Will EU Reject Italy’s Budget or Choose to Work With Rome to Reduce Deficit?

The Euro is trading higher early Tuesday as Italy prepares to submit a revised version of its budget, keeping investors on edge. On top of the simmering tensions between the European Union and the Italian government, investors are also expressing concerns above the negotiations between the UK and EU over Brexit.

On Monday, the single-currency plunged more than one percent to trade at its lowest level in more than a year. The Euro is now down more than 5.9 percent of its value over the last six months. Compounding the two geopolitical issues is the divergence in the monetary policies of the hawkish U.S. Federal Reserve and the dovish European Central Bank.

The Rome, Brussels Stand-off

The standoff between the Rome-based Italian government and the Brussels-based European Union could come to a head on Tuesday when the Italian government is expected to present its revised budget to the European authorities. The European Commission rejected Italy’s 2019 budget last month, saying it spurned a previous commitment to lower the country’s deficit.

Last month, the European Union executive body demanded a revised budget from the Italian government. The commission effectively rejected the first budget on the grounds that it constitutes a clear deviation from EU fiscal rules.

The Italian government is under pressure to satisfy campaign promises even if it means deficit spending. The election promises include a citizen’s income for the poor, lower taxes and a cut in the retirement age.

European Commission’s Dombrovskis Digs In

Tensions rose over the week-end after European Commission Vice President Vladis Dombrovskis issued a warning ahead of the Tuesday deadline to revise the spending plan. Tensions could rise further if the Italian government fails to meet the expectations of the European Commission. According to a media report, Italy’s finance minister is working on only limited adjustments to the government’s 2019 budget.

“From previous experiences, we’ve seen that damages to the economy can be done quickly,” Dombrovskis said in an interview with La Stampa. “But then it takes years to repair them.”

In response to Italy’s Finance Minister Giovanni Tria’s statement that meeting the commission’s demands would be “suicide” and calling its economic forecasts “a technical fault,” Dombrovskis retorted: “Slogans cannot cancel economic reality.”

Tria Expected to Confirm a Deficit

According to a report on Saturday from newspaper II Sole Ore, Finance Minister Giovanni Tria, will confirm a deficit of 2.4 percent of national growth despite pressure from the commission.

Tria and his staff are working hard to meet the EU requirements, but they are facing an uphill battle. They have been assessing economic growth targets, emergency spending needs after devastating storms, the weight of interest payments on debt and measures to guarantee that there will be no breach of the 2.4 percent target range, according to the newspaper.

The newspaper further added that Italy could predict growth below a current target of 1.5 percent for next year, after the European Commission set its own forecast Thursday at 1.2 percent.

Expected Outcome

Based on the Euro’s recent weakness, it looks as if investors are betting that Italy’s budget will fall short of the European Union’s expectations. If this occurs then the EU can send the budget back to Rome with the request for further revisions. However, it also has the option to work with the Italian government to overcome its obstacles.

According to Dombrovskis, “The commission is considering a possible excessive deficit procedure for Italy – in which the country would have to reduce its deficit by a set deadline or risk sanctions of up to 0.2 percent of economic output. Dombrovskis further added that the government’s strategies “are slowing down the Italian economy further.”

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Tria May Be in a No-Win Situation

Besides the tremendous pressure being exerted by the European Commission, Tria is also facing internal resistance from within his ministry. His deputy Massimo Garavaglia of the League is urging an acceleration of reforms given growth prospects, rather than slowing down the actions. “There is probably the need to apply them even faster,” Garavaglia told the newspaper Corriere della Sera. “We’re seeing the economy slowing, so all the more reason” for an expansive budget, he said.

It seems the fate of the Euro is in the hands of Tria and he is going to have to decide if he is a politician with a need to fulfill election promises, or a finance minister with a mandate to balance the budget.