Italy offers to change GDP estimate as EU demands revised budget

The deadline for the Italian government to submit a revised budget to the EU Commission is Tuesday. 

Italy has said it will not change its deficit spending plans setting up a potential test of the Commission’s never used enforcement mechanism.  

Giovanni Tria, the Italian Finance Minister has offered to lower the government’s estimate for 2019 economic growth to 1% from 1.5%, according to Italian media reports, but would leave the proposal for deficit spending at 2.4% of GDP.

Because the government spending plans for 2019 are set this year, basing the deficit on a percentage of next year’s GDP means the size of the deficit depends on the estimated growth rate of the economy. If the government is correct and the economy grows at 1%, the deficit would be 2.4% of GDP. But if the economic expansion is slower, the already set deficit amount would be a larger percentage of GDP, if the growth is faster it would be smaller.  

The Italians have promoted the latter scenario saying that the deficit spending and consumption is necessary to lift the economy from stagnation and that faster growth will reduce the deficit percentage. The Commission has complained that Italian growth targets are far too optimistic, and predicted their own estimate of 1.2% GDP growth in 2019 would produce a deficit percent of 2.9%.

Since reducing the growth rate for 2019 lowers the size of the deficit, it also lowers the amount of borrowing Italy would have to obtain from to the credit market.

Officially the EU has a treaty deficit limit of 3% of GDP but that limit has been breached by several EU countries notably multiple times by France. The previous Prime Minister Matteo Renzi had agreed to reduce Italy's deficit to 0.8% of GDP.

If the EU Commission finds these actions by Italy insufficient the first enforcement step could  be a request that Italy remit a deposit of 0.2% of GDP ($4.4 billion,  $2.2 trillion economy PPP) to the European Stability Mechanism, the EU’s financial rescue fund.   It could also set a deadline for early next year for Italy to begin to reduce its debt, which at 130% of GDP is  second only to Greece in the EU, though Eurozone governments would have to approve such a measure.

Missing that deadline could turn the deposit into a fine and suspend billions in EU funds that are spent in Italy and impose monitoring by the Commission and the European Central Bank of Italian government finances similar to the oversight on Greece imposed after her bailouts.

The EU Commission would, or should be extremely reluctant to take these actions. Italy is the third largest economy in the EU and one of its original members.  The Italian economy has lagged behind the EU in growth for most of the past ten years and the current government was elected largely on its economic promises. 

The government of Prime Minister Matteo Renzi was roundly defeated in the March election, coming in third behind The League and 5 Star, the government coalition’s partners. The EU demand that Rome kowtow to its deficit wishes pits Brussels against the Italian electorate.  That is a position that should terrify any sensible bureaucrat 

Reuters