The One Thing Euro-Area Finance Ministers Are Thinking About: Italy
(Bloomberg) -- Euro-area finance ministers gathering in Brussels on Monday will discuss Italy’s escalating budget standoff with the EU as the bloc waits for the government in Rome to respond to the unprecedented rebuke it received two weeks ago.
The discussion comes as Italy is asked to submit revised spending plans by Nov. 13, after the European Commission essentially rejected the country’s budget for 2019, saying that it constitutes a clear deviation from commonly agreed fiscal rules. Despite repeated warnings, Prime Minister Giuseppe Conte has said there’s no “Plan B” for the fiscal program, indicating the government has no intention to comply with EU demands.
Italy’s deputy prime minister, Luigi Di Maio, told the Financial Times in an interview published Sunday that he believes Rome’s controversial spending plans will become “a recipe” for reviving European growth and that the continent is ready to abandon austerity and embrace the deficit-busting approach of U.S. President Donald Trump.
Given the populist government’s reluctance to revise its budget, the standoff with Brussels is set to escalate further in the coming weeks. At their meeting on Monday, finance chiefs are likely to back the commission’s stance toward Italy, something already done by their chief aides, who debated the matter last month.
“We are in discussions with Italian authorities and hoping to reach a constructive outcome,” Commission Vice President Valdis Dombrovskis said in an interview on Monday in Brussels. “We are trying to convince Italian authorities that the approach they are taking is actually counter-productive also for the Italian economy.”
Italian 10-year yields rose four basis points to 3.36 percent. The yield spread over their German peers widened four basis points to 293 basis points. The FTSE MIB Index of shares dropped 0.5 percent.
Once Italy responds to the commission, the EU’s executive arm will have three weeks to publish its final assessment on whether the country’s spending plans are in breach of EU rules. One possible outcome, EU officials say, would be for the commission to bring up to Nov. 21 the publication of a report on Italy’s compliance with EU rules on debt that was originally planned for the spring.
If the report shows that Italy is failing to comply with rules on reducing it’s debt -- which is more than twice the EU limit -- then that could trigger the so-called excessive deficit procedure, a process that could eventually lead to financial sanctions for the government in Rome. The penalty could reach 0.2 percent of the country’s annual economic output.
The commission’s rejection follows months of discord and tension over the spending targets, which Italy itself accepts are in breach of EU rules. Italy has the highest debt ratio in the euro area after Greece, and its plans have unsettled investors, sending its bond yields to four-year highs last month.
Moody’s Investors Service last month downgraded Italy to just one level above junk, but the country managed to avoid a second rating downgrade as S&P Global Ratings decided only to lower its outlook on the nation’s creditworthiness. Still, a further escalation will likely fan market jitters.
Financial penalties proposed by the commission have to be approved by member states, which can block the process. But while Brussels has no real powers over national budgets, governments have in the past sought to avoid an official reprimand because of the stigma and the potential market implications.
Under EU rules, no country should have a budget deficit larger than 3 percent of gross domestic product or debt above 60 percent of output and those that are outside of those limits must set annual targets to show they’re moving in the right direction. While Italy’s deficit is well within the 3 percent limit, the commission has demanded smaller gaps for the country to bring down its debt load.
Crucially, the so-called structural deficit, a key measure for the commission, which strips out effects of the economic cycle and one-time spending items, is also way off the mark. Italy projects this will deteriorate by 0.8 percentage points of GDP while the commission has demanded an improvement of 0.6 percentage points.
Dombrovskis cited the risk that Italy’s economy might “slow even further” under the current plan. “Italy’s budget is substantially deviating from the requirements so it would also require substantial adjustment,” he said.
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