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Pressure Builds – and Sanctions Loom – as Impasse Over the Italian Budget Continues

Italy and the European Commission are at loggerheads over the Italian budget. While Italy seeks to avoid unprecedented fines - as it heeds electoral anti-austerity commitments - Europe is adamant about keeping Italy in line with budgetary goals. To the surprise of many, some of the Italian proposals have found the unlikely support of Germany Finance Minister, Olaf Schulz.

Worried about the possible effects of overspending, the European Commission demanded Italy trim its high-spending budget plan or else face possible fines; only for Italy – the third-largest government in the Eurozone – to reject the Commission’s terms. Last Tuesday was the deadline for the populist government to respond to the Commission, but that deadline has come and gone. Italian Finance Minister, Giovanni Tria, insisted nonetheless, that Italy would keep to a deficit target of 2.4 per cent, and a growth forecast of 1.5 per cent.

The current Italian budget plan is very popular with the Italian people. Italian discontent over globalization closing local factories, exasperation at endemic corruption, and migrants competing for badly paid jobs, pushed far-right parties to a surprise win during the most recent election. Luigi Di Maio’s Five Star Movement blamed Italian economic woes on the EU, and Salvini’s Northern League reproached the EU for “abandoning” Italy to face the migrant crisis alone. Mr. Salvini, who leads the League party, was quoted as telling Rai radio that the Commission had “got it wrong if they are even just thinking of imposing fines on the Italian people”. As for Di Maio, he defied critics by stating “we are convinced that this is the budget that will restart the country.”

As a result of this exchange, Milan’s stock exchange fell by 1 per cent before partially recovering, and Italian government bonds rose to a three-week high, amid fears that borrowing costs would soon rise. Analysts are still unsure how the markets will react to the continued impasse, but continued pressure from the EU, additional market downgrades, and higher risk spreads, may force Italy to concede to some EU demands. A worst-case scenario would be an economic tailspin, in which investors would sell off Italian bonds at a greater pace, amid fears of a possible default. In this scenario, the bonds would lose value, and Italy’s interest rates would rise. Italy would then have to pay more to service its debts, which would in turn spook banks across Europe. Banks would subsequently reduce their lending, and economic growth would stagnate.

Should this occur, and Italy’s debt become unsustainable, it is unclear whether the EU would wish to bail out a defiant bloc member.  Based on previous EU economic adjustment programmes implemented in Ireland, Portugal, Cyprus and Greece – this would likely cause Italy to return to austerity measures. Austerity would mean Italy accepting the very financial reforms the country is currently trying to buck.

The Italian government, in the meantime, is trying to avoid having to be subjected to the European Commission’s Excessive Deficit Procedure (EDP) over next year’s spending assessment. This would grant the EU Commission the power to demand that Italy provide guarantees that, according to Di Maio, would be equal to “sacrificing Italian lives”. Since missing the deadline, it is likely that the European Commissioner for Financial and Economic Affairs, Pierre Moscovici, will soon announce that Italy is entering the EDP procedure. The Commission has until December 4th to decide what the disciplinary action will entail, and whether any will be levelled at all.

Italy’s previous government kept a deficit target of 0.8 per cent, but Italy’s new coalition government came to power vowing to “end poverty”. Proposed measures include a minimum income for the unemployed, tax cuts, and scrapping the extension of the retirement age. These promises, on the other hand, mean that the government has tripled its deficit target. Finance Minister Tria, insisted that the deficit target of 2.4 per cent was an “impassable limit,” which would be covered by raising a value equivalent to 1 per cent of the GDP, through the sale of state assets to pay back debt.  He told reporters in Rome, that the bloc’s partners “are asking Italy for a budget built on blood and tears”, and that “it is unbelievable that they don’t understand our reality”.


Italian Minister of Economy and Finance Giovanni Tria during a Eurogroup meeting with the Ministers of Finance in the EU Headquarters. Copyright: Alexandros Michalidis / Shutterstock.com

In his letter to the Commission, Finance Minister Tria was upbeat about the country’s growth prospects, predicting that Italy’s debt would fall over the next three years, to reach 126 per cent of GDP in 2021. However, the Commission believes that these measures will have a much lower impact on the GDP than Italy expects, and reiterated warnings of the economic dangers that stem from surging bond yields for Italian lenders.

Nevertheless, Italy’s government is still willing to bargain with the EU, despite the deadline’s passing. “We are ready to make major cuts on wasteful spending,” Deputy Prime Minister Luigi Di Maio told the Italian daily Corriere della Sera in an interview. “We would also eventually be ready for safeguard clauses that would protect against deficit widening. But the big reforms of this budget law need to remain in place.”

The other Deputy Prime Minister, Matteo Salvini, warned that he would bring down the government if the coalition’s budget deficit target was changed – remarks made immediately before Prime Minister Giuseppe Conte was scheduled to attempt to convince the European Commission about the soundness of the Italian budget. Salvini is suspected of whipping up anti-EU fervour to boost his ratings in the polls, ahead of European elections. And indeed, Salvini’s popularity has risen due to his hard-line anti-EU stance, with his party climbing in the polls by 36.2 per cent. Still, it is still very likely that the government will continue to make conciliatory budget changes behind the scenes.

While the key budgetary points will remain intact, there are “one thousand ways” to improve it, stated a government official. In addition to the sale of private property, the government is considering raising several taxes to increase revenue and lower its debt – thereby avoiding EU fines. Prime Minister Conte, said during his meeting with the Commission, that he trusted continued dialogue could help prevent negative outcomes and sanctions against Italy. However, on Monday  – and following conversations in Brussels over the weekend, between Prime Minister Conte and European Commission President Jean-Claude Juncker – the Italian government’s tone toughened, with Conte stating that objectives for 2019 had already been fixed.

In response, the Commission has started taking steps to fine Italy because of Salvini’s defiance, with possible sanctions starting at 0.2 per cent of Italy’s GDP. “Being a member of the EU remains very popular amongst the Italian electorate – two-thirds still support ongoing membership. But what they’re uncomfortable with are the obligations that come with the privilege of being in the eurozone,” said Simon French, chief economist at Panmure Gordon & Co.

“The obligations are to be relatively austere in terms of their fiscal outlook and something that successive Italian governments have been fairly poor at doing. They’ve run an average deficit of 3 per cent of GDP over the last 20 years. So, to be asked to pare that back at this time towards 2%, at the same point as they’ve elected a coalition government who are wanting to be much more expansionary – comes with its democratic challenges, rather than its financial challenges.”

Italy has received some surprising support for its budget, from the German Finance Minister Olaf Schulz, who said he understands some of the reforms Italy wants to put in place, especially programs that support the unemployed. Speaking at the Wirtschaftsgipfel Economic Summit in Berlin, Scholz said a complete lack of support for the long-term unemployed in Italy was “a bit astonishing” and a change of policy in that direction could be considered. “If they, the Italian government, is working on questions like this, we can understand this,” said Scholz. However, he still urged caution.

French agrees: “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.”

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B. Lana Guggenheim

Lana is a freelance journalist based in New York City. She has a M.Sc. in International Conflict from the London School of Economics and Political Science. She has worked as an analyst, reporter, and editor, covering extremism, culture, economics, and democracy.

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