The panic following the announcement of Italian official deficit target of 2,4% for 2019 was followed by the expression of political criticism, at home and abroad.

The budget crisis

The Italian government announced on Thursday evening that it would aim for a 2019 budget deficit of 2,4%, triggering a market panic. 2,4% is treble the official deficit target set by the previous Italian centre-left government in spring (0,8%).

Until Thursday evening, the Minister of the Economy Giovanni Tria was insisting on a budget deficit target of 1,6%, that is, double the original projection but marginally lower than the 2018 projected deficit (1,7%). That triggered speculation that Tria would resign.

On Friday morning 10-year sovereign bond yields started to climb, breaking the 3% before the end of the day.

Milan’s stock market saw its main index drop by 4%. The two biggest banks, Unicredit and Intesa Sanpaolo lost approximately 8%.

The Italian government reacted with a mixture of appeasement and defiance.

“Now dialogue will start with the EU and the big private investors and we do not intend to have a clash,” deputy prime minister Luigi Di Maio said. Prime minister Giuseppe Conte expressed his certainty that the Italian budget will not be rejected in Brussels, reiterating Rome’s determination to reduce debt by boosting growth.

Deputy prime minister Matteo Salvini was in a more combative mood on Saturday. “Years of budgets imposed by Europe have made our public debt explode… finally we are changing course and betting on the future and on growth,” Salvini said.

Salvini said that the 2,4% deficit represents €15bn of additional investment, which will boost growth.

Policy background

The 2,4% deficit remains below the 3% threshold set by EU regulations, although it challenges the European Commission that is demanding from Rome to maintain its debt-to-GDP ratio in a downward trajectory.

The Italian government will have to submit its final budget draft to the European Commission by October 15. By November Brussels will issue its own recommendations. Moodys is expected to follow with its own report for the Italian economy at the end of October.

The Italian debt-to-GDP ratio stands at 130% and is second only to Greece. The Italian government argues that its new economic policy will stimulate growth, keeping the debt-to-GDP ratio under control.

In absolute numbers, the Italian public debt amounts to €2,3 trillion, that is, the highest in the Eurozone.

Evidently, the Five Star Movement is driving the policy debate.

The Five Star Movement (MS5) expects its flagship policy of a minimum guaranteed citizens’ income of €780 a month to be rolled out in March. The MS5 also insists on lowering the age of retirement.

To the contrary, the promise for a decisive curb in corporate taxation promised by Lega will be diluted. There will be debt relief on the overall tax burden of the self-employed (15%) and a planned VAT hike will not go forward. However, a two-tier corporate flat tax rate (15-and-20%) will have to wait.

Political reactions

On Saturday the Italian President Sergio Mattarella recalled that the Italian constitution requires governments to guarantee “balanced budgets and the sustainability of debt.”

His views were echoed by the Governor of the Bank of Italy, Ignazio Visco, who insists that the Italian public debt must be “put on downward path,” the public news agency ANSA reports.

One of the concerns is that increased sovereign bond yields will add pressure on the Italian budget, reducing rather than increasing Rome’s scope for welfare policy.

European Economics Commissioner Pierre Moscovici reiterated on Friday that it was in Italy’s national interest to reign over its “explosive” public debt.

On Sunday, Dutch Prime Minister Mark Rutte also expressed his concern; the Finnish finance minister Petteri Orpo was more outspoken, referring to the Italian government’s populism and lack of responsibility.