Italy experiences only a brief respite

„If we want to rule Italy for a long time, we cannot allow public finances to get out of hand.“ We are quite unaccustomed to such tones from the leader of the populist Lega and Interior Minister Salvini – whose position until now has been more like that of an anti-European hardliner. The negative decision by the rating agency Fitch at the end of last week has evidently prompted a rethink in the Italian executive’s communication strategy, with the prospect of a Maastricht-compliant budget now being signalled. No objections were expressed to this by the coalition partner either, so that the apparent disagreement between Salvini (Lega) and Di Maio (Five Star Movement) on the one hand, and Finance Minister Tria, who has been adopting a moderate line, on the other, seems to have been resolved, at least for the moment.  At all events, capital markets were very relieved to hear the more conciliatory tone of voice. The risk premiums on Italian government bonds have receded noticeably since the beginning of the week.

However, the respite on capital markets will probably only be short-lived because the current budget plans are unlikely to sufficiently concur with the requirements of the EU Commission! For one thing, Brussel’s fiscal requirements call for a deficit significantly below 3% of GDP in view of Italy’s high public-debt ratio. The risk of conflict between Brussels and Rome has therefore not been averted. For another, Salvini – whose party is riding high in the opinion polls – and Di Maio have let it be known that it is their intention to implement, at least gradually, both the flat tax, the universal basic income and the pension reform from 2019 onwards.The question here is how well-conceived and realistic the proposals for raising the funds to finance these projects are. Ultimately, the targeted deficit may well look moderate on paper without there being a more than slim chance of the government actually meeting this target.

Should the details of the draft budget fail to stand up to closer scrutiny, there would not only be a threat of a standoff with Brussels; the rating agency Moody’s could also, as already signalled, soon pass a negative assessment on Italy.  What is more, the longer-term outlook for Italy’s debt sustainability would also remain unfavourable if all measures agreed on in the coalition agreement were to be gradually implemented.

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