Italy's Populist Budget to Land in Brussels With EU in Bind

(Bloomberg) -- By midnight Monday, the guardians of the European Union’s rule-book will finally get their first proper look at a draft of Italy’s populist budget.

After weeks of conflicting messages from Rome, market turmoil, and an early warning that the spending plans would breach EU rules, the European Commission will start reviewing Italy’s plan to start delivering on costly election promises.

Italy's Populist Budget to Land in Brussels With EU in Bind

For the populist administration, it’s not just about delivering on their coalition agreement. They also need to show their electorate that they can win against the Brussels eurocrats ahead of European Parliament elections in May.

"Everyone is taking shots at us -- not a single day passes without news bulletins, the European Commission, the Bank of Italy, the state accountant or the statistics agency saying we can’t do this," Deputy Prime Minister Matteo Salvini told supporters at a campaign event in northern Italy over the weekend. "Your votes give me strength to go to Brussels and say it’s the Italians that decide, not them."

Italy's Populist Budget to Land in Brussels With EU in Bind

With Italian bond yields close to a four-year high, the prospects for the country’s public finances are a focus of concern around the world. In Bali, where policy makers gathered for the annual meetings of the International Monetary Fund and the World Bank, Mario Draghi, the Italian president of the European Central Bank, sought to reassure his colleagues that a compromise would be found between the government’s ambitions and the demands of financial stability.

Both Salvini of the anti-migrant League, and his fellow-Deputy Premier Luigi Di Maio, have repeatedly challenged the Commission, insisting they will not backtrack on measures including a “citizen’s income” for the poor, tax cuts and lowering the retirement age.

Still, Di Maio and Salvini remain in disagreement over fiscal measures to be included in the budget law, newspaper la Repubblica reported Monday morning without citing its sources.

Italy's Populist Budget to Land in Brussels With EU in Bind

Prime Minister Giuseppe Conte will seek to press his government’s case with leaders including German Chancellor Angela Merkel, French President Emmanuel Macron and Commission President Jean-Claude Juncker during a summit in Brussels on Wednesday and Thursday.

If the EU executive arm thinks there is a risk of Italy’s finances going seriously off track then it must raise the alarm with the government within a week, and issue a negative opinion requesting revisions to the budget within two. That’s a step the Commission has never taken before.

Alitalia

The pressure from the Commission, and from financial markets, is straining the government in Rome, where Finance Minister Giovanni Tria lost his fight for a smaller budget deficit last month. The latest spat was over Di Maio’s suggestion that public money could be used to help struggling airline Alitalia SpA. After Tria objected to that idea, Salvini told him he had to follow the party line.

EU officials have signaled it will be very difficult not to reject the country’s spending plans if the government’s targets remain unchanged. This is not just because the planned 2.4 percent headline deficit is too high to be within EU limits.

The so-called structural deficit, a key measure for the Commission, which strips out effects of the economic cycle and one-off spending items, is also off the mark. Italy projects this will widen by 0.8 percent, more than the 0.6 percent improvement Brussels wants. The EU is likely to send the budget back to Rome, officials say.

Under EU rules, no country should have a deficit larger than 3 percent of GDP or debt above 60 percent of output, and governments are required to set annual targets to show they’re moving in the right direction. Even if Italy doesn’t breach the deficit target, it would still run afoul of EU rules if the deficit doesn’t narrow at the pace agreed. The Italian government’s growth forecasts may be seen as overly optimistic, meaning its deficit and debt may ultimately be even higher than planned.

If Brussels sends back the budget and asks for revisions, Italy will have three weeks to re-submit new plans. EU officials hope that during that period the government will be open to talk with the EU and make adjustments to its budget, though they concur that a lot will depend on how investors react to this standoff and the willingness of the country’s leadership to cave in to market pressure.

The process that could eventually lead to sanctions wouldn’t typically be triggered until the Spring, when the Commission has final 2018 data to work with. And even if it decides to trigger the procedure sooner as part of a broader escalation, sanctions wouldn’t kick in for quite some time.

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