Italy Reaches Budget Accord as Juncker Warns About EU Rules

(Bloomberg) -- Italy’s fractured coalition government cobbled together a last-minute budget accord that starts delivering on costly election promises but risks a confrontation with Brussels over European Union fiscal rules.

The European Commission, which already warned Italy about earlier budget projections that had caused a selloff in Italian bonds, has a week to make an initial assessment of the draft 2019 budget that Italy submitted overnight. The EU’s executive branch has to balance enforcing the rules without further stoking populist resentment.

“If we accepted a slippage” away from EU rules “some of the other countries would cover us with insults and invective accusing us of being too flexible with Italy,” European Commission President Jean-Claude Juncker told Italian journalists Tuesday in Brussels.

Italy Reaches Budget Accord as Juncker Warns About EU Rules

The agreement reached after meetings throughout Monday afternoon and then an evening gathering of the full cabinet had been held up by the conflicting electoral promises of Matteo Salvini’s League and the Five Star Movement of fellow deputy premier and coalition partner Luigi Di Maio.

“This budget doesn’t accomplish miracles, it doesn’t multiply fish and bread, but it opens opportunities to work for hundreds of thousands of youths,” Salvini said in Monday evening news conference flanked by Prime Minister Giuseppe Conte, Di Maio, and Finance Minister Giovanni Tria. “After 137 days of governing, I think we can be satisfied with what we’ve done.”

In early trading Tuesday, the yield difference between Italian and German 10-year bonds narrowed 4 basis points to about 300 basis points.

Italy Reaches Budget Accord as Juncker Warns About EU Rules

Tria said he expects “continued dialogue” with the commission over Italy’s plans to increase next year’s budget deficit to 2.4 percent, which he said was needed to lift Italy’s slowing economy. While the shortfall is much wider than the 0.8 percent targeted by the center-left government swept out of power in the March elections, Tria said the deficit was already trending toward 2 percent because of slowing growth.

“Our deficit would be considered normal in all Western democracies, not explosive,” Tria said at the news conference. He also denied reports that he’d quit once the budget was approved by parliament. Di Maio, who has clashed with Tria over spending, said Monday evening “you don’t change a winning team.”

According to the draft submitted to Brussels, growth next year will rebound to 1.5 percent from 1.2 percent this year; growth next year would have been just 0.9 percent without the expansionary effect of the budget. The unemployment rate is seen falling to 9.8 percent from 10.6 percent, which if confirmed would be the first time since 2012 it’s below 10 percent.

Italy’s Parliamentary Budget Office refused to endorse the economic forecasts saying they weren’t acceptable on the basis of the information available.

After jumping to 2.4 percent of GDP next year, the budget deficit will decline to 2.1 percent in 2020 and 1.8 percent in 2021. The draft also sees a continued decline in the debt ratio, falling to 128.1 percent in 2020 from 130 percent in 2019 and 130.9 percent this year.

Di Maio said the “citizen’s income” for the poor that was the basis of his campaign will be introduced in the first three months of next year. In addition, the budget bill allows people who have worked 38 years to retire next year if they’ve reached 62 years of age, reversing increases in the retirement age pushed through by previous governments. Both measures have led to rebukes from Italy’s partners in the euro zone and the European Commission.

Salvini said the early retirement will allow 400,000 youths to find work.

‘Fiscal Decree’

Tria said the extra spending is entirely covered by other measures. The budget cuts the most generous pensions, which the government says will yield 1 billion euros ($1.16 billion) over three years, and shifts spending on migrants to family support measures. It also will eliminate some tax breaks on banks’ interest payments.

Italy Reaches Budget Accord as Juncker Warns About EU Rules

“We are eliminating privileges to fund your rights,” Di Maio said at the news conference.

Di Maio’s promise of a basic income is seen as a risky giveaway to jobless southerners by many League supporters in the north. Five Star politicians, meanwhile, have sought to limit tax breaks championed by Salvini on behalf of businesses in the north.

Salvini and Di Maio said they reached a compromise on the so-called “fiscal decree,” which allows for people with tax disputes to settle their cases with set payments. The Five Star Movement had pushed for more restrictive conditions than the League, which has strong support from Northern entrepreneurs. As part of the compromise, the settlement mechanism will be limited to disputes of less than 100,000 euros whereas the League was reported in Italian media to be seeking a 1 million-euro ceiling.

Di Maio also said the budget law eliminates many “useless laws,” and includes measures to even out car insurance rates across the country and adds protections such as regulations to discourage doctors from forcing patients to get appointments outside of public hospitals.

Salvini and Di Maio have repeatedly challenged the Brussels-based commission, insisting they will not backtrack on campaign promises. Tria has sought to block some of their initiatives, and has had the job of seeking to reassure investors and Brussels.

The Commission on Oct. 5 sent a letter to Tria warning him that earlier drafts of the budget deviated from pledges made by previous Italian governments to cut Italy’s debt. At more than 130 percent of gross domestic product, the debt load is the largest in Europe in absolute terms and second only to Greece’s as a percentage of the economy.

Individual commissioners and Commission President Jean-Claude Juncker have said the Italian government is breaking earlier commitments, prompting Mario Draghi, the Italian head of the European Central Bank, to call on both sides to tone down their rhetoric.

While Italy’s deficit is well within the 3 percent limit laid out in treaties, the Commission has demanded smaller deficits for Italy to bring down its debt load.

EU Rules

Conte will seek to press his government’s case with leaders including German Chancellor Angela Merkel, French President Emmanuel Macron and 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 weeks. That’s a step the Commission has never taken before, even when France for a decade ran deficits over 3 percent.

If Brussels sends back the budget and asks for revisions, Italy will have to re-submit new plans. EU officials hope that during that period the government will be open to talking with the EU and make adjustments to its budget. A lot will depend on how investors react to this standoff and the responsiveness of the country’s leadership 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.

©2018 Bloomberg L.P.