Global Daily – Italy’s government is new, but fiscal risk remains

by: Aline Schuiling , Nick Kounis

Euro Macro: Italy’s new government set to face serious fiscal problems – Italy’s incoming coalition government of  the left-wing populist Five Star Movement (M5S) and the centre-left social democratic pro-European Democratic Party (PD) presented a rough sketch of its policy programme today. The first, and most important point of the programme states, that the government intends to pursue expansionary economic policy, without undermining the government’s budget balance. The parties want to support the income of families and disabled people, while spending more on housing, education and research. On top of that they plan to lower taxes on labour, introduce a minimum wage and increase labour protection. Finally, they want to step up environmental investment (implement a Green New Deal) and increase investment in infrastructure. Part of the plans should be paid by reducing bureaucracy (amongst others by reducing the number of parliamentarians), by fighting tax evasion, introducing a new web tax on multinational internet companies, and reducing inefficient public spending programmes. In regard of its European agenda, the M5S-PD programme states that the rules for fiscal policy need to be changed in order eliminate the excessive rigidity of the fiscal rules, and to allow for more investment and social cohesion within Europe.

The M5S-PD government will probably have serious problems implementing its plans. According to the agreement with the European Commission the budget deficit (2.1% of GDP in 2018) needs to decline to 2.04% in 2019 and 1.8% in 2020. In case these targets are not met, it was agreed that the VAT rate would be hiked or other income-generating measures amounting to EUR 23.1bn (1.3% of GPD) would be implemented in 2020. We think the M5S-PD government will likely not meet the agreements with the EC, not only because of its new policy plans, but also because Italy’s economy is likely in recession. We see a high risk that the budget deficit breaches the 3% GDP mark next year. In any case, Italy’s government debt ratio (132% GDP in 2018) is expected to continue to rise this year and the next, implying that the EC’s Excessive Deficit Procedure (EDP) could be triggered after all. (Aline Schuiling)

ECB View: Hawks unlikely to derail stimulus package – Over recent days, a number of the traditionally hawkish members of the Governing Council have expressed their opposition to the ECB embarking on the path of further monetary stimulus. Bundesbank President Jens Weidmann got the ball rolling saying it was ‘wrong for us to act for action’s sake’ and called for ‘special caution with government bond purchases because they threaten to blur the line between monetary policy and fiscal policy’. More recently, the President of the Dutch central bank Klaas Knot noted that ‘If deflation risks come back on the agenda then I think the asset-purchase program is the appropriate instrument to be activated, but there is no need for it in my reading of the inflation outlook right now’. Meanwhile, Executive Board member Sabine Lautenschlaeger, said resuming QE should be a last resort, while Robert Holzmann, the Austrian central bank governor asserted that he was ‘sceptical about further expansion of the money supply…of lowering the deposit rate’.

We do not think the hawks on the Governing Council will derail a stimulus package at the September meeting. The hawkish group on the council most likely numbers 5-6 members of the total of 25. A majority of members is clearly in favour of stimulus and this was represented in the statement following the July meeting, which represents the central tendency of the Governing Council. Indeed, the main message in the press statement was that the ECB ‘stands ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner… we have tasked the relevant Eurosystem Committees with examining options, including ways to reinforce our forward guidance on policy rates, mitigating measures, such as the design of a tiered system for reserve remuneration, and options for the size and composition of potential new net asset purchases’. We continue to expect a large +package of monetary stimulus measures at the September meeting. (Nick Kounis)