The Italian national flag flies on top of the Quirinale Palace in Rome, Italy. (Photographer: Alessia Pierdomenico/Bloomberg)

Italian Populists Double Down on Spending Plans

(Bloomberg) -- Italy’s populists are insisting their plans to ramp up government spending will shield the nation from recession, brushing off warnings that their confrontational approach may already be hurting the economy.

Deputy Finance Minister Massimo Garavaglia made the case for more public investment after figures showed the economy stagnated for the first time in four years. Deputy Premier Matteo Salvini said the previous administration was to blame for bowing to European Union demands for fiscal frugality.

Italian Populists Double Down on Spending Plans

The Italian government has two weeks to send the EU a more moderate budget after its plans to run up a deficit of 2.4 percent next year were thrown out by officials in Brussels last week. The administration is trying to get the economy going again after years of under-performance, but its plan to cut taxes and increase benefits before lowering Italy’s massive public debts means they are testing investors’ risk tolerance.

In a statement late Tuesday, the Treasury said it received an Oct. 29 letter from the European Commission asking Italy to submit further details on its plan to reduce the country’s debt.

"Italy’s public debt remains a key vulnerability," according to the Commission. "Such high public debt constrains the government’s room of maneuver for more productive investment for the benefit of its citizens. Given the size of the Italian economy, it is a source of common concern for the euro area as a whole."

Italy confirmed it will reply to the Commission by the Nov. 13 deadline.

Leaders may attempt to make the case to the European Union that a slower rollout of its pension and “citizens income” plans as well as higher tax receipts will bring the effective deficit nearer to 2 percent for 2019, Il Sole 24 Ore reports without citing anyone.

The political uncertainty surrounding the government’s plans has already spooked financial markets. Italian bond values rose on Wednesday after falling the day before as data showed the economy unexpectedly stalled. The 10-year bond yield fell 3 basis points to 3.45 percent as of 8:48 a.m. Rome time, narrowing the spread over German equivalent bunds to 306 basis points.

The bond selloff that marked the new government’s first five months in power is starting to nudge up borrowing costs for households and companies, European Central Bank President Mario Draghi has warned. It may also have deterred some executives from investing.

“We do not rule out that along with ongoing weakening external demand conditions, preliminary signs of political instability that emerged during the summer may have affected households’ and firms’ spending decisions,” Fabio Fois, a senior European economist at Barclays Plc, wrote in a note.

Salvini offered a different interpretation.

‘Hunger for Growth’

“If GDP slows because those that were here before obeyed requests from Brussels, that is yet another reason to push ahead as planned with our budget law,” said Salvini, leader of Garavaglia’s party the League. “Brussels friends, you can write to us. We are well mannered and we will reply, but there is hunger for growth."

Prime Minister Giuseppe Conte, who leads a ruling coalition made up of the League and the anti-establishment Five Star Movement, said that the bad news was “expected” by the government.

“That is the reason why we decided to do an expansionary budget,” Conte said during an official visit to New Delhi. “Italy must not enter an economic recession and we need to reverse the current trend.”

While bond markets may have started to stabilize since S&P Global Ratings reaffirmed the country’s credit rating last Friday, some officials have flagged concerns at the strain on the banking system even at the current levels.

Executives’ Concerns

In its gross-domestic-product report for the third quarter the nation’s statistics agency Istat said that the economic stagnation was due to a “decrease in industry” and that on the demand side there was zero contribution from net exports.

The government’s high-risk strategy is fueling concern among the nation’s executives.

The nation’s main business lobby Confindustria said that if the Italian economy does not grow over coming months, it will be the government’s fault. No one else would have to be blamed in case a new recession takes place, Confindustria’s head Vincenzo Boccia told a conference in the northern Piedmont region.

Italy’s executives are growing pessimistic about the prospect for the economic activity. A separate monthly report by the statistics office showed that manufacturers’ confidence fell this month.

“After the unexpected stagnation registered by GDP in the third quarter, October surveys apparently are not suggesting a spectacular recovery in the final months of the year,” said Paolo Mameli, a senior economist at Intesa Sanpaolo in Milan. He now expects a mild rebound with output rising in the 0.1-0.2 percent range during the fourth quarter.

“Risks on the growth outlook remain clearly on the downside,” he said.

©2018 Bloomberg L.P.