Extracting concessions

New populist coalition puts Italy on collision course with EU

Italy Politics
Luigi Di Maio, Five Star general, takes on Brussels. Source: AP

After more than two months of haggling and posturing, Italy’s populist Five Star Movement and the far-right League finally unveiled a coalition deal on Friday, filled with promises of tax cuts and government spending increases. With Italy’s government already deeply in debt, the pact sets the scene for the biggest confrontation with the European Union since Britain’s vote to leave the bloc almost two years ago.

Luigi Di Maio, head of Five Star, said the new government heralded a “wave of change” for all Italians. In parliamentary elections on March 4, Mr. Di Maio’s party came out the strongest by far, but needed a partner to govern. The League came in third place – just behind the still-ruling Social Democrats, who will now join the opposition.

If it delivers on its policies, the new administration in Rome could well set the scene for the euro’s next crisis, European policymakers fear. “This brings back memories of the early days of the current Greek government, which sought confrontation with Brussels in 2015 and triggered considerable market turbulence,” said Stefan Bielmeier, chief economist at DZ Bank.

“The only answer to blatant blackmail would be that Italy must exit the euro.”

Clemens Fuest, Ifo Institute

As the two parties were nearing a deal on Thursday, European Commission Vice President Valdis Dombrovskis urged Italy’s new government to stick to fiscal prudence and keep reducing the country’s public debt. “This is our message to the new government. It’s important to stay the course,” Mr. Dombrovskis said.

Italy becomes the first country in western Europe to be ruled by a fully populist government – one that is bent on challenging the European Union’s rules on debt and budget deficits. The parties’ manifesto provides for a review of the so-called euro stability pact. Much maligned by spend-happy European politicians, this touchstone agreement limits members’ budget deficits to 3 percent of gross domestic product and their debt to 60 percent.

With Italy’s tepid economic growth and debt running at a scary 132 percent of GDP – more than twice Germany’s – the cradle of the Roman Empire has long been a worry for euro-zone policymakers. In recent years, populist opponents have blamed the EU for virtually everything that ails the Mediterranean country, making it rife for a backlash against the austerity programs of the mainstream parties.

The coalition parties want to pay for their new spending programs by launching new government bonds – short-term obligations called Mini-BoTs (a variation of Italian treasury bonds, or BoTs). Earlier this year, Italy’s outgoing economics minister, Pier Carlo Padoan, already warned that such bonds endangered financial stability and economic growth.

FILE PHOTO: People walk past a “debt clock” screen displaying Italy’s public debt in Rome
Italy's debt clock may soon run a lot faster. Source: Reuters

The plans include a provision for a basic income of €780 ($918) per month for the poor, lowering the income tax rates to a flat 15 and 20 percent, canceling a planned increase in retirement age to 67, and postponing a hike in value-added tax to 25 from 22 percent. All told, the price tag for the coalition’s spending plans comes to an estimated €65 billion, according to Italian newspaper Corriere della Sera. Carlo Cottarelli, a former director of the International Monetary Fund, says the costs could run as high as €126 billion.

Earlier this week, Matteo Salvini, chairman of the League, said he planned to ask Eurostat, the EU’s statistics office, not to count the €250 billion of debt held by the European Central Bank towards Italian debt levels for the purposes of EU budget rules. But EU officials dismissed the idea, saying that because Italy was the issuer of the debt, it did not matter who held it – private investors or the ECB – as it was still money that Italy owed.

All the same, Mr. Silvana is insisting that Italy’s investment expenditure should not be included in the deficit calculations, in direct violation of Brussels rules.

Some observers were relieved that the coalition partners backed away from the most extreme of its earlier demands, such as forcing Italy’s withdrawal from the euro or holding a referendum on the issue. But suspicions remain that the new regime would exploit the threat of an “Italexit” to extract debt concessions from its euro-zone partners, whom Italy owes a staggering €440 billion.

Italy Elections
Mr. Salvini gives the thumbs-up to debt creation. Source: AP

“Italy could exert considerable pressure on other countries to take over the €250 billion in debt with the Bank of Italy,” said Clemens Fuest, president of the Ifo economic research institute in Munich. If push comes to shove, Germany and its European partners will have to make clear that “the only answer to such blatant blackmail would be that Italy must exit” the euro.

The coalition document is being put to a vote by the parties this weekend. If its members approve the deal by Sunday as expected, the new government could be in place next week, and Mssrs. De Maio and Silvana can present the coalition deal to President Sergio Mattarella, provided that they can nominate a prime minister (candidate still to be announced).

News of the impending deal had unsettled Italian stocks and bonds all week. The rout continued on Friday, when yields on 10-year debt rose to 2.2 percent, their highest level since last October, while Milan’s stock index fell sharply. Meanwhile DBRS, a ratings agency, warned that the coalition’s economic proposals could threaten Italy’s sovereign credit rating.

Jeremy Gray is an editor with Handelsblatt Global in Berlin. To contact the author: j.gray@handelsblattgroup.com

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