Italy’s populist government appears determined to drive EU economy and markets into recession

Visit of Jean-Claude Juncker, President of the EC, to Austria
Date: 04/10/2018 Location: Austria,Vienna
© European Union , 2018. Source: EC – Audiovisual Service

The Italian budget plan has recently created turbulences and serious concerns in the EU economy as the third largest economy of the bloc cuts growth forecasts and increases spending.

The European Commission together with the International Monetary Fund (IMF) have urged the Italian government to restate its budget and comply with the EU fiscal rules of the Stability and Growth Pact. The latter agreement implies that all EU member states have to follow a fiscal policy to stay within the limits on government GDP deficit of 3% and debt to GDP ratio of 60%. In the case where a debt level above 60% is occurred, the member state has to decline it each year with a satisfactory pace towards one level below.

The financial markets reaction was swift upon the decision of the Italian government to increase its deficit to 2,4% next year. The Italian government bonds continue falling which raises the cost of borrowing while the Italian banking index has dropped sharply.

The Italian finance minister Giovanni Tria has been trying to calm the situation but his actions and words do not seem to ease the markets’ turmoil and investors’ fears.

Italian economic targets

The new populist government of Italy lowered its growth forecasts to 1,2% in the current year compared to its 1,5% previous estimate. Regarding the subsequent years, growth rates are foreseen to be 1,5% in 2019, 1,6% in 2020 and 1,4% in 2021. The above figures are mainly driven by Italy’s goals to reduce the tax burden on small and medium-sized enterprises and self-employed workers.

Italy has also confirmed a deficit of 2,4% of the gross domestic product (GDP) in 2019 while aims to reduce it by 0,3% both in 2020 and 2021. Another Rome’s economic target is its debt-to-GDP ratio which is set to be 130% in 2018, 130% in 2019, 128,1% in 2020 and 126,7% in 2021. The aforementioned figures create serious concerns as Italy continues having the second largest debt in Europe without showing signs of decrease.

EC rejects Italy’s budget

Italy’s decision to increase its debt and further deviate from the application of the Stability and Growth Pact has caused the reaction of the European Commission. EU Commissioners Valdis Dombrovskis and Pierre Moscovici wrote in a letter to Italian Finance Minister Giovanni Tria that: “Italy’s revised budgetary targets appear prima facie to point to a significant deviation from the fiscal path. This is therefore a source of serious concern”. Moreover, the president of the EC said last week that Italy has to find a way to change its budget and comply with the EU fiscal policies.

More specifically, Jean-Claude Juncker mentioned in the interview with the dailies Der Standard and Kurier and the weekly Falter: “The commission has to look out for the observation of the rules, and in the case of Italy we have introduced lines of flexibility in the application of the Stability and Growth Pact. Italy was allowed to make expenses that it wouldn’t have been allowed to make had we applied the pact in a strict but not intelligent manner. When it comes to how we treated Italy, I don’t have a bad conscience. It’s up to the Italian policy makers to find rules and measures that make it possible that Italy doesn’t deviate from the agreed budget goals.” It is quite clear that the EC will be very strict in case Italy does not manage to reduce its debt level to a satisfactory level and possibly initiate the “Excessive Deficit Procedure” (EDP) which was avoided during the last years.

However, the response by the Italian government was harsh. Matteo Salvini, Deputy Prime Minister of Italy and Minister of the Interior, said the following: “The EU has approved economic measures that impoverished Italy and made it precarious. I don’t get up in the morning thinking about people like Juncker and Moscovici — who have ruined Europe and Italy”. In a less intense statement, Giovanni Tria attempted to ease the relations between the EU and Italy by saying that the promise of growth rate increase was made in order to vanish the gap with the rest of the EU.

All in all, the EU officials are well aware of the fact that Italy’s large amount of debt (€2.3 trillion) and bad loans (€173 billion) are enough to cause tremendous shocks to the whole region and that is the reason the EC attempts to persuade Rome to change its economic policy; something which seems to be very difficult with the current government.

The fight between Italy and the EU has just begun and will start intensifying next week when the Italian government will send its budget to the EC.