“If fully implemented, Italian fiscal measures could prove very costly and derail Italy’s debt dynamics.”
September will be a key month for gauging the Italian government’s budgetary plans for 2019. The government has communicated neither a precise timeline for implementing the measures announced in its ‘contract for government’ nor a precise cost analysis for these measures.
In this contract, the governing coalition, made up of the Five Start Movement (M5S) and the League, committed to a significant degree of fiscal easing via measures such as a flat tax and a partial roll-back of the 2011 Fornero pension reform, as well as a kind of universal basic income. These measures, if fully implemented, would likely prove very costly and thereby derail Italy’s debt dynamics (according to an estimate made by one think tank, the government’s plans could cost between 6.2% and 7.1% of GDP).
The Italian government will need to submit its draft budget plan to the European Commission by October, leading to a period of negotiations. The road to an agreement is likely to be bumpy before the Commission announces whether the Italian budget complies with EU rules or not at the end of November.
An agreement on the draft budget will depend on the fiscal flexibility that the Commission is willing to give Italy:
- A contained slippage of the deficit (1.4%-1.6% of GDP in 2019) might get the green light from the Commission and would be greeted with a sigh of relief by markets. However, this could create some political tensions in Italy.
- The Italians could propose an ‘in-between’ fiscal stance (with a deficit above but close to 2% of GDP in 2019), with infrastructure spending excluded from EU deficit rules. Such a proposal would lead to market tensions and to a confrontation with the Commission, as it breaches EU deficit rules. Any move by the Italian government to boost debt-funded public investment would be quite complicated as Italy has already benefited from some flexibility on this score in previous years.
- One should not underestimate the possibility that the Italians will adopt an aggressive fiscal stance, pushing for a deficit at or above 3% in 2019. This would put Italy on a collision course with Brussels and push the Commission to open an excessive deficit procedure. It would also likely derail Italy’s debt dynamics.
All in all, there is room for the Commission and the Italian government to find an agreement on fiscal spending, but the road is likely to be quite bumpy and lead to significant market volatility.