Political instability in Italy is unlikely to affect the rest of the eurozone in the short term, but it will keep weakening the country's prospects for a substantial economic recovery. The European Union is worried that Italy could breach the bloc's deficit and debt targets. At 130 percent of gross domestic product, Italy has the second-highest debt-to-GDP ratio in Europe, and public spending has been growing at a faster pace than fiscal revenue (according to Eurostat, Italy's total general government expenditure is at 50 percent of GDP, below France's 56.6 percent but above Germany's 44.7 percent). Rome presented a budget for 2014 that was designed to keep the country's deficit below the 3 percent of GDP ratio established by EU legislation, and the Italian government is undertaking a spending review, but Brussels is worried that the new government of Prime Minister Matteo Renzi could break its promises. The fiscal compact treaty, which was designed to apply stronger control on national budgets, will enter into force in 2015, but several EU officials are worried that the pact will not be implemented effectively.
While the European Union will pressure Rome to honor its commitments, this pressure will not be the main factor driving Renzi's decisions. Countries such as Spain and France have made it clear that targets and goals can be continually renegotiated with no significant repercussions from Brussels. Some EU officials also suggested that the EU Commission could be flexible with Italy if Rome presented a comprehensive reform program. On Feb. 23, Renzi spoke with German Chancellor Angela Merkel and agreed to visit Berlin in mid-March to discuss his plans. Italy will likely be able to manage its relationship with the European Union and avoid extreme pressure from Brussels.
Rome could feel some pressure from international markets, but things have substantially calmed down since the European Central Bank promised to intervene in debt markets if need be. It is extremely unlikely that Brussels would decide to teach Italy a lesson and withdraw its promise of assistance. The whole system was created to help Italy: in November 2011, as former Italian Prime Minister Silvio Berlusconi was asked to step down, Italian banker and economist Mario Draghi was named president of the European Central Bank. To a large extent, Draghi's promise of intervention brought Italian bond yields down, as well as Portuguese, Spanish and Irish bond yields. This is one of the few EU policies that has actually worked, so no change is expected on this front.
