EconoMatters, Rethinking Europe

The Battle for Italy (Continued)

The European Commission exposes Italy’s wishful thinking.

Takeaways


  • With a new set of forecasts, the EU Commission has just raised the pressure on Italy to revise its spending plans.
  • Faced with the sobering EU forecasts for Italian GDP growth, the Italian government has accused the EU Commission of treating Italy different to France.
  • A credit crunch with a refusal of banks to lend and higher borrowing costs for businesses could turn into a catalyst for change in Italy.
  • Once the next global recession reveals the weaknesses of the Italian economy, Rome must either undertake serious pro-growth reforms or leave the euro.

With a new set of forecasts, the EU Commission has just raised the pressure on Italy to revise its spending plans. The EU now expects Italy’s fiscal deficit to surge to 3.1% by 2020 – above the Maastricht limit.

Italy vs. France

Faced with the sobering EU forecasts for Italian GDP growth and the like, the Italian government has accused the EU Commission of treating Italy different to France.

However, in the Q&A after the presentation of the forecast, Commissioner Pierre Moscovici stressed that the Commission would not treat the countries differently.

The EU commission has approved the French fiscal plans as France’s structural balance is pointing in the right direction, thanks partly to a wide array of structural reforms introduced by President Emmanuel Macron. By contrast, Italy’s structural deficit is going up.

Who will blink first?

Of the two radicals calling the shots in Italy, the 5Stars’ Luigi di Maio and Lega’s Matteo Salvini, the latter seems to be less fiscally irresponsible.

Whereas the Lega stresses its anti-immigration stance, the 5Stars consider expanded welfare spending as their top priority. According to opinion polls, Salvini’s Lega would gain in hypothetical new elections whereas 5Stars would not.

If the going gets rough in coming weeks, as it may, Salvini could use his stronger position to force di Maio to accept some changes to the budget that would help to prevent an immediate debt crisis.

In such a case, Italy would only be a minor drag on business confidence and growth in the Eurozone as a whole beyond some short-term irritation.

A possible catalyst

A credit crunch with a refusal of banks to lend and higher borrowing costs for Italian businesses could turn into a catalyst for change.

If Matteo Salvini’s business owners in the North, which make up a significant part of the Lega’s base, face credit constraints and higher lending rates, they could lean on Salvini to drop out of the coalition with the 5Stars and try a coalition with Silvio Berlusconi’s centre-right party and the right-wing Fratelli d’Italia instead.

Global recession

Once the next global recession reveals the underlying weaknesses of the Italian economy in, say, 2021, a massive sell-off in Italian debt may finally force Rome to choose between two options it considers equally distasteful at present: Either undertake serious pro-growth reforms coupled with an end to spending excesses – or leave the euro.

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About Florian Hense

Florian Hense is European economist at Berenberg Bank in London.

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