Italy’s 2% pledge is just cosmetic

Italy’s populist government has pledged to the European Commission that it will lower its deficit target to 2 percent of national income next year. For a cabinet that vowed to defy the ‘bureaucrats’ in Brussels, this is a stunning climb-down. But unless Rome is ready to row back on some of the key pledges included in its 2019 budget, it will amount to little more than cosmetic change.
At the end of September, Rome shocked investors and its euro zone partners by announcing that its budget deficit in 2019 would reach 2.4 percent. Italy’s bond yields rose and the Commission rejected the budget, a first in the history of the currency union. Italy now risks an “excessive deficit procedure,” which might involve intrusive monitoring and a fine of up to 0.5 percent of gross domestic product.
Matteo Salvini and Luigi Di Maio, leaders of the ruling League and Five Star Movement, were unmoved at first. They said they’d push ahead with a higher deficit because they had a clear mandate from voters. A lower budget would force them to rein in their favourite giveaways: A lowering of the retirement age and an income support scheme. They also said the financial markets would
settle down once the details became clear.
So when Giuseppe Conte, Italy’s prime minister told reporters that Italy would now target a 2.04 percent deficit, this was indeed a remarkable U-turn. It wouldn’t be the first. Di Maio and Salvini had originally drafted a huge list of expensive promises, including a steep cut in income taxes, only to drop them in their original budget. They’d also floated the idea of leaving the euro during the electoral campaign. Now they are in power, they say they’re committed to the single currency.
Investors will no doubt take heart from this latest change of tack. They show that the moderates in government are back in the driving seat, at least for now.
In a sense, the 2.4 percent deficit target for next year wasn’t the main problem with Italy’s budget. Worse is the wildly optimistic growth target, which means that borrowing will probably be much higher than predicted. Then you have the non-credible budget deficit targets for the following two years, which rely on VAT increases that no-one believes in. Finally, there’s the decision to keep the structural deficit unchanged between 2019 and 2021, instead of aiming to reach a balanced budget over the medium run. For a country whose public debt stands at more than 130 percent of GDP, these are hardly details.
Conte says that the new target won’t affect the government’s flagship policies. He has hinted that Rome could find some money through a program of privatisations. The finance ministry hopes to save some cash by delaying the introduction of some of the proposed changes, for example pushing back the reduction in the retirement age to later in 2019. But while these one-off savings would help lower the budget deficit lower next year, they’d do little in following years. Italy’s debt would remain on a very dangerous path.
—Bloomberg

Ferdinando Giugliano is a senior fellow at the Niskanen Center and founder of the blog Modeled Behavior.