Here's What the EU Could Do About Italy After Rome's Defiance

(Bloomberg) -- The European Commission may take its next step toward financial sanctions for Italy next week.

The escalation follows the Italian government’s decision to stick with its 2.4 percent budget deficit target and 1.5 percent growth forecast for next year. Rome defied warnings by the European Commission, which had demanded changes to ease concerns about excessive spending and overly optimistic growth estimates.

Key Steps

  • Since Italy stuck to its guns, the commission is expected to say the country’s budget is in breach of EU fiscal rules when it issues its opinions on euro-area draft budgets on Nov. 21.
  • The EU’s executive arm is also expected to bring forward the publication of a report on Italy’s debt, which will likely say the government isn’t sufficiently reducing its debt.
  • The publication of the report, which has to be endorsed by EU governments, will trigger a so-called excessive deficit procedure, the first step in a process that could lead to disciplinary actions, including financial sanctions.
  • Under the procedure, which likely wouldn’t officially kick-start until January, Italy will be given three to six months to bring its deficit down to a prescribed level or face fines.
  • European elections in May could further complicate the timeline, as the commission would be reluctant to take any decisions close to the vote that could play in the hands of euroskeptic populists.

Outlook

  • The process that leads to financial sanctions could take many months and EU governments get several opportunities to weigh in until a final decision is taken.
  • The EU has never fined countries for budget breaches in the past.
  • EU officials have been hoping that market pressure will make Italy reconsider its expansionary plans and take a step back from its optimistic targets.
  • If Italy fails to do so by the end of the excessive deficit procedure, then the commission could propose imposing fines worth up to 0.2 percent of gross domestic product -- a decision that would need a final green light by euro-area governments.
  • If Italy gets six months to show it is bringing its finances in check, any decision on possible sanctions wouldn’t take place before the summer.

Market Reaction

Italian bonds dropped on Wednesday, with yields on 10-year notes rising by as much as 11 basis points, after the government confirmed it won’t amend its budget targets for next year. Borrowing costs for Europe’s most indebted state have been rising ever since Rome chose to defy the EU’s rules on fiscal prudence.

Stocks haven’t been doing much better: The FTSE Italia All-Share Index has dropped more than 20 percent in the past six months, making it among the worst performing major equity indexes in Europe.

Here's What the EU Could Do About Italy After Rome's Defiance

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