Promises, Promises: Italy's Populists Face Governing Reality

(Bloomberg) -- If you think the talks on the controversial program of the aspiring Italian government leaders were long and complicated, now comes the difficult part: implementation.

The hurdle for the League and Five Star Movement populist parties is the economy, with growth set to be the slowest in the euro area this year. To turn things around, they’ve promised a package that some estimate may cost as much as 100 billion euros ($117 billion) a year, but that would stretch the coffers of a nation with the currency zone’s biggest debt load.

Promises, Promises: Italy's Populists Face Governing Reality

Fitch Ratings, European partners and investors already have expressed concerns about the country’s ability to abide by its fiscal commitments while seeking to keep its election promises.

“The rules are the rules,” Lorenzo Codogno, Macro Advisors Ltd. founder and a former chief economist at the Italian Treasury, told Bloomberg Television. “You have a fiscal framework in Italy embedded into the constitution and you have the European framework -- so you have to respect what is in place right now, maybe change it in the future but not now.

The yield spread between Italian 10-year bonds and similarly dated German bunds widened 16 basis points to more than 192 basis points Wednesday, almost a one-year high though it’s much narrower than the 550 basis points seen in 2011 at the height of the European debt crisis.

Italian President Sergio Mattarella summoned law professor Giuseppe Conte, the two parties’ candidate for premier, to a meeting late Wednesday afternoon. La Repubblica newspaper said Mattarella would ask Conte to try to form a government. .

The odds seem stacked against the governmental program, which includes more state money for the poor, tax cuts for companies and individuals and a lower retirement age.

The European Union projects that Italy will have the slowest growth in the 19-nation euro area this year and next.

National debt is more than 130 percent of gross domestic product, the second-highest rate in the euro zone, a load that will be difficult to reduce with the proposed spending plan. Italian unemployment consistently hovers around 11 percent, far above the euro-area average of 8.5 percent.

Lurking in the future is the European Central Bank’s winding down of its quantitative-easing program, which has kept Italy’s debt financing costs in check.

In an interview published on May 20 with Corriere della Sera, the new head of Italy’s debt agency Davide Iacovoni played down those concerns by saying that the ECB’s reinvestments could still provide support for Italy’s bonds.

In addition to concerns about QE, the country needs to refinance debt maturing this year and next worth respectively 187 billion euros and 233 billion euros.

Promises, Promises: Italy's Populists Face Governing Reality

On a positive note, the country’s statistics institute Istat said Tuesday that it expects investment growth to contribute to an extended economic recovery in Italy. It sees a 4 percent increase this year, “driven by the persistently favorable financial credit conditions.”

Still, productivity growth -- forecast to be 0.6 percent in 2018 -- would be only half the pace seen in Germany and France.

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On Sunday, Five Star defended its plan, rejecting claims that spending measures would add up to 100 billion euros or that they are partly unfunded. It said that at least 40 billion euros will come from cutting tax breaks and 30 billion euros from spending adjustments.

The rest would come from allowing the deficit to widen, once there have been discussions with the European Union. But that would almost certainly prove contentious given the EU’s insistence on Italy living within its means.

The European Commission in Brussels on Wednesday urged Italy to stay on the path of fiscal responsibility, warning that high debt levels leave little room for economic experimentation.

There was a similar message from the ECB. Executive Board member Benoit Coeure, in an interview with Die Zeit, reminded the populist coalition that “Europe has clear fiscal rules, and they should be respected.”

No Coverage

“We know that there is no financial coverage for all of the promises and the wish list in the so-called government contract,” Nathalie Tocci, director of the Rome-based Istituto Affari Internazionali, said on Tuesday in an interview with Bloomberg Television’s Francine Lacqua.

The two parties’ government plan includes a new class of short-dated government notes that would be created specifically to pay Italy’s chronically late arrears to private companies. The idea gave rise to fears the notes would be a parallel currency and possibly lead to a euro exit, sending jitters across Europe’s markets.

The two populist parties have called for a review of EU treaties and said the European Commission should exclude some of the member states’ investments from deficit calculation.

“The bottom line is whether this particular government will have the strength and credibility to be able to renegotiate some of these rules,” Tocci said. “When it comes to this, my personal assessment is extremely negative.”

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