bonds and the safer German equivalent has more than doubled to 286 basis points on Monday.

“It’s in Italy’s interest to control public debt,” Economic and Monetary Affairs Commissioner, Pierre Moscovici, said last week.

The previous government targeted a budget deficit of 1.6% of GDP in 2018 and 0.8% in 2019. But Tria said last month that next year’s deficit, without introducing any new measures, would be around 1.2% of GDP.

Over the weekend, after the Fitch move to cut its rating outlook, Tria promised to respect EU commitments and said bond yields would settle after the government provided its budget intentions over the next two months.

On top of the universal income, the coalition has said it wants to slash taxes, partly roll back a 2011 pension reform, head off an automatic VAT rise next year, and increase investments in public works.

But recent data have indicated that Italy’s economy, the eurozone’s third biggest, is slowing this year, further reducing the government’s room to manoeuvre.

Growth in Italian manufacturing slowed in August to the lowest rate in two years, a survey showed on Monday.

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