On October 15 the Italian government will submit its highly-anticipated national budget to the European Union. Already, the forecasted budget has caused a spat between Italy’s Deputy Prime Ministers (Matteo Salvini and Luigi Di Maio) and the EU. The proposal contains controversial targets which contradict EU policy, and, as it stands, Italy’s government is determined not to break its resolve and make changes. In doing so, Salvini and Di Maio are disregarding warnings from the European Commission, Italy’s central banks and the Italian parliamentary budget office.
The populist government has already witnessed severe turbulence on its route to power, following a hung parliament after Italy’s general election in March. Now, the speculation around the budget is reviving fresh fears about the anti-EU sentiment across the Five Star-League coalition. FXTM Staff Writer Natasha Keary takes a look at the market atmosphere ahead of the national budget deadline, and examines the wider consequences for Italy and the EU.
On the markets
The markets flinched soon after the European Commission’s initial response to the budget. Yields on Italian bonds have undergone a month-long rise, reaching the highest levels in four and a half years. Overnight, Italian stocks have dropped 2%, with investors noticeably wary during the pre-budget speculations.
Italian assets which may be damaged in the EU-Italy budget collision are being markedly treated with caution. In Milan, Italy’s benchmark FTSE MIB index dropped 2.24% – to its lowest level since April last year. The EURUSD currency pair fell to seven-week lows. With market sentiment looking resoundingly negative, investors seem to believe that the EU-Italy clashes are far from at an end, and may even spread across Europe.
On the budget
So what exactly is so controversial about the Italy’s national budget? The issue is concentrated around two central targets: one for the country’s deficit, and another for its debt.
In September, the Italian government – comprising of the anti-establishment Five Star and far-right League coalition – created a budget which projected a deficit of 2.4% GDP for the coming three years. The projection directly contradicts the promises of the previous government, who pledged to reduce the deficit to below 0.8% in 2019.
The projection also breaches EU fiscal rules. Italy is weighed down with a debt of 130% GDP, meaning that it has the second-largest sovereign debt of any eurozone member. The EU rules that a country with a debt over 60% GDP must take steps to reduce its amounting burden. The Italian government has no intention of doing so – stating that continued high spending is important to fulfil its anti-austerity policies. The wide deficit will, according to the Italian government, kick-start the economy and bolster growth.
The policies which gathered support for the League and Five-Star parties during the election depend on high spending. Among the most popular policies were the citizens’ income – a basic income for those out of work – and a lower retirement age. The Five Star Movement threatened early on in the process to reject the budget unless it contained these – very costly – policies.
The European Commission wrote a letter to Italy’s Economy Minister Giovanni Tria expressing their concerns over the proposed budget. The President of the European Commission, Jean-Claude Juncker, warned that a disregard for mounting debt was reminiscent of the Greek financial crisis. Greece are currently the only eurozone country to hold a national debt larger than Italy.
The International Monetary Fund also stepped in to align itself with Brussels. A rift with the EU and a disregard for EU rules could risk the confidence of the international money markets, says the IMF’s Maurice Obstfeld. With the threat of a no-deal Brexit stumbling closer, Italy’s rebellious budget could risk destabilising the eurozone entirely.
Once the budget has been submitted, the cabinet has just five days to approve the final version. There are rumours that the European Commission may, in an unprecedented move, reject the budget if it does not comply with EU rules. In this case, Italy’s government would be given a period of time to revise the proposal before resubmitting it.
In the eurozone
The quivering relationship between the EU and Italy is casting doubt on the League-Five Star’s desire to remain in the currency union. The single currency, already pressurised by Dollar strength and the growing fears of a global trade war, is being put under even more strain by Italy’s seemingly unwavering defiance of EU rules. Salvini, along with other Italian political leaders, has expressed the view that the EU is enforcing rules simply to weaken Italy’s government.
The growing animosity is encouraging prolonged caution on the markets. As the deadline nears, investors are likely to be wary of events which could put further strain on the Euro. If the budget is rejected on October 15, the markets might be cast into further turmoil over the stability of Italy’s future in the eurozone.
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