Italy’s Smoke and Mirrors Won’t Fool Markets
(Bloomberg Opinion) -- The Italian government has finally presented its much-awaited economic and fiscal forecasts. They are an exercise in smoke and mirrors of which Harry Houdini would be proud.
The inflated growth figures and frankly incredible future budget adjustments are unlikely to sway investors and the European Commission. Italy is heading for a fight with the EU and, more dangerously, the financial markets.
The plans emerged on Thursday night after a week-long delay. They are the product of uneasy negotiations between Giovanni Tria, the technocratic finance minister, and his political masters from the League and Five Star Movement. Tria wanted to reassure investors and the EU that Italy would cut both its budget deficit (after an initial increase) and its debt over the coming years. The two parties had eyes only for their lavish spending pledges, the core of their coalition contract.
The end result is an unhappy compromise. Italy will now target budget deficits of 2.4 percent, 2.1 percent and 1.8 percent of gross domestic product for the next three years. Public debt is expected to come down from 130.9 percent of GDP this year to 126.7 percent in 2021. Meanwhile, Five Star and the League won an explicit acknowledgement that the government will introduce a number of expensive giveaways, including additional income support for the poor and a targeted reduction in the retirement age.
So, all’s well that ends well? Hardly. For a start, the budget plans are based on very doubtful economic assumptions. Take growth: The government predicts the economy will expand by 1.5 percent in 2019 — thanks, in part, to its own programs, which will contribute 0.6 percentage points. It is hard to find an off-the-shelf comparison, since most forecasters haven’’t had time to include the higher deficit in their computations. But a recent projection by Confindustria, Italy’s industrial federation, suggests that it will be hard for the economy to expand by much more than 1 percent next year.
In fact, there are significant risks that mean the rate of expansion will likely be lower. Italy’s bond yields have shot higher since it became clear that the League and Five Star would form a government, and it is possible they will climb further. This is bound to increase the cost of lending for families and businesses and weigh on the recovery.
The expected impact of the government measures also looks optimistic: They are largely aimed at increasing day-to-day spending rather than funding investment projects, which would have a higher multiplier effect.
Furthermore, the deficit-reduction targets appear very hard to believe. The government is once again promising it will raise value-added tax in 2020 and 2021 if it fails to find other deficit-saving measures. These pledges have been repeatedly ducked by successive Italian governments, including the current one. If you remove these safeguards, the budget deficit will grow in both 2020 and 2021. Italy risks finding itself exposed and with no fiscal buffers when the next recession hits Europe.
These tricks are unlikely to go down well with the European Commission. They confirm that Italy will flatly ignore the EU’s recommendation that the structural budget, which takes the economic cycle into account, should be reduced in the coming years. Brussels had demanded that Italy should improve its structural balance by 0.6 percentage points next year: instead, the budget will worsen it by 0.8 percentage points. Nor is there any convergence towards a budget balance. Italy will run a structural deficit of 1.7 percent for each of the next three years. So much for the idea of shoring up the public accounts while the economy is expanding.
The League and Five Star are likely to ignore any warnings from Brussels, which they consider a noxious intrusion. But they will find it harder to neglect what’s happening in the financial markets. Yields on Italy’s government bonds fell somewhat when it became clear that the government wanted to reduce the deficit in 2020 and 2021. That move has since been almost entirely reversed, a sign that investors remain unpersuaded.
With bond yields climbing across the world, and the European Central Bank poised to end its quantitative easing program, Italy could soon find itself trapped in a very uncomfortable place — one from which even Houdini would find it very hard to escape.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
©2018 Bloomberg L.P.