The financial front of confrontation between the European Commission and Rome, opened in mid-October a project of the Italian budget in 2019. The deficit in the proposed Brussels document was declared at the level of 2.4% of GDP, which is three times higher than agreed with the previous government options (0.8% of GDP). The reaction of the European officials bordered on bewilderment. Vice-President of the European Commission Valdis Dombrovskis called the presented project is a conscious and deliberate violation of the commitments undertaken by Italy in 2017. In Brussels, by the way, for the first time in the history of the EU as a whole has rejected the draft budget of one of the countries, denoting her period of three weeks to develop a new option.
However, as stated by the Prime Minister of Italy, Giuseppe Conte, there is no “plan B” on budget, despite the concerns of the European Commission and investors. And Deputy Prime Minister Matteo Salvini and all the hearts left in the address of officials: “They are attacking not the government but the people.”
The steadfastness of the Italian side is easy to explain, because at stake is the enforcement of pre-election promises of the ruling coalition. And this coincided with a decisive phase of reducing the quantitative easing program. Go to past times, when the ECB in large quantities bought up Italian bonds, allowing Italy to be comfortable enough to service their debt.
Although indicated in the Italian project a 2.4% deficit technically do not violate the Maastricht criteria (the budget deficit to 3% of GDP), practically, this means that Rome is going to borrow approximately €25 billion more than originally anticipated.
Brussels is unable to agree with this, not only because the basis of the budget laid overly optimistic forecast of development of the Italian economy. Agreement on a spending may serve as a precedent, which with high probability will decide to take advantage of other “problematic” member States of the EU, which may enhance disintegration tendencies in Europe.
Issues of fiscal sovereignty and sound in France. The second largest European economy have recently advised Brussels that the draft budget for 2019 provides a reduction of the structural deficit by 0.1% this year and 0.3 percent next. In the spring of Paris agreed with Brussels a reduction of the structural deficit by 0.6% of GDP per year.
On the other hand, it seems that the European authorities have to control the stiffness of their rhetoric, mindful that it is not far off, in may 2019, the election to the European Parliament. To strengthen the position of eurosceptics pointedly harsh rhetoric, statements about the need to cut spending, including social, Brussels in the coming months, not with his hands.
There certainly account for the dramatic experience of the “pacification” of the Greek government, Tsipras, who skillfully played on the public mood, and even held a referendum in which the Greeks voted for the rejection of austerity. However, Italy is not Greece, on the agenda of the third economy in the Eurozone, the Greek in excess of about 10 times, with extensive banking system, and without abiding in protracted crisis.
In the case of the stubborn resistance of the approval of Brussels to Rome can theoretically be of a financial and technical nature. Brussels will have to start the disciplinary procedure, which should result in a fine of several billion euros. But such a scenario the permission of the Italian “fiscal rebellion” seems unlikely.
Although the European Commission has no real authority over the budgets of countries of the Union (which constantly refers to Rome), the European governments have in the past tried to avoid negative opinions, knowing that this is a serious negative signal for financial markets.
Italy is the largest debtor in the Euro area. Its debts amount to €2.3 trillion — that’s nearly a quarter of the debt of all participants in the monetary Union. The ratio of debt to GDP since 2010 has grown from 116% to 131%. Further growth of budget expenditures will increase the already enormous debt burden, warned the international rating agencies.
Agency S&P downgraded the rating of Italy (BBB -) to negative, and before that, Moody’s decided to downgrade the country to “Baa3” with a previously installed Baa2. The cost of Italian bonds decreases, the yield of the securities is growing. There are two weeks of waiting the denouement of the budget crisis, nervousness will only increase.
The blow to the banks
The risks of such a situation for Italian banks is multidimensional. First, they keep on the balance sheets of significant volumes of debt securities of the country is more than 10% of total Bank assets (for comparison, German banks hold only 2% of the sovereign debt of Germany).
Falling on the background of the negative government securities weakened the main banks ‘ capital in Italy, with the yield on their bonds increase the cost of servicing the debt. Obviously, the stiffer will be the scenario of the controversy of Rome and Brussels, the more precarious will be the position of the banks of the Apennine Peninsula.
The second threat to the banking system in Italy can be a massive outflow of deposits. Amid growing informational noise, the owners of deposits in Italian banks started to get nervous. The point of no return, followed by capital flight may occur suddenly — after a surge of negative news on the topic of the budget crisis.
There is a third problematic dimension: the Italian banks to 2020-2021 years to repay loans from the ECB, we are talking about approximately €250 billion At the current development paradigm can predict serious difficulties with repayment. Since may the stock market of Italy dipped by a quarter, leading to lower capitalization of natural banks.
However, the extreme vulnerability of the financial sector and the growth in yields on government bonds can cool the ardor of the Italian government and, most likely, will not leave other way than compromise. Giuseppe Conte has recently dropped the idea that in Rome, perhaps, “will review expenditures as necessary” and at the same time confirmed the commitment of Italy to the European single currency.
Of course, the new Italian government publicly adhering to hard line, it understands that the trajectory of the development of the economy should be changed, and that the increased costs can add political points, but not percent economic growth. Are the authorities of Italy to come down from the stands to the ground — we’ll find out very soon.