On 23 October, in the context of the European Semester, the European Commission rejected Italy's Draft Budgetary Plan (DBP) for 2019 due to a "particularly serious non-compliance" with the recommendation addressed to Italy by the ECOFIN Council on 13 July 2018. This unprecedented decision is accompanied by a request to the Italian government to submit a revised document, more compliant with European rules, within three weeks.
The Commission criticizes the Italian DBP for four reasons:
- With the DBP, the convergence path towards the medium-term structural budget balance objective was openly abandoned, instead envisaging an increase of 1,4 percentage points of GDP compared to previous commitments. This deviation would also be maintained in 2020 and 2021;
- The Parliamentary Budgetary Office (PBO) declined to validate the nominal growth forecasts underlying the DBP (above 3 percent annually), as they are nearly one percentage point outside the confidence interval of the panel forecasters of the PBO;
- It follows that the stated goal of the DBP to reduce the public debt-to-GDP ratio is not credible;
- The Italian government's decision to increase the public deficit, despite the difficulties related to the sustainability of the public debt, carries the risk of spillovers for the other members of the eurozone and the Union.
There is no doubt that Italy is violating the Stability Pact. In the letter sent to the European Commission on 22 October, Minister Tria declared that the government "is aware that it has chosen a budget policy approach that is not in line with the application rules of the Stability and Growth Pact". Furthermore, by setting the 2019 debt target at 2,4% of GDP, with 2018 net borrowing already close to 2%, the 0,6% increase in GDP growth certainly appears overestimated, even if it does not take into account the negative impact of the increase in interest rates on private investment and the supply of credit. There are therefore serious doubts about the ability of the Italian government to meet even the 2,4% debt target, not to mention the announced reduction in the debt-to-GDP ratio.
Italy now has three weeks to react. The general tone of the latest statements by the government and the main political forces that support it has so far been conciliatory, but in essence an attitude of challenge prevails. The government sees the DBP sent to Brussels as an expression of its political commitments to its constituents and that it is necessary to increase growth and reduce poverty and social unease. Furthermore, the government argues that infrastructure investments and administrative reforms will significantly improve the business climate and will be a lever for private investment. Therefore, there is currently no intention to amend the DBP, despite some allusions to the possibility of keeping spending programs below target levels, should financial conditions deteriorate further.
In the absence of amendments to the DBP, the Commission is likely to launch an Excessive Deficit Procedure (EDP) for non-compliance with the debt relief rule. For Italy, the Commission had until now considered that this rule was satisfied, despite the fact that the debt-to-GDP ratio was not falling at an adequate speed, thanks to compliance with the Stability Pact; therefore, the abandonment of the convergence path from the medium-term objective on the structural deficit also implies the failure to comply with the debt rule, thus leading directly to the opening of an excessive deficit procedure. Someone whispers that the Commission intends to speed up the process to obtain a decision as early as the European Council in December. This could, according to Article 126 of the TFEU, lead to possible sanctions for Italy even before the European elections in May.
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Unfortunately, recent and foreseeable developments in the economy and financial markets do not contribute to strengthening the credibility of the Italian DBP. GDP growth already stalled in the third quarter of 2018 and most forecasters expect the Italian economy to stall or go into recession in the next two quarters. Furthermore, while investor confidence falls, the spread between 3-year Italian government bonds and German bunds widens. Investors could be further destabilized by the acceleration of the EDP by the Commission. The rating agencies are reassessing the situation: Moody's has already downgraded the Italian securities by one point (to BaaXNUMX, one point higher than "junk") and S&P has maintained the rating but downgraded the outlook to negative. The cost of funding for banks is rising and there is a real possibility of a renewed credit crunch as banks are forced to increase their capital to meet emerging losses on their (large) government debt portfolios.
Since the Commission has made it clear that it will not accept the current DBP - also following the inability to reduce public debt to GDP at all in the last legislature - the relevant question is whether the government really intends to challenge European rules to the point of putting question its membership of the Eurozone (and the Union), or whether it is just probing the waters to see how far it can go before retreating from the edge.
Some statements by influential members of the government are not encouraging. For example, European Affairs Minister Savona recently publicly reiterated his point of view that Italy does not want to leave the euro, but it remains to be seen whether European positions will push us out. However, it still seems probable that the government will choose the path of compromise with the European institutions, while the two coalition parties will try to take advantage of the "outrageous demands" coming from Europe to increase their electoral support. Certainly, if the crisis of confidence in the financial markets were to worsen and the specter of a loss of access to the markets for Italian government bonds were to reappear, then the return to reason by the Italian government could have to pass through a "Syriza phase". – when in 2015 the closure of the banks forced the Greek government to return to Brussels and accept harsh economic conditions – and, probably, due to a government crisis. The problem in this scenario is that – unlike November 2011 when market pressure led to the resignation of the Berlusconi government and its replacement by Mario Monti – today there is no political alternative to form a government more responsive to the Commission's requests.
°°°°This is the Italian translation of the author's Commentary published yesterday by CEPS in Brussels and by LUISS SEP in Rome
