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Late Tuesday evening, Finance Minister Giovanni Tria sent Economic Affairs Commissioner Pierre Moscovici and Vice President Valdis Dombrovskis the long-awaited reply to their letter asking the Italian government to rework its draft budget plan, which flouts the country’s previous commitments under the EU’s fiscal rules.
The Italian government did make a small concession by including so-called safeguard clauses that would be automatically triggered to avoid the deficit-to-GDP ratio climbing above 2.4 percent in 2019 and to sell some real estate properties belonging to the state, according to statements made by 5Stars leader and Deputy Prime Minister Luigi Di Maio after Tuesday night’s Cabinet meeting.
On his way out from Prime Minister Giuseppe Conte’s office, he said: “We won’t go over 2.4 percent deficit, and we believe in 1.5 percent economic growth next year.”
“If Brussels like our plan we’re happy; if not, we press forward,” added the League’s Matteo Salvini, Italy’s other deputy prime minister.
The Italian government’s deadline for sending a reply to the Commission was before midnight Wednesday.
Earlier on Tuesday, Tria issued a statement saying, “the growth rate isn’t negotiable as the forecasts are exclusively technical.”
In response to Rome’s defiant stance, the Commission could launch the so-called “excessive deficit procedure” (EDP) against Italy as early as November 21. [...]
Related op-ed on Financial Times: Italy’s budget row leaves eurozone in limbo
[...] The Italian budget stand-off is a serious matter for the euro area and for world markets in general. Italy’s coalition government is pledged to increase spending through a basic income scheme, wants to lower taxes rather than increase them and needs substantial infrastructure renewal.
Much of Italy and her ruling parties resent the Fornero pensions cuts they were made to apply in 2011 and wish to reverse part of them. The EU Commission is insistent the rules apply to Italy, which means it needs to cut its deficit further and get to the point where the state can pay off some its huge debts. Italy’s government says its draft budget, with a deficit of 2.4 per cent, is within the EU ceiling of 3 per cent. The EU points out Italy has state debt more than twice the permitted level of 60 per cent of GDP, so the country should be taking steps to cut its borrowings, not increase them. Indeed, the EU has recalculated Italy’s figures on more cautious assumptions and claims Italy will even break the 3% deficit ceiling in 2019-20.
All of this could be bridged by a bit of creative accounting and some give and take. With a relatively optimistic forecast for growth, Italy could start to cut debt as a percentage of GDP even though it is still borrowing a bit more. With some adjustments to assumptions about tax collection and costs of programmes, the two lines of revenue and spending could be brought closer together without public cuts to cherished programmes. So far it does not look as if the EU wants to do this, and thinks too much of this has already been done to present a better face to the Italian budget.
The EU has been here before with Greece and Cyprus. In each case, the EU stuck firmly to its positions and there was concern in markets, followed by the errant states giving in. There are two ways the EU can increase the pressure on Italy to cut spending or raise taxes. It can do more of what it seems to be doing now, which is trying to get the Italian bond markets to sell off. This raises interest rates, making the government’s budget more difficult, and increases the cost of capital for Italian companies and individuals. The EU seems to hope bond vigilantes will frighten the Italian government into amending its budget.
The other way is the draconian approach used to bring Greece and Cyprus into line. The ECB could refuse to finance the Italian commercial banks to the extent they want. This forces commercial banks to refuse access to customer deposits, or to ration the amount of money people can withdraw. It rapidly seizes up the economic system — which gets the attention of errant governments. It also does a lot of damage to markets.
Doing this on a scale to tackle Greece was dangerous but it worked quite quickly and markets soon recovered. Doing it at 10 times the scale in the Italian case would be very damaging to euro assets and would have knock-on effects in other locations. Greece decided to give in because it wanted to stay in the euro. Italy will be told that it needs to give in if it wants to remain in the single currency with access to all that free money from the ECB. [...]
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Related article on The Economist: An Italian budget showdown underlines the need for euro-zone reform