EU’s stand off with Italy over budget plans could turn nasty

In an unprecedented and potentially catastrophic move, the European Commission has refused Italy’s budget plan. Italy has been given three weeks to come up with an alternative plan or face ‘consequences.’ It’s the first time the Commission has turned down a budget plan from one of its 27 members.

The decision is already sending shivers through the already fragile financial markets. Traders fear that Italy will forge ahead with its ambitious budget plans despite the EC rebuke. That could lead to an even more damaging bust-up. As one analyst said: “This is going to the wire. This could be one of the biggest punch-ups we have seen since Greece. I reckon the Italians will have learnt from the Greeks and are not going to give up.”

If the Italian government doesn’t come up with a new revised plan, the Commission is threatening financial sanctions and other “consequences” including bringing forward the timeline of “excessive deficit procedure” from next May. Yet the Commission’s decision to turn down Italy’s plan – which break the eurozone’s rules – will come as no surprise to the coalition government, made up of the eurosceptic right-wing League and 5-Star Movement, which have been arguing with the EU for the last few months over the details.

They want to increase Italy’s deficit to 2.4% of gross domestic product to finance its big public spending programme. The amount was much higher than the targeted 1.8 % this year and breaks EU requirements that the deficit should fall steadily towards a balanced budget. What’s more, the Italians have been warned by EU officials for months that they would not be permitted to break the rules but they went ahead anyway.

Only a few days ago, the Bundesbank President Jens Weidmann, said that the Commission was right to be critical of Rome’s plans, and that the government must obey its fiscal commitments. It was an unusual move from Weidmann as most senior policy-makers try not to comment on the domestic policies of another eurozone country. But the Bundesbank chief said that the normalisation of monetary policy will place a greater burden on all highly indebted countries – so there is no place for leniency with Rome.

The College of Commissioners took the same stand today. Announcing the decision at a press conference in Strasbourg, vice president, Valdis Dombroviskis, said: “It is tempting to cure get with more debt… but this would not be fair for the younger generation. Keeping sound fiscal policy and confidence is crucial.” Dombroviskis went on: “This is about making sure Italian companies can raise funding and young Italian families that need a loan can get one at a cost they can afford.”

EC commissioner Pierre Moscovici when further, adding that “this is an unprecedented situation, and the decision should not be surprising to anyone as the Italian government’s draft budget represents a clear and intentional deviation from the commitments made by Italy last July.”

The Italians knew this. As Finance Minister Gioanni Tria wrote in his letter to the Commission: “Italy is aware it has chosen a path that isn’t in line with EU rules. It was a hard decision but necessary in order to bring the country’s GDP back to pre-crisis levels and considering the ongoing economic difficulties for Italians.” He also promised to stick to the rules in future years.

So what now? How will the Italians respond?  Could resentment with the EU boil over into full-scale war?

To date, Italian Prime Minister Giuseppe Conte has tried to steer a clever path between his eurosceptic ministers and the EU, claiming that Italy is committed to staying within the eurozone. But this latest rebuke is likely to spark fury from deputy prime minister, Matteo Salvini, and head of the 5-Star Movement, Luigi De Maio, who has said he will not entertain backtracking on what was agreed in Cabinet.

Both leaders have been persistent critics of the euro and their power base rests on the generous promises made to voters in this year’s election that spending on infrastructure and welfare will increase.

Both have since toned down their anti-euro rhetoric because of the harsh realities of governing but also ahead of what they knew would be delicate negotiations with Brussels and to keep foreign investors sweet.

Since budgetary plans were agreed by Italy’s government, the country’s borrowing costs have soared with the gap between Italian and German 10-year bond yield spreads briefly reached its widest level in 5 and a 1/2 years. This has spilled over to fears for the overstretched banking sector due to higher yields on government debt, reducing the value of lenders’ large holdings of Italian bonds.

It’s too early to tell whether this latest contretemps with the Commission will provoke Salvini and di Maio to take up arms against the euro again. What’s more likely is that we are going to see months and months of back and forth sniping until a deal is finally done. Hopefully they will not be as tortuous as our own Brexit negotiations.

Back in 1997, the prime minister at the time, Romano Prodi, said, while making the case for Italy to join the eurozone, that it was “impossible to think of Europe cut off from its great Latin culture.” Does that hold true today?