(Bloomberg Opinion) -- There’s one worrying aspect about the decision by Brussels to trigger a disciplinary process against Italy – and, no, it’s not the prospect of financial sanctions. It’s that the European Commission report, which states that Italy hasn’t made enough progress in cutting its debt, lands at a time of utter political chaos in Rome.
The ruling League and Five Star parties cannot make up their mind on whether their coalition government should survive, let alone what economic policy it should pursue. Prime minister Giuseppe Conte and the technocrat finance minister Giovanni Tria appear completely powerless. The country’s populist leaders must decide what they want to do – and quickly – before the situation drifts out of control.
The surprising thing about the Commission’s report is that it didn’t come sooner. At the end of last year, Brussels chose to climb down from the previous standoff with Italy, after Rome made some last-minute concessions over its deficit targets. Those new deficit and debt objectives were always difficult to believe, since they were based on wildly optimistic growth forecasts and a privatization plan that’s devoid of substance. Still, Brussels gave Italy the benefit of the doubt and decided it was best to avoid a clash ahead of elections to the European Parliament.
It’s now impossible for the Commission to avert its gaze. Italy’s ratio of debt to gross domestic product continued to climb last year, data have shown. While it’s true that growth slowed across the EU, Italy’s recession was at least partly self-inflicted. The coalition program included lavish spending measures, which sparked a steep rise in bond yields.
Moreover, there’s no sign that Italy is serious about shrinking its debt in the future. The government says it wants to find more than 20 billion euros ($22.5 billion) of savings next year – or else raise VAT – but the politicians have vowed repeatedly that taxes will not increase. It’s telling that Tria’s ministry couldn’t specify any area where it intends to cut public spending in its response to the Commission, no doubt because the coalition’s leaders wouldn’t allow it. If the EU’s fiscal rules have any credibility left, a disciplinary process was unavoidable.
A stronger government would do one of two things. The first option would be to take a conciliatory approach and find common ground with the Commission. The disciplinary process is still at an early stage, and the EU’s finance ministers would be able to say whether they agreed with any new Italian proposal by next month. Without this, Italy risks a financial sanction of up to 0.2% of GDP (about 3.5 billion euros), an unprecedented punishment. In the more emollient scenario, Tria would be given a political mandate to identify clear areas of savings for next year, giving comfort to investors too.
The alternative would be to adopt a confrontational stance and ignore the Commission. The League and Five Star may feel they have a mandate from voters to bust the EU’s fiscal rules and pass strongly expansionary measures, including tax cuts. Of course, this would carry a steep political and economic cost, going beyond a financial sanction. Investors would almost certainly demand higher risk premiums on Italian debt, pushing the country’s borrowing costs even higher. Italy would also be isolated within the EU at a time when key positions at the Commission and the European Central Bank are being handed out.
The problem is that the current government isn’t in a coherent enough position to decide on either course. The European election results raised profound questions about the coalition’s viability. Matteo Salvini’s League, which is nominally the junior partner, doubled its share of the vote to more than 34 percent. Meanwhile, Luigi Di Maio’s Five Star finished in a humiliating third place. The two partners are bickering constantly, as Salvini tries to extract as many concessions as he can from Di Maio. On Monday, the non-aligned Conte – who’s meant to balance the two sides – said he’d be willing to resign unless the allies papered over their differences.
Unfortunately, the League and Five Star may feel it’s still in their interests to continue as things are. Salvini will wonder whether he can repeat his excellent European result in a national election. Di Maio will fear being replaced ahead of a new vote, and many Five Star lawmakers would also lose their seats. But weak government is the last thing Italy needs right now. The country has to decide what to do about the disciplinary process and, most important, what to include in the 2020 budget, due at the end of the year. Bond yields remain dangerously high and could rise further given the political and economic backdrop.
Salvini and Di Maio have vowed repeatedly that their government would last for four more years. But if they can’t work together any longer, it would be best to hold a general election. That way, they would have to tell Italians what their economic plans really are. More duplicity and ambiguity serves no one.
To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net
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Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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