- Italy set next year’s budget deficit at 2.4% of GDP. That would be unchanged from the shortfall registered for 2017, though it exceeds most of the figures leaked to the media.
- Additional deficit projections for 2020 and 2021 should be released later today along with the GDP forecasts that underpin the estimates. All of those will be important to watch.
The figure announced last night in itself won’t wreak havoc on the country’s huge stock of debt. With a shortfall of 2.4% of GDP, the debt-to-GDP ratio should still fall slightly in 2018 to about 130.4% from 131.2%, according to our calculations.
Budget Deficit Fails to Narrow
The real problem for the Italian government is Brussels. An EU official told Bloomberg News that the headline deficit should have been around 1.6% to ensure a marginal improvement in the structural balance — that’s the cyclically adjusted balance excluding one-time items, such as bank bailouts. The IMF previously estimated the structural deficit would be about 1.3% for 2018.
It was only in negative territory because of the huge burden created by debt servicing costs. The primary balance, which excludes interest payments on government debt, should stand at about 1.9% at the end of this year. With the economy growing and inflation perking up, that’s still high enough to chip away at Italy’s huge stock of debt. However, the European Commission would like Italy to pay off the debt at a faster pace next year.
The next step for Italy will be to present the budget to the EC by Oct. 15. EU officials already have grounds to start an excessive deficit procedure. Under EC rules, if the debt-to-GDP ratio surpasses 60%, the overshoot must be reduced by 5% annually. (For example, if the ratio stands at 80%, it must fall by 1 percentage point each year.)
But launching an EDP is far from automatic. The EC examines each country’s fiscal situation and reports to the European Council on whether an EDP should be opened. The Council makes the final decision. Leniency can be shown for a whole slew of reasons.
As the EU official alluded to, the EC is unlikely to be overly lenient in the absence of any improvement in the structural balance. As part of the “preventive arm” of the EC’s fiscal rules, the structural budget deficit may not surpass a medium-term objective of no more than 0.5% of GDP if the debt-to-GDP ratio is above 60%. A compromise between Brussels and Rome will have to be found.
In the meantime, financial markets may do some of the EC’s work for it by applying pressure on Italian government bonds. The 10-year sovereign yield has risen 30 basis points today to 3.18%. Because the average maturity of Italy’s debt is seven years, the seven-year yield provides the best read on the damage that will eventually be done to the country’s finances. It now stands at 2.77%. A sustained rise of that figure above 3% would make the stock of debt too expensive to finance.
Seven-Year Yield Jumps
The coalition government has yet to release all the details of its budget projections – more bad news may lie ahead. It’s not just next year’s deficit that matters. The figures for 2020 and 2021 will also be in sharp focus. If the deficit exceeds 3% in either of these years, which may well be the case if the government’s spending plans are phased in over time, Italy’s sovereign yields would probably rise significantly — it would also cause major ructions with the EC.
Looking at the GDP projections used to calculate the deficits will be important as well. We forecast GDP growth of 1.1% in 2019 and 2020, slowing to 1% in 2021. The IMF expects 1.1%, 0.9% and 0.8%, respectively. The EC forecasts 1.1% in 2019. Any projections from the Italian government significantly above those rates would cast doubt on the credibility of the budget forecasts.
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