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Reality Catches Up With Italy's Populists

Reality Catches Up With Italy's Populists

(Bloomberg Opinion) -- Italy’s government has updated its economic and budget forecasts with ones that are much more credible than those it manufactured in December. Even if the ruling League and 5 Star coalition has finally come clean, it hasn’t grasped the true implications of the numbers. The country still lacks a strategy to revive its ailing economy.

Rome is now targeting a growth rate of 0.2 percent for this year, down from an earlier goal of 1 percent. This figure is in line with those from the European Commission and the International Monetary Fund. It is also consistent with the country’s worsening economic outlook: Italy plunged into recession at the end of last year amid the broader euro zone slowdown.

Lackluster growth has hit the public finances. The government had to increase its target for this year’s budget deficit to 2.4 percent of gross domestic product from 2 percent before. Public debt is also forecast to edge higher, from 132.2 percent of GDP last year to 132.6 percent. Whichever way you look at it, the picture is far gloomier than it seemed just four months ago.

And so it should be. The revisions amount to an admission of failure by Italy’s populist rulers. For months, 5 Star and the League vowed that their budget measures – including a lower retirement age and an income support program – would revive the Italian economy, boost employment, and stabilize the debt-to-GDP ratio through higher growth.

Paolo Savona, then minister of European Affairs and now head of the country’s securities regulator, had forecast growth would be 2 percent in 2019 and 3 percent in 2020. Most independent economists believed such predictions were laughable, but their opinion was ignored. The two anti-establishment parties have now had to agree that the experts they so despise were right after all.

Yet, when it comes to policy, 5 Star and the League are still in denial. The government’s fiscal forecasts rely on a string of value-added tax increases and privatizations to ensure that the budget deficit and debt stabilize over time. But these measures aren’t credible as long as politicians insist they want to avoid tax hikes and say they are open to nationalizing “strategic” companies, including Alitalia SpA, Italy’s troubled flag-carrier. Indeed, the governing coalition is busy in a surreal discussion about introducing a so-called flat tax that would really be no such thing since it would still involve several income tax brackets. Needless to say, there is no mention of where the money to pay for such a tax cut would come from.

For now, Italy is enjoying a period of calm in the financial markets. Its government still pays a significant premium to borrow in the bond market compared with Spain and Portugal – but yields have narrowed sharply since the autumn. The government has reassured investors by dropping, at least for now, any plans to leave the single currency, an idea with which the League and 5 Star both flirted with during the electoral campaign. Rome also chose to compromise with the European Commission over its budget, a sign that it is willing to play by the EU’s rules.

Still, a deteriorating fiscal and economic outlook could remind investors of Italy’s enormous public debt-to-GDP ratio – the second highest in the euro zone after Greece. Nor are there signs that the government is serious about lifting productivity growth, which has been abysmal over the last two decades. Finance Minister Giovanni Tria has proposed a package of reforms, but most of these are measures adopted by previous governments that the populists decided to abandon to make way for their giveaways. As a result, they are unlikely to provide a decisive boost. The European Commission, which struck a fragile truce with Rome in December, may demand Italy stick to its earlier pledges and take action.

It would be wrong for Italy to engage in more belt-tightening at a time of slowing growth. But the risk is that the government’s blasé approach to economic policymaking will leave this administration, or its successors, with no option but to impose austerity to stem a market panic. The European Central Bank can only help individual countries, like Italy, if they embark on a program of budget cuts and structural reforms.

If the Italian government is looking for a free lunch, there isn’t one. Just as with the government’s incongruous economic forecasts, reality catches up sooner or later.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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.

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