In a significant motion, the European Union rejected a proposed Italian budget for 2019 on the grounds that it was in violation of the EU’s rules on fiscal discipline. This event marks the first time that the European Union has ever rejected a draft budget on such grounds, and it speaks to the ongoing troubles roiling the bloc that such an unprecedented action was taken.
While Italy’s budget proposed a deficit of 2.4% of GDP, this would not violate EU rules, which state that a nation must limit its budget deficit to 3% or less of GDP. However, this deficit is above the recommendations for a country with a debt load as massive as Italy and it also constituted a renegement on a May commitment that Italy would cut its structural deficit in 2019. Though Italy is not in an absolute sense required to slash its budget deficit to a more acceptable level, a failure to do so could lead to the European Commission opening up sanctions proceedings against Italy, which could then lead to fines or other financial reprimands.
The Italian leadership has thus far held its ground, with Prime Minister Giuseppe Conte responding by pointing out his government’s popularity and claiming it to be the most envied in Europe. Other key government figures have responded in a similar fashion. Deputy Prime Minister Luigi di Maio stated, “It’s the first Italian budget that the EU doesn’t like. I’m not surprised: This is the first Italian budget written in Rome and not in Brussels!", and Deputy Prime Minister Matteo Salvini claimed that the European Commission was attacking not the Italian government, but the Italian people. The ministers have reason to act confidently. A September poll found that the government’s approval rating was at 62% and with only 44% of Italians believing that EU membership has been good for Italy, the lowest of any nation in Europe), continued tough talk towards Brussels will play well to the populist, nationalist, and Eurosceptic sentiments that continue to dominate Italian political discourse. Given this political incentive, it should thus come as no surprise that both Di Maio and Salvini have already stated that they have no intention of making any changes to the proposed budget.
The timeline regarding the next steps is already laid out. On November 5th, Eurozone finance ministers will meet to discuss ongoing events. Presumably, they will try to seek to find some means to sway Italy to soften its stance and make some concessions to the European bloc. On November 8th, the EU will release economic forecasts pertaining to debt, deficit, and growth. These numbers will influence how each side will approach further negotiations, and the EU could seek some form of sanction if their numbers and the Italian numbers diverge sharply. By November 13th, Italy will owe a revised budget proposal, which would then trigger a three-week period for the EU to review the second proposal. If this further proposal is rejected or if Italy buckles down and refuses to propose a new budget at this point, then the European Commission could begin excessive deficit procedures against Italy, which could trigger fines and would likely set off fresh rounds of market volatility.
The stakes are high. Italian debt stands at 2.3 trillion Euros. Doubts about Italian ability or willingness to pay it back could quickly spiral into a crisis of rising interest rates and mounting debt. Turmoil in the Italian banking system beyond a certain level would spill over into the Eurozone as a whole. The fear of an Italian default, if such a thing began to look like a possibility, would trigger further panic. Greece was small enough for the Germans to bail it out; Italy is not. It is the third-largest economy in the Eurozone and the ninth-largest in the world. An Italian default would be disastrous for the Euro and even the mere threat of it would lead to talk of Italy leaving the monetary union.
Such an undertaking would be unprecedented and could lead to chaos in European markets for years. However, at present, the odds of it seem to be slim though there is cause for concern. In response to such fears, Prime Minster Conte replied: "Read my lips: for Italy there is no chance of Italexit, to get out of Europe or the Eurozone". While it is theoretically possible that the “read my lips” line was only incidentally similar to George H.W. Bush’s infamous line about new taxes, it could very well be the case that the reference was intentional. After all, Conte made a point of delivering this line in English instead of Italian. If so, Italeave is among the cards that this government is willing to play. It might even be the plan. Whether this is so or whether this was simply a threat used to incite Brussels to back down, will become clear in time.
The EU is thus in a tricky position. It must thread the needle of punishing Italy enough to dissuade other European nations from pushing back against the rules while at the same time not punishing it so much that the conflict rocks European financial markets beyond a tipping point. The Italian government believes that it has the political mandate, support, and incentive not to back down no matter what the EU throws at it. Indeed, it cannot do so without losing face. The situation is further complicated by below-expected Eurozone growth in recent months. With such anemic growth, any disruption could tip the Eurozone into a recession. Brussels will have its work cut out for it to find a solution that is not too hard and not too soft, but just right.
The most likely outcome as things stand is that Italy stands its ground, the EU begins the process for sanctioning it, and the markets shake but do not collapse. However, there are several points at which events could depart from this sequence. On one hand, it is possible that Italy will concede to budget cuts in exchange for other demands1. On the other, it is possible that despite measures to ameliorate any damage from sanctions on Italy, a crisis arises anyway. It is even possible that the stall in Italian economic growth will take the wind out of the government’s sails and put the brakes on its headstrong approach strategy. The situation is delicate, but as of yet it is not critical. Still, the potential for disaster lurks in the background, and the events of the next few months could have consequences that will last for years to come.
