Italians to push the boat out, but again on credit

May 14, 2018 5:08 PM|Marcin Lipka

"Up to 100 billion EUR a year could be spent on the economic changes announced by the groups preparing to form the government in Italy. Two parties promise the moon. The problem is that the Italian economy cannot afford it," writes Marcin Lipka, Conotoxia Senior Analyst.

Marcin Lipka, główny analityk

Last weekend, the Northern League and the 5 Stars Movement held a series of meetings concerning the future economic programme and the election of the Prime Minister. The name of the new head of government is still unknown, but the economic policy may suggest that Italy's debt will once again become a serious problem for the eurozone.

Billions and billions of euros in additional deficit

The surprising relationship between the right-wing Northern League and the left-wing 5 Star Movement means that the government will, not only ideologically, stand out from the general values of the right-wing and left-wing political scene. The economic policy of the sprouting coalition also looks unusual and it's a marriage of liberal and social extremes.

As announced by the League, a flat tax will be introduced. For households with income below 80,000 EUR, it is to be 15%, and 20% for those above this threshold. The very idea of reducing taxes for citizens is not bad. The problem, however, is the cost. According to Bloomberg's calculations, they are expected to reduce budget revenue by 40 billion euros annually.

5 Stars Movement, located much closer to the left than to the right, wants to introduce two other extremely expensive projects. The first is a guaranteed income of 780 EUR. Compared to earlier announcements, it will not be granted to everyone but only to those unemployed and struggling to find work. These additional conditions, which may be difficult to verify, do not change the fact that the project will cost about 30 billion EUR annually - according to the head of the Italian Social Insurance Institution, quoted by Bloomberg.

Another idea of the 5-Star Movement agreed with the League is the withdrawal of the 2011 pension reform. In the case of Italy, this is particularly costly due to the low participation of older people in the labour market. According to Carlo Cottarelli, former IMF Director, it costs 15 billion EUR.

In total, the costs of only three ideas pushed through by the winning coalition are expected to be 85 billion EUR per year. The Corriere della Sera newspaper, on the other hand, estimated that the fiscal costs of the new programme would amount to 100 billion EUR.

Problems for Italy, problems for the eurozone

Implementing the announced economic changes will put Rome on a collision course with Brussels. Even assuming that the final costs will be much lower (e.g. 50-60 billion), they still translate into an increase in the public finance deficit by an additional 3-4 percentage points of GDP. Taking into account that next year it is expected to reach 1.7% GDP without any new spendings, the gap in Italian finances will reach around 5% GDP.

This is much more than the EU's deficit limit of 3% GDP. In addition, the increase is expected to occur in relatively good times. Italy's GDP grew by 1.5% last year, although potential growth is only around 1.0%.

Italian economic policy may also have a negative impact on the entire eurozone. On Friday in Florence, ECB President, Mario Draghi argued for deeper fiscal integration and the creation of a fund to reduce negative effects of future crises.

However, closer fiscal integration will not be possible in an irresponsible national fiscal policy scenario. Italy, with its debt-to-GDP ratio of 131%, is still one of the weakest links in the EU. The changes implementation planned by the new coalition will not only jeopardise the stability of the Italian debt, but will also make the eurozone even more sensitive to hypothetical shocks, and reduce solidarity among the countries sharing the common currency, during economic turbulence.

May 14, 2018 5:08 PM|Marcin Lipka

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