EU Warns Italy's Populists to Stay the Course of Fiscal Prudence

(Bloomberg) -- The European Commission urged Italy to stay on the path of fiscal responsibility, warning that high debt levels leave little room for economic experimentation.

With markets already stunned by the radical policy platform presented by the populist alliance of Five Star Movement and the League parties, commission Vice President Valdis Dombrovskis said “our message is that Italy should continue with responsible fiscal policies, continuing to reduce both the budget deficit and public debt.”

In its economic policy recommendations for EU countries, the bloc’s executive arm said Italy should ensure its government’s net primary expenditure doesn’t grow faster than 0.1 percent in 2019, and urged it to push with the reduction of its government debt -- the second highest in the euro area after Greece’s. The report also said Rome should work on making civil trials shorter, implement labor reforms and maintain the pace of reducing bad loans.

But the recommendation steered clear of directly addressing the upcoming government’s plans. European commissioner for economic affairs Pierre Moscovici said the commission should should not comment on announcements and would instead will take a position based on action, budget and laws.

“The formation of the government is still ongoing, so we are not jumping to conclusions at this stage,” Dombrovskis said in a Bloomberg TV interview before the release of the report. “What we are doing is we’re reiterating our message of the necessity to continue with prudent fiscal policies, especially in the case of Italy, which has the second-highest debt-to-GDP ratio in the EU.”

EU Rules

The bloc’s rules allow the commission to propose penalties for countries breaching a deficit limit equal to 3 percent of gross domestic product and failing to reduce their debt-to-GDP ratio towards a commonly agreed ceiling of 60 percent. The tool of economic sanctions has never been used, and big countries including France, Italy and Spain have traditionally enjoyed lenient treatment.

Still, a hardline stance from the commission wouldn’t bode well for the populist coalition which is already facing market scrutiny for its pledges to roll back pension reforms and introduce a flat income tax rate of as low as 15 percent.

Yields on Italy 10-year yields climbed 10 basis points on Wednesday afternoon to 2.43 percent, the highest level since June 2015 and taking a surge this month to over 60 basis points.

“Italy can’t afford these measures,” Bloomberg Economists David Powell and Jamie Murray wrote in a note. “The new government will be under pressure to water down its proposals - or face an unsustainable jump in borrowing costs.”

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