October 19, 2018
Finance

4 burning questions on Italys budget scaremongering

ROME — The Italian government is taking a gamble on the countrys budget, which could make or break the country — and the eurozone.

The Italian parliament is due to vote on the budget proposals on Thursday and once lawmakers approve them, possibly with a few significant amendments, the government will forward the document to the European Commission for review. But other national institutions, from the Bank of Italy to the Parliamentary Budget Office (PBO), have slammed the update to the countrys budget targets — the documento di economia e finanza (DEF) — as unrealistic.

Heres why the Italian budget scares the eurozone.

1. Whats the government proposing?

The populists proposals include borrowing more to finance generous campaign pledges like a universal income and postponing the budget balance until “the economy is back to pre-crisis levels.” Another pillar of their budget is a substantial rollback of the pensions reform approved under Mario Montis government, to allow workers to retire at a much younger age. A public investments plan to promote growth is another element at the core of the plan, but details are yet to be unveiled. The measures should lead to a sustained path of debt reduction, according to the DEF, based on the assumption that Italys economy will grow 1.5 percent next year and 1.6 percent in 2020.

The country hasnt seen such growth levels since the early 2000s. Nevertheless, the League and 5Stars coalition is confident skeptics will be proven wrong. On Tuesday and again on Wednesday, Finance Minister Giovanni Tria told the parliaments budget committee that the measures are “courageous.” In the governments view, the universal income will trigger consumption and a younger retirement age will boost youth employment. However, the Treasury has allocated €9 billion to the 5Stars flagship measure, which doesnt translate into the promised monthly €780 for two years for 6 million people.

2. What do critics say?

The International Monetary Fund said on Tuesday it expects Italy to be one of the slowest growing economies in the eurozone, with a GDP growth rate of 1 percent in 2019. The IMF also urged the Italian government not to backtrack on the job market and pension reform implemented by previous governments. Speaking at an event in Florence, Prime Minister Giuseppe Conte said the IMF forecasts should be revised in light of the draft budget proposals.

Italian Minister of Economy and Finance Giovanni Tria arrives during an Eurogroup meeting at the EU headquarters in Luxembourg on October 1, 2018 | John Thys/AFP via Getty Images

But later on Tuesday, the PBO also said the governments growth forecasts appear to be “excessively optimistic” and the investments plan is “desirable but particularly ambitious compared to current trends.” One London-based Italian investor agreed: “The [finance] minister has completely lost credibility and can no longer act as the gatekeeper of Italian public finance as President [Sergio] Mattarella had hoped when he forced his appointment.”

Former Finance Minister Pier Carlo Padoan, currently a Democratic Party MP, told POLITICO the budget objectives “depict an ambiguous and imprudent approach to public finance.” He explained that it is imprudent “because its based on unreliable growth forecasts and if the growth doesnt happen, the only certainty would be a rising public debt.” Padoan, who is also a former OECD chief economist, pointed out that if things dont go according to plan, the countrys fate will “no longer be in Romes or Brussels hands, but in financial markets.”

3. What do EU rules mandate?

The blocs so-called fiscal compact mandates a “budget balance.” The rule “is considered to be respected if the annual structural balance meets the country-specific medium-term objective and does not exceed a deficit (in structural terms) of 0.5 percent of GDP,” or 1 percent if the countrys debt-to-GDP ratio is below 60 percent (which isnt Italys case). This rule has also been incorporated into the Italian constitution.

According to the previous governments plans, Italy would have reached a budget balance by 2020, but this has now been postponed. Delaying it indefinitely while also increasing the structural deficit to 1.7 percent for the next three years marks a significant departure from the countrys previous commitments and is cause for “serious concern” in Brussels. In a letter to Tria last week, Commissioners Valdis Dombrovskis and Pierre Moscovici said: “Italys revised budgetary targets appear prima facie to point to a significant deviation from the fiscal path recommended by the Council.” The Commission noted that “according to the governments own projections, the new targets would correspond to a structural deterioration of 0.8 percent of GDP in 2019.” Brussels and Rome will engage in formal discussions after October 15 once the Italian government submits the draft approved by parliament.

Italian Deputy Premier and Labour and Industry Minister Luigi Di Maio with Italian Deputy Premier and Interior Minister Matteo Salvini in Rome on October 3 | Giuseppe Lami/EPA

4. Will Italy be the next Greece?

Both the Leagues Matteo Salvini and the 5Stars Luigi Di Maio said they have no intention of backtracking on the budget proposals. However, bond yields rose during early trading on Wednesday after Moodys Analytics economist Mark Zandi told Italian daily La Stampa that the “budget was a mistake that will reflect on the countrys rating.” However, Zandi, who works for a subsidiary of the ratings agency and does not focus on ratings actions, said: “Ratings decisions are based on numbers not politics.”

Tria has said “we are ready to act if the spread between Italian and German government bonds yields reaches 400 basis points.” But Salvini and Di Maio dismissed concerns and suggested there must be some sort of investors “conspiracy” against the country. The measures contained in the draft take into account a debt yield figure of around 240 basis points but if borrowing costs go up significantly, the governments math will have to change. Debt yields reached 3.75 percent this week, a four-year high, and investors are now eyeing the 4 percent mark (which translates into the 400 basis points Tria mentioned) as the “tipping point” for a possible eurozone contagion.

The situation isnt helped by ongoing rumors that Tria will be sacked and replaced by a more “friendly figure.” But according to two government sources, “it isnt realistic at this point because as much as wed like it, it would put too much pressure on the government.”

Moodys and S&P will give their verdict on Italys sovereign debt at the end of this month, and a downgrade seems highly likely. “I dont see how it can be avoided with these numbers,” said one ratings agency official in London. Italy is just two notches away from “junk.” A double downgrade would make it impossible for many corporates and the European Central Bank to buy Italian bonds — making it extremely hard for the country to finance its debt on its own.

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