The negotiations in Rome over the 2019 budget are entering their final stage – the government is obliged to present a draft budget to parliament by 27th September. Behind the scenes, the parties involved are trying to thrash out a compromise, with the main battlelines currently being drawn between Finance Minister Tria and Five Star leader Di Maio. Tria is continuing to advocate a budget deficit well below 3% of GDP and in compliance with the European Commission’s requirements. By contrast, Di Maio is mainly seeking to promote a universal basic income, which would inevitably lead to a higher new borrowing requirement. Of late, Lega chairman Salvini has surprisingly kept his head below the parapet, even though his party is actually leading in the opinion polls by now, benefiting above all from the government’s hard line over the migration question. As of yet, the outcome is wide open: an agreement between the warring parties, Tria’s resignation, or even a breakdown of the coalition would all appear to be possible scenarios.
Recently, capital markets have kept decidedly cool about the renewed political escalation in Italy. Since the beginning of September, spreads on Italian government bonds have narrowed to a noticeable extent in response to the fact that the government has been sounding a considerably more level-headed tone, at least in the direction of the market. True, risk premiums had previously widened to a marked extent from April until late August; the current recovery trend must therefore, so far, be interpreted as more of a consolidation at a still high level.
The current political situation involves a two-way risk. If the government comes up with a compromise in the budgetary spat and if the budget presented – including ideas for finding the funds to pay for the flat-tax and basic-income proposals – convinces investors, at least in part, the upheavals surrounding the Italian government could subside and market gyrations may become less pronounced. Admittedly, Italy’s major structural problems would still be a burden: mention should be made here of the persistently high volume of impaired loans with which the banking sector is saddled, the towering public-debt ratio, relatively inefficient administrative structures and a large underground economy. By contrast, if the quarrel within the cabinet were to escalate further, with the moderate Finance Minster Tria maybe resigning, a new wave of political chaos and massive market disruptions would threaten. Italy, in other words, is standing at a crucial crossroads.