September 27, 2018 / 2:05 PM / 2 months ago

Brussels in waiting mode as Italy budget uncertainty rattles markets

BRUSSELS (Reuters) - EU officials were waiting anxiously on Thursday for the eurosceptic Italian government’s decisions on its deficit targets for next year, which could challenge the bloc’s fiscal rules and further rattle markets.

FILE PHOTO: People walk past a "debt clock" screen, installed by Bruno Leoni Institute's analysts, displaying Italy's public debt at the Termini central station in Rome, Italy February 15, 2018. REUTERS/Alessandro Bianchi

Fearing that public statements from Brussels could inflame the eurosceptic wave in Italy, they have largely preferred to maintain silence, but informally admit “concerns” for its economy and the risk of spillovers into other euro zone countries.

“Let the markets talk” is the refrain repeated by officials, implying that Italy may be forced into fiscal discipline by higher yields on its sovereign bonds and crashing prices of its domestic bank shares rather than by EU recommendations.

Market pressure resurfaced vigorously on Thursday as the Italian press reported divisions within the government on fiscal plans.

A spokesman for the European Commission on Thursday declined to comment on Rome’s budget plans until they are submitted to Brussels. The government is expected to agree its targets later in the day and submit a draft budget for next year by mid-October.

Privately, EU officials say nobody expects Italy to stick to a pledge of a structural correction of public finances worth 0.6 percent of the country’s gross domestic product next year.

The issue is how broadly this target can be missed. Under highly complex EU rules, a member state may deviate from targets by a maximum of 0.5 percentage points over two years.

RED LINES?

EU economics commissioners have repeatedly stated they expect Italy next year to “improve” its structural deficit, a measure that strips out the effects of the business cycle and one-off income and spending.

This in turn would allow a reduction of the country’s huge debt, the second largest in the EU after bailed-out Greece as a proportion of GDP.

They have not clarified publicly what headline deficit figure would correspond to a minimal structural improvement, but EU officials have informally said between 1.5 and 1.7 percent of GDP could allow a debt reduction.

A 1.8 percent headline deficit could also be consistent with a slight drop in Italy’s debt, which hovers dangerously around 130 percent of GDP, but only in exceptionally positive circumstances.

The Commission said it had reached an “understanding” on fiscal targets with Italy’s Finance Minister Giovanni Tria, but many in his government are pushing for a deficit above 2 percent, to meet election promises on tax cuts, a lower retirement age and a basic income for the poor.

That could cross Brussels’ red lines.

EU reaction depends on how far Italy tries to bend the rules. The Commission could reject its draft budget after receiving it in mid-October, but this is a “nuclear option” that has never been used against euro zone states who have broken fiscal rules in the past.

More likely, the Commission would wait until spring to decide whether to open a sanctions procedure against Rome, when final figures for the 2018 deficit will be available.

That is very close to European Parliament elections in May, and political considerations might weigh heavily on its decisions then.

Reporting by Francesco Guarascio; editing by Andrew Roche

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