Italy had until Tuesday this week to respond to the European Commission’s demands over its outsized budget, and it hasn’t disappointed its new populist-leaning voters: Scoring another political capital coup, Rome’s far-right government has defied Brussels and vowed to spend, spend, spend—no matter the consequences.
The rest of Europe is worried that Italy will drag it down with it, and an economic crisis would be infectious. So much so that it made an unprecedented move to warn Rome that if it failed to adjust its budget to something more realistic, it would face penalties and fines. After all, Italy is the EU’s third-largest economy. If it falls, it won’t do so without hostages.
Italy’s national debt is at 132 percent of GDP and it’s got one of the slowest growth rates in the euro zone, with unemployment at 11.2 percent.
Still, Italian Finance Minister Giovanni Tria said the deficit target for the 2019 budget would remain at 2.4 percent, with a growth forecast of 1.5 percent.
Italy is hoping to reduce debt by using funds from privatization equal to 1 percent of GDP. The EU’s main problem with Rome’s budget was that it wouldn’t have seen debt fall enough. However, the 2019 budget still envisions an increase in the structural deficit, according to Reuters, by 0.8 percent of GDP. EU requirements are that structural deficit be cut by 0.6 percent of GDP.
Brussels is also taking issue with Rome’s growth figures, which it finds unrealistic. Still, Italian deputy prime minister Matteo Salvini insists asset sales will be increased, while spending will be monitored.
Investors fear that Rome is on a destructive path that will see it take on more debt than it can handle, with dangerously rising bond yields, which have almost doubled this year. That means higher borrowing costs putting pressure on the country’s banking system.
Indeed, Italian government bond yields rose to a three-week high on the news, prompted by fears that the 2019 budget will raise borrowing costs further. The 10-year bond yield hit 3.55 percent, while Italy’s five-year credit default swaps rose 7 basis points from Tuesday’s close, Reuters cited HIS Markit as reporting.
At the same time, yields on higher-rated euro zone bonds fell in part on Italy’s renewed volatility. Related: Why Are Wall Street Banks Fighting Over Gamers?
"Continued pressure on Italian government bonds could spark a major debt crisis, which could easily spread across the region," media quoted David Madden, market analyst at CMC Markets UK, as saying.
Pascal Blanque, the head of Amundi, Europe’s biggest fund manager, told Reuters that Italian bond spreads could go even wider before a solution is found.
“We are in a critical phase between today and the European parliamentary elections (in May 2019). In terms of positioning, we err around neutrality,” he told the Reuters Global Investment Outlook Summit.
In the meantime, Rome shows no sign of backing down. As Bloomberg puts it, Salvini is essentially daring investors to sell Italian bonds until the yield spread over Germany reaches 400 basis points. That hasn’t happened yet because credit ratings agencies haven’t downgrade Italy to junk.
Nor is Italy under much public pressure at home to bow to Brussels. As we’ve mentioned before, Italians are tired of living under austerity, and the age of fiscal irresponsibility has firmly taken hold. In fact, support for the far-right government has increased since it’s made a show of taking on the European Union and not backing down from its defiance.
What’s next? On November 21, the European Commission will be giving an opinion on Rome’s revised 2019 budget draft. Rome isn’t worried.
“We have not changed our targets because our major commitment is to give growth to the Italian economy,” said Davide D’Antoni, a spokesperson for Italy’s 5Stars party in Brussels, as cited by Politico.eu. “We believe that expansionary fiscal policies, financed by increasing deficit spending, will lead to higher economic growth and better public finances.
“This stance is not defiance,” he said, adding the Italian government wants to continue its dialogue with Brussels.
Politico.eu cited “two people familiar with the discussions” as saying that Italy believes “sanctions can be avoided.”
By Josh Owens for Safehaven.com
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