Euro-Area Finance Chiefs to Talk Italy as Sanctions Threat Looms

Nov 04 2018, 7:33 PMNov 04 2018, 8:57 PMNovember 04 2018, 7:33 PMNovember 04 2018, 8:57 PM

(Bloomberg) -- Euro-area finance ministers gathering in Brussels on Monday will discuss Italy’s escalating budget standoff with the EU as the bloc waits for the government in Rome to respond to the unprecedented rebuke it received two weeks ago.

The discussion comes as Italy is asked to submit revised spending plans by Nov. 13, after the European Commission essentially rejected the country’s budget for 2019, saying that it constitutes a clear deviation from commonly agreed fiscal rules. Despite repeated warnings, Prime Minister Giuseppe Conte has said there’s no “Plan B” for the fiscal program, indicating the government has no intention to comply with EU demands.

Italy’s deputy prime minister told the Financial Times in an interview published Sunday that he believes Rome’s controversial spending plans will become “a recipe” for reviving European growth and that the continent is ready to abandon austerity and embrace the deficit-busting approach of U.S. President Donald Trump.

Given the populist government’s reluctance to revise its budget, the standoff with Brussels is set to escalate further in the coming weeks. At their meeting on Monday, finance chiefs are likely to back the commission’s stance toward Italy, something already done by their chief aides, who debated the matter last month.

Once Italy responds to the commission, the EU’s executive arm will have three weeks to publish its final assessment -- which may include triggering a procedure that could eventually lead to financial sanctions for the government in Rome. The penalty could reach 0.2 percent of the country’s annual economic output.

The commission’s rejection follows months of discord and tension over the spending targets, which Italy itself accepts are in breach of EU rules. Italy has the highest debt ratio in the euro area after Greece, and its plans have unsettled investors, sending its bond yields to multi-year highs last month.

Moody’s Investors Service last month downgraded Italy to just one level above junk, but the country managed to avoid a second rating downgrade as S&P Global Ratings decided only to lower its outlook on the nation’s creditworthiness. Still, a further escalation will likely fan market jitters.

EU Rules

Financial penalties proposed by the commission have to be approved by member states, which can block the process. But while Brussels has no real powers over national budgets, governments have in the past sought to avoid an official reprimand because of the stigma and the potential market implications.

Under EU rules, no country should have a budget deficit larger than 3 percent of gross domestic product or debt above 60 percent of output and those that are outside of those limits must set annual targets to show they’re moving in the right direction. While Italy’s deficit is well within the 3 percent limit, the commission has demanded smaller gaps for the country to bring down its debt load.

Crucially, the so-called structural deficit, a key measure for the commission, which strips out effects of the economic cycle and one-time spending items, is also way off the mark. Italy projects this will deteriorate by 0.8 percentage points of GDP while the commission has demanded an improvement of 0.6 percentage points.