Italy’s extraordinary act of self-harm

Let there be no doubt, the budget that the Italian government is about to pass is a remarkable act of economic self-harm. It could take a long time to repair.
The measures defy the rules of prudent debt management in order to fund outlays that will do little to improve Italy’s competitiveness. Most important, they tell investors that the populists have the upper hand in government. Italy’s creditworthiness is now that of its ruling parties: the League and the Five Star Movement.
The Italian government aims to run a budget deficit of 2.4 percent of gross domestic product next year, up from a forecast of below 2 percent in 2018. This change provides only a small fraction of what would be needed to fund the lavish coalition agreement between the League and Five Star. But it’s a huge shift from the deficit of 0.8 percent forecast by the previous
government in the spring.
These may look like marginal changes, but they must be put in context. Italy’s public debt stands at more than 130 percent of GDP — the largest in the euro zone after Greece. For the past few years, Italy has benefited from ultra-low interest rates thanks to the European Central Bank’s (ECB) quantitative easing. The ECB is now pulling back from net purchases (although it will continue to reinvest its stock), leaving governments with a much thinner safety net. This isn’t the time for extravagance.
Italy’s growth rate tells a similar story. The government has enjoyed a phase of mild expansion after a long recession. Prudent bean-counting would recommend shrinking the debt-to-GDP ratio somewhat sharply, to create a fiscal buffer for when the next recession hits. Of course, the euro-zone economy is slowing, which necessitates a gentler pressing on the brakes. But the new deficit target is far too high. A sensible compromise could have been around 1.6 percent, as originally proposed by finance minister Giovanni Tria.
What’s worse, the extra borrowing will be used for a series of giveaways that will simply worsen Italy’s structural problems. A sounder plan would have seen Italy borrowing more only to invest more. Instead, the new government is planning to lower the retirement age for some workers and sharply increase the lowest pensions.
That will make the pension system less sustainable in the future, reversing recent reforms which had put it on a sound track. Nor are the steps especially equitable. Italy has a huge generational divide, which worsened since the financial crisis. The League and Five Star will make today’s younger workers pay for the handouts to the over-60s.
This budget is a clear sign of who’s in charge in government. Five Star and the League have rowed back on many promises such as a steep cut in income taxes. While there will be tax cuts, they’re only for some self-employed workers. But they’ve shown much more assertiveness over the past few weeks, sidelining Tria — who had won the confidence of the markets.
Tria has chosen not to resign, reportedly following the advice of Italian president Sergio Mattarella. But even if he stays, he looks a spent force. His lines in the sand have been repeatedly crossed by Luigi Di Maio and Matteo Salvini, the Five Star and League leaders. They, not him, will decide Italy’s economic policy.
They do, of course, have a democratic mandate. But that won’t stop the great escape from Italy’s assets, which started last week and could get worse. Investors need to decide whether to give their money to a country where De Maio and Salvini are truly in charge. It’s not an exciting prospect.
— Bloomberg

Lionel Laurent is a Bloomberg Opinion columnist covering finance and markets. He previously worked at Reuters and Forbes