By Iakov Frizis, CASE
As opposed to complying with a 0.5pp of structural deficit reduction set out by the SGP (Stability and Growth Pact), Italy approved an expansionary budget plan of €26.5bn last week, reiterating extraordinary circumstances, which sanction deviation under SGP’s flexibility clause. Notably, the 2017 budget plan raises the deficit target to 2.4% of GDP for 2016 and 2.3% for 2017, up from 2.3% and 2% respectively. Meanwhile, debt to GDP is at 133.3%, second only to Greece among Eurozone countries. Italy’s banking sector is also going through dark times, holding approximately €360bn of non-performing loans. As a result, Fitch cut its credit outlook for Italy from stable to negative, quoting weak growth, high debt and political uncertainty as the cause for downgrade.
Granted, breaching budget rules is not a novelty for EU politics. A number of countries have failed to comply with the criteria that are often seen as outdated, with Portugal and Spain avoiding to become the first countries fined for such a practice as recently as August. Italy justifies this budget by quoting the adverse effect of the migration crisis and the recent earthquake on economic cyclicality; such unforeseeable events could indeed, according to the European Commission’s (EC) response, sanction a breach of the country’s medium term objectives. Nonetheless, Italy is called by the EC to provide further clarification as to the requested amount.
How valid are Italy’s justifications? As for the earthquake, Mr. Codogno, visiting professor at the European Institute of LSE, approximates the bill at €5bn. Whilst impacts of the disaster on GDP growth appear limited, the most significant costs are associated with population losses in the region (i.e. regional economic potential). Increased public spending on reconstruction included in the new budget can, however, help offset the negative impacts of the crisis once implemented.
When discussing the fallout of the earthquake in his proposal for the new budget, Italy’s Prime Minister, Matteo Renzi, made emotional pleas relating to the reconstruction of schools. But when it comes to migration, he takes the gloves off. For instance, earlier this week, he demanded sanctions against countries rejecting migrants (Visegrad 4), threatening to raise border walls and veto the upcoming EU budget if the Eastern countries do not open their doors to more asylum seekers.
As with any budget, the one recently put forward by Italy is underpinned by both political and economic reasoning. Undeniably, there is an economic cost associated with extraordinary circumstances that is to be determined. Yet, the balance that the Italian budged strikes, between sufficing the European Commission’s requests and addressing Italy’s economic woes, still raises a few eyebrows.