Italian deficit worries the EU

It is a kid-glove confrontation – and yet it is of great importance. Because it is about the question of when and how the euro states should leave the fiscal policy state of emergency and return to regular budget management. “We cannot postpone consolidation forever, the governments have to start at some point,” warns Guntram Wolff, director of the Bruegel Economic Institute.

There is also growing concern in the EU Parliament. “Italy is a cause for concern with its high level of debt,” says CSU finance politician Markus Ferber. Especially since the support of the European Central Bank will fail “in the medium term”.

For years, the ECB has been helping to lower interest rates in the euro area by buying government bonds. Southern European countries in particular benefit from this. But rising inflation could soon force the central bank to correct its course – and leave the government in Rome to the whims of the capital markets. “If investors lose confidence, it will be priceless for Italy,” warns Ferber.

Italy currently bears almost a quarter of the debt burden in the euro zone. At the end of the year, the mountain of debt could pile up to 2.7 trillion euros – a new record. This makes the country a systemic risk for the euro zone, or in the jargon of the financial crisis: “too big to fail”.

Prime Minister Mario Draghi has repeatedly emphasized that he wants to reduce liabilities. But also that there is only one way to do this for him. “We, but also the French, the Spaniards, all Europeans, will only get out of this high debt situation through higher growth,” said Draghi months ago.

He has also recently made more and more calls for the EU to reform its debt rules. These stipulate a maximum national debt of 60 percent of the national economy and limit the permissible budget deficit to three percent.

National debt in the euro zone average at 100 percent of economic power

The EU Commission has initiated consultations for a reform of the Stability and Growth Pact. In the coming year, Monetary Commissioner Paolo Gentiloni, who himself will be Italian Prime Minister from late 2016 to mid-2018, will present his proposals. During the pandemic, the national debt on average in the euro zone rose to 100 percent of economic power.

According to the current rules, Italy would have to generate such high surpluses that the country would reach the 60 percent mark again within 20 years. According to economists, this would require such severe budget cuts that Italy and similarly indebted countries would face a severe economic slump – and the debt level, measured against national economic strength, would even rise.

The EU’s 750 billion euro reconstruction fund was set up specifically to protect the euro countries from a self-destructive austerity policy. Italy alone can expect 191 billion euros from Brussels, almost a third of which are grants that do not have to be repaid. Rome should use this opportunity to limit national spending, says economist Wolff. “Otherwise the deficit will be too high and the adjustment required later too hard.”

Omikron, the new, apparently highly contagious variant of the coronavirus, is fueling additional uncertainty. “It cannot be ruled out that the protection of previous vaccinations is poor and that new lockdowns are necessary,” argues Wolff. In this case, the governments would have to support the economy with new aid programs. That is one of the reasons why it is wise to keep financial leeway.

The International Monetary Fund (IMF) comes to a similar assessment. IMF boss Kristalina Georgiewa took part in the Brussels meeting of the Eurogroup and presented the analysis of their economists. “Credible medium-term consolidation plans should be announced now,” demands the IMF. Georgieva had already warned a few days ago that Omikron would cloud its growth prospects. “A new variant, which could spread very quickly, can affect trust,” said the IMF director.

Government does not want to stifle growth

A flare-up of the pandemic would be particularly dramatic for Italy. The country was hit particularly hard by the crisis. In 2020 economic output collapsed by almost nine percent. At the moment it seemed as if Italy was gaining traction again. The economy has developed more dynamically than it has been in a long time: it is expected to grow by more than six percent in 2021 – 1.5 percentage points better than forecast at the beginning of the year and much faster than many other industrial nations in the world.

The level of 2019 will be left behind by the Italian economy in the first half of the coming year, and GDP growth is estimated at 4.6 percent for 2022. The government does not want to stifle this growth under any circumstances – and continue to borrow. The budget deficit is expected to be 5.6 percent of economic output in 2022, well above the Maastricht criteria. Of the 30 billion euros in the new budget law, twelve billion alone are earmarked for tax cuts.

Above all, families with low incomes should benefit from a tax reform. But pensioners will also have to pay less taxes in the future. According to the draft, which has to go through parliament by the end of the year, even high earners are asked to pay less.

With such spending-friendly plans, doubts arise as to whether Italy is seriously pursuing the goal of tackling structural debt. It is already 155.6 percent of gross domestic product (GDP). In the euro zone, only the Greeks are worse off. If you look at budget planning for the coming years, this figure will only shrink slowly: Finance Minister Daniele Franco is still planning a debt of 146.1 percent of GDP in 2024. Before Corona, this value was 134.8 percent.

After all, debt servicing has recently fallen due to the low interest rate level. While the weighted average cost of liabilities was four percent in 2012, it has now fallen to an estimated two percent. Currently, Italian government bonds with a ten-year term have an interest rate of 0.9 percent – lower than they have been for a long time. And thanks to rising inflation, which was 3.8 percent in November, as high as it was last in 2013, Italy’s mountain of debt is melting off somewhat.

Companies criticize budget planning

Nevertheless, the industry association Confindustria also criticizes budget planning: It is “not an essential step towards modernizing the country”. For companies there is “nothing” in the budget, complained Confindustria President Carlo Bonomi in an interview with the newspaper “Corriere della Sera”. “On the contrary, there are a number of points that undermine the growth of the companies.”

The API association, which represents small and medium-sized companies, has a similar opinion: “Our companies are the ones that are innovative,” explains API President Paolo Galassi. “But they need more support.” In the case of green innovation, for example, a centerpiece of the EU reconstruction fund, he sees “not yet a real project” by the government.

For the Italian economist Lorenzo Codogno, “no budget consolidation is in sight” either. The country has deep structural problems, the reforms initiated by Draghi’s government and increased investment are not enough to change the outlook for the long term.

Codogno is certain: “This government would have to remain in power for at least five years to ensure that reforms are not only passed but also implemented.” But that is not particularly likely given the chronic instability of the Italian system of government.

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