Italy and Spain: A tale of two deficits

While Italy has opted for a confrontational approach to clinch budget spending leeway from the European Commission, Spain is hoping that better-than-expected growth will placate EU demands.

The European Commission is resisting renewed efforts by Rome and Madrid to bend its fiscal rules, despite Spain’s unexpected growth in 2016 and Italy’s additional costs brought on by the refugee crisis and successive earthquakes.

Italy and Spain, the third and fourth-largest economies in the eurozone respectively, remain test cases for the EU’s credibility when it comes to the enforcement of its Stability and Growth Pact, the rules that limit deficit and debt figures for member states.

In recent months, France, Italy, Spain and Portugal have benefited from a more liberal interpretation of fiscal rules.

A gradual but still timid economic recovery and the spread of populism in Europe did not favour a return to the austerity stance championed by Brussels and Berlin until 2012.

“It should no longer be said that this Commission continues the austerity measures applied in the past,” European Commission President Jean-Claude Juncker said on 7 November.

But Juncker lost his patience with those leaders who kept demanding further flexibility on budget rules, especially with the Italian Prime Minister, Matteo Renzi.

“Italy continues to attack the Commission wrongly and it does not produce the desired results,” Juncker added.

If Renzi wants to continue bashing the Commission, “in fact, I don’t give a damn,” he said in an unusual outburst.

Juncker went further, estimating for the first time the additional costs of the earthquakes and the arrival of 300,000 refugees over the last year.

He said the extra spending equals 0.1% of GDP. But Renzi submitted a draft budgetary plan for 2017 with six billion euros extra (0.5% of GDP) compared to the 1.8% of GDP deficit target agreed with the EU institutions for next year.

The president’s assessment arrived at a very sensitive moment, as the Commission is still examining the draft budgetary plans sent by EU capitals. The verdict is expected to come on 16 November.

The Commission added fuel to the fire on Tuesday (8 November) when Juncker’s team removed the 0.1% figure from the transcript of a speech by the President of the EU executive.

However, the Commission can hardly respond to Renzi’s initiative at this time.

Italy will hold a referendum on constitutional reforms on 4 December. An overly strict application of EU fiscal rules could have a negative impact on the referendum vote by inspiring Eurosceptic voters to reject them.

In growth we trust

Spain is also struggling to fulfill the recommendations to cut deficits below the mandatory 3% of GDP by 2018.

The country was told to make a “structural effort” of 0.5% of GDP, namely an adjustment of around €5 billion in the budget for next year, in order to reach a nominal deficit of 3.1% of GDP in 2017.

But the minority government led by the Partido Popular’s Mariano Rajoy needs to convince Ciudadanos, a liberal party, and the Socialists, to include these additional adjustments in the new draft budget that must be submitted to Brussels in the next few weeks.

Speaking after the Ecofin Council on Tuesday, Spanish Economic Affairs Minister, Luis de Guindos, confirmed that Madrid’s budget will include the structural effort of 0.5% of GDP.

“There is no bargaining of any kind, we have a very clear commitment,” he told reporters.

But while Guindos was busy trying to reassure the guardians of fiscal discipline in Brussels, his colleague Cristobal Montoro, Finance Minister, suggested in Madrid that the adjustment would be lower thanks to better than expected growth figures for this year and next.

On Wednesday (9 October), the Commission will publish its economic forecast for the  28 EU member states.

Even if the Spanish economy improved more than expected, Economic Affairs Commissioner Pierre Moscovici warned that the country “must respect” the 0.5% of GDP of structural effort.

But a senior Spanish official recalled that no country has been punished for breaching a structural deficit target if they met the nominal target.

In private, the official said Madrid was only aiming for the 3.1% deficit target, thanks to improved growth figures.

Spain, together with Portugal, still face a partial suspension of their EU funds if their governments do not take “effective action” to balance their budgets. The Commission’s verdict is expected on 16 November.

Speaking before MEPs on Tuesday afternoon, Guindos emphasised that Spain has implemented “the most impressive turnaround” in the EU when it comes to reaching budget deficit objectives.

Punishing the country “would be the opposite the eurozone and the EU as a whole needs”, the Spanish minister said.

Over the next few months, the European Commission will struggle to maintain its credibility as guardian of EU fiscal rules. But the time is not right for a battle that was lost from the beginning.