EU Says Italy Must Comply With Rules, Rejects Fiscal Outline

(Bloomberg) -- European Commission President Jean-Claude Juncker called on Italy to redouble its fiscal efforts to avoid deviating from the goals agreed to with Brussels, saying the government in Rome has already enjoyed concessions on spending.

The commission “has to look out for the observation of the rules, and in the case of Italy we have introduced lines of flexibility in the application of the Stability and Growth Pact,” the European Union’s set of budget rules, Juncker said in an interview with Austrian media. “Italy was allowed to make expenses that it wouldn’t have been allowed to make had we applied the pact in a strict but not intelligent manner.”

“When it comes to how we treated Italy, I don’t have a bad conscience,” Juncker said in the interview with the dailies Der Standard and Kurier and the weekly Falter.

On Friday, the commission rejected Italy’s plans for a wider budget deficit next year, raising the risk of an escalation in the showdown between the EU’s executive arm and the Italian government that has already taken a toll on the country’s bond and equity markets.

“Italy’s revised budgetary targets appear prima facie to point to a significant deviation from the fiscal path” commonly agreed by European Union governments, EU Commissioners Valdis Dombrovskis and Pierre Moscovici wrote in a letter to Italian Finance Minister Giovanni Tria. “This is therefore a source of serious concern,” the commission’s finance chiefs said in their letter Friday responding to a note sent by Tria the day before.

In the letter announcing the details of Rome’s budget outline and obtained by Bloomberg, Tria had said that the government plans “to pursue a program of socio-economic reforms,” including a flat tax for small businesses and an income-support scheme that would result in a wider deficit next year.

In order to ensure the success of the government’s fiscal strategy, Tria had maintained that Italy needs to keep its structural deficit unchanged from 2019 to 2021.

The finance chief stressed that the “policy of gradually improving the structural balance will be reinstated once real GDP and the unemployment rate return to pre-crisis levels.” Unemployment in August was at 9.7 percent, compared with a low of 5.8 percent in 2007. Italy’s gross domestic product remained in the second quarter about 5 percent below its pre-crisis peak in 2008.

Fiscal expansion plans and the prospect of a showdown with EU institutions have spooked investors, as Italy is already burdened by the highest nominal debt in Europe. Yields on Italian 10-year notes rose 10 basis points to 3.42 percent Friday, more than 110 basis points higher than Cyprus, a euro-area country which only recently regained an investment-grade credit rating

Political Leaders

In the interview Juncker also countered criticism by Italian political leaders including Deputy Premier Matteo Salvini that the EU’s executive arm is trying to weaken the government in Rome.

“We need to get talking to the Italians in a noble competition of ideas,” Juncker said. “It’s not as if the commission is working on replacing the Italian government -- that’s not the commission’s job.”

Salvini, who is also the leader of the coalition junior partner League, said on Friday that the EU has approved economic measures “that impoverished Italy and made it precarious,” according to Ansa newswire. “I don’t get up in the morning thinking about people like Juncker and Moscovici -- who have ruined Europe and Italy,” he was reported as saying.

Commenting in the interview with Falter on Rome’s 2019 budget, Juncker said that “it’s up to the Italian policy makers to find rules and measures that make it possible that Italy doesn’t deviate from the agreed budget goals.”

In the fiscal outline unveiled Thursday, the Italian Treasury included a rise in the structural deficit, or deficit net of the economic cycle, to 1.7 percent of output in each of the next three years. That’s up from the 0.9 percent estimated for this year. The figure is considered key by the EU in its assessment of member countries’ budget plans.

Italy, like all highly indebted countries in the euro-area, is required by the bloc’s rules to narrow its fiscal gaps and thus lower its debt burden. Failure to comply with the obligation to reduce its structural deficit could lead the commission to demand changes to the budget, and eventually result into financial penalties, if Rome doesn’t conform to the prescribed policies.

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The government is expected to submit a draft budgetary plan to the Commission by Oct. 15. Italy’s parliament has to approve the budget law by year-end.

The EU hasn’t rejected Italy’s 2019 budget, office of Italian Prime Minister Giuseppe Conte said late on Friday in reference to the commissioners’ letter. No formal procedure has yet been launched and the Commission’s assessment will be based on the plan which government will send this month. Rome has “strong will to start a constructive dialog with the EU,” the premier’s office said.

Speaking to reporters on the sidelines of an event in Rome on Saturday, deputy premier Luigi Di Maio said that the government won’t change its fiscal goals and that future economic growth will allow it to lower the budget deficit in the years after 2019.

“We’ll tell the European Commission that the Italians need these measures which are not one offs, but aimed at improving their economic prospects,” Di Maio also said in remarks broadcast via his Facebook page.

©2018 Bloomberg L.P.