The EU Commission and Italy continue to butt heads over Italy’s budget proposal, but economic uncertainty, along with recent events in France, have complicated matters.
The row originally had nothing to do with France; it started when the EU rejected Italy’s proposed budget, back in late October, due to concerns that the budget broke EU rules on public spending, and violated commitments it had made to the European Union. Since then, the EU and Italy have been at loggerheads, and concerns remain that another fiscal crisis could threaten the stability of the euro.
However, Italy’s budget remains popular within Italy, it fulfils campaign promises, like broad unemployment benefits, tax cuts, and more generous pension benefits. Despite the current tension, Italians continue to support remaining in the EU, while Italy’s government still seems willing to reach a consensus.
Simon French, chief economist at Panmure Gordon & Co, said, “What you need to see to break this impasse, is the Italian government saying, ‘Look, we want to be more expansionary on the fiscal side, but we’re also going to do a lot more on the structural reform side, to raise the trend rate of growth in Italy,’ because ultimately that’s what all sides of the discussion want to see.”
The bottom line is that Italy wants it all. They want to avoid a showdown with the EU and please the Italian populace, whilst keeping campaign promises to raise welfare benefits and pensions, on top of slashing taxes. On the other hand, the EU is keen to avoid a fight, as current tensions have caused market unrest, spooked bond investors, and pushed the Italian economy to the brink of a recession.
A recession would be particularly bad news for Italy’s government and the country’s economic recovery, as well as for Europe. It would be their first recession in five years. The economy shrank unexpectedly in September – more than a month before the current budgetary woes – and the weakness seems to be persisting. According to the IHS Markit and the Purchasing Managers Index survey, manufacturing contracted in November at its fastest pace in the past four years, and companies have seen export demands continuously fall for the last five months. Italy’s GDP fell by an annualised 0.5% in the third quarter, mostly due to the combination of a steep drop in business investment with hesitant spending on the part of consumers. Bond markets also took a hit, as did Italian banks.
All of this is a blow to the populist right-wing coalition currently ruling Italy, which promised economic growth as a result of their expansionary budget. However, it is precisely this fear that may have prompted the government’s willingness to cooperate with the EU, and lower its deficit target for 2019. “I have no interest in a clash with Europe. It’s in nobody’s interest. We will find an agreement in the end. We are working on it with alacrity,” the League’s leader and Vice-Premier, Matteo Salvini said.
However, this puts the government in an impossible position: they can’t back down from their campaign promises, even though those promises cost too much. Adhering to EU guidelines means they won’t have the money to pass their tax cuts, reduce the retirement age, and increase welfare payouts. Regarding the EU budget demands, “I can’t see that happening without affecting the implementation of the key plans of the budget,” said Francesco Daveri, an economics professor at Milan’s Bocconi University. “That would mean losing face with their voters.”
“Those measures are still in the budget,” Di Maio told reporters. “We will bring home the budget measures, avoiding the disciplinary proceedings and keeping the promises.”
Despite all of this, earlier this month, Italy seemed ready to finally make big budget cuts, in order to reconcile with the EU, and the EU appeared willing to compromise on Italian needs. “We didn’t discuss numbers but we’re working on a solution — which is both in Italy’s and the EU’s interest — to avoid the excessive deficit procedure (…) we’re in the same boat,” Prime Minister Giuseppe Conte said on the sidelines of his meeting with European Commission President Jean-Claude Juncker, and Economic Affairs Commissioner Pierre Moscovici, at the G20 in Buenos Aires.
That is because the European Commission gave the Italian government just enough leeway, so long as the GDP-to-deficit-ratio does not go over 1.95 per cent– a higher ceiling than Italy’s previous agreement of keeping the deficit of 1.8 per cent. However, Salvini and Di Maio are refusing to cut the deficit to below 2.2 per cent, according to the newspaper La Stampa. Still, there is noticeable movement from both Rome and Brussels on this, and it’s likely a final agreement for a 2 per cent deficit is within reach.
The unrest in France may also be pushing the EU to ease up on Italy. President Macron sought to institute a new tax on fuel, which resulted in widespread riots by citizens wearing yellow jackets – or giles jaunes. As a result, Macron apologised, scrapped the tax, and offered a new wage hike, among other concessions. Resulting in costs to the French government of 10 billion euros and an increase in France’s budget above 3% of GDP – larger than Italy’s projected 2.4%. Unrest in France may serve as a warning to the EU about risks of ignoring the needs of citizens for the sake of austerity, despite fiscal imbalances.
“It may be claimed that President Macron is engaged in much-needed structural reform, and Brussels should cut him some slack, but if there’s acknowledgment that the current environment requires some fiscal accommodation, it can’t hurt relationships between Rome and Brussels,” said Kit Juckes, global macro strategist at Société Générale, in a note.
“Macron’s spending will encourage Salvini and Di Maio,” said Giovanni Orsina, head of the School of Government at Rome’s Luiss-Guido Carli University. “Macron was supposed to be the spearhead of pro-European forces, if he himself is forced to challenge EU rules, Salvini and Di Maio will jump on that to push their contention that those rules are wrong.” Indeed, Italian ministers have already pointed at France, promising that their budget would prevent similar unrest back home.
“There are several million forgotten Italians we are taking care of, so that what has been happening in France doesn’t happen in Italy,” said Interior Minister Salvini, who is also the leader of the right-wing League party..
Still, France is not Italy. Italy’s economy is seen as more fragile and risky than France’s, and requires greater funding to address its debt. Moreover, France’s economic reforms were those designed to boost long-term growth, but Italy’s current budget has modifications that are meant to address public desires, rather than fiscal health. This will likely result in the EU avoiding a crackdown on the French.
Italian Prime Minister Giuseppe Conte is due to meet with commission head Jean-Claude Juncker in Brussels, for another series of budget talks, followed by a summit of European leaders. Both Prime Minister Conte and Finance Minister Giovanni Tria have been pushing for a deficit target of 2%, and are eager to keep Italy and the EU on the same page. Conte has expressed that he is hopeful talks will bring about an agreement.
This means that the Prime Minister’s next biggest challenge is keeping both The League and the 5 Star Movement on board with the budgetary cuts, while honouring enough of the campaign promises to keep both the parties and the people happy – a precarious balancing act. A member of the Italian Treasury noted that “We’ll eventually avoid the disciplinary procedure, but the government must take things one step at a time, without handing Brussels too many concessions, or they will look weak in the eyes of voters.”