Jun 5, 2019 | 21:33 GMT

4 mins read

Italy: Facing Another Battle With Brussels, Rome Maps Its Next Move

The Big Picture
In previous forecasts, Stratfor identified Italy as the main source of economic and political risk in the eurozone. The continued escalation of Rome's dispute with Brussels over its high deficit and costly fiscal policies aligns with this assessment.

What Happened

On June 5, the European Commission issued a report arguing that an Excessive Deficit Procedure (EDP) against Italy is justified and asked EU governments to authorize the implementation of one. The bloc's finance ministers are expected to make a decision on the matter July 9. If the EDP is approved, Brussels would watch to see whether Italy implements policies to reduce its debt and deficit. Failure to heed the commission's requests could eventually result in a fine of up to 4 billion euros (or roughly $4.5 billion).

Why It Matters

The government in Rome has roughly a month to convince Brussels and the rest of the EU governments that it is committed to reducing its deficit and debt. Italy avoided sanctions over this same issue in late 2018 by promising to keep its deficit at 2.04 percent of gross domestic product (GDP) this year. But Brussels believes that the Italian government's policies — which include higher welfare spending and tax cuts — will increase its deficit, which, when combined with Italy's dismal growth rates, would lead to a higher debt-to-GDP rate.

In the coming weeks, the Italian government will fight a battle not only at the European Union level, but also at home as it tries to balance between promising reforms to Brussels without abandoning flagship domestic policies. For example, Italy could promise to increase state revenue by cracking down on tax evasion, while rejecting EU demands to cancel popular domestic programs such as a recent pension reform that allows for early retirement. Meanwhile, the two governing Italian parties (the populist Five Star Movement and the right-wing League) will spar over which priorities to rescind or downsize — risking additional discord within an already fragile government alliance.

An excessive deficit procedure could lead to higher borrowing costs for Rome by spooking financial markets, making it all the harder for Italy to escape its massive deficit.

Should the European Union formally trigger an EDP against Italy in July, it could be years before Rome would face any concrete sanctions. But an EDP would involve permanent demands for deficit-reduction measures that would exact a high political cost for Italy's government, which has remained highly critical of Brussels-promoted austerity measures. But more importantly, an EDP could make financial markets nervous and lead to higher borrowing costs for Rome — making it all the harder for Italy to escape its heavy debt burden, which stands at roughly 132 percent of GDP (the second-highest rate in the eurozone after Greece). 

Desperate Times Call for Desperate Measures?

As Rome prepares for another battle with Brussels, some lawmakers are considering more extreme measures. Last week, the Italian Chamber of Deputies approved a nonbinding motion that, among other things, called for the creation of so-called "mini-BoTs" — bonds in small denominations (ranging from 5 to 100 euros) that could be used make payments to the state, such as for taxes. While the proposed bonds would not technically be an official currency, in practice they would function as such.

The idea has been around for years, with supporters arguing it would increase the supply of money and boost economic activity in Italy. However, its implementation risks running into at least two major problems. First, the European Union could see it as a violation of eurozone rules, which names the euro as the only legal currency in member states. And second, it could ignite fears among Italians that the bonds would be the prelude to an exit from the eurozone and lead to a bank run in which worried savers would move their money outside Italy. Those issues make it unlikely that the country would install such a policy any time soon, and will thus probably remain a pipe dream among nationalist politicians. But the fact that the country's parliament has discussed it suggests that Rome wants to send Brussels a message that all options are on the table during this time of fights over Italy's policies. 

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