EU Warns New Italy Gov’t on Ballooning Debt

The European Union's budget commissioner says he hopes Italy's prospective new government will master a "big learning curve", and cautions that the eurozone's rescue fund wouldn't be able to stabilize the country.

Law professor Giuseppe Conte is trying to form a government of two populist parties. Nervousness about what could be an administration hostile to fiscally sound measures has rattled bond markets, AP reported.

EU budget chief Guenther Oettinger told Germany's Funke newspaper group Saturday the currency union's rules on debt are "crystal clear."

The German conservative was quoted as saying that "the rescue mechanism ... could hardly stabilize such a large economy as Italy. So I hope very much that the governing parties will master a big learning curve."

Oettinger said an Italian euro exit is "not at all likely."

EU officials will probably not do much to enforce their borrowing rules on Italy’s new government, but they are hoping they won’t have to because financial markets will do the job for them.

A new government is expected to take office in Italy next week, a coalition of the anti-establishment 5-Star Movement and far-right League, who have jointly promised a bonanza of tax cuts and spending increases that would burst through the EU’s limits on borrowing by member states, Reuters said.

Suicide Mission

Slovak Finance Minister Peter Kazimir on Thursday called the policy mix a “suicide mission”. Markets have already responded: yields of the benchmark 10-year Italian bonds have jumped 0.7 percentage point since the start of May to 14-month highs above 2.46%.

Morgan Stanley warned this week that sustained yields that high could spark contagion by hitting the profits of banks which hold a big chunk of their assets in government debt. Shares in Italian banks hit 11-month lows on Friday, having fallen almost 14% so far this month.

Economists say that is only a taste of what could come: the rise in rates would be much steeper if markets believed that Italy was actually prepared to go through with the plans.

“If they do what they say they want to do, the reaction of the market will be much more than what we have seen so far,” said Francesco Papadia, a senior fellow at the respected Brussels-based Bruegel think-tank.

The spread of the Italian benchmark paper over comparable German bonds hit 200 basis points this week, still a far cry from the 550 basis points spread at the peak of the sovereign debt crisis in 2012.

“So far (the market reaction) has been clear, but not extreme. Maybe the market still has a hope they won’t do at least the most extreme version of what they said they would do,” Papadia said.

Structural Deficit Rising

Italy’s increased spending against EU rules “would likely be met by aggressive Italy underperformance versus other markets”, investment bank JPMorgan said in a note for investors.

As a EU member, Italy is obliged seek a balanced budget in structural terms and have debt below 60% of gross domestic product. Instead, its structural deficit has been rising since 2015 and its debt has been close to 132% of GDP since 2014. But most Brussels-watchers do not expect Europe to take political action to enforce its rules.

The European Commission, the guardian of EU laws, has the task of disciplining profligate governments through what is called an excessive deficit procedure that could end in fines.

But it has repeatedly declared that punishment is not the way to deal with budget rule-breaking, and showed leniency to repeat budget offenders like France, Portugal and Spain.

Standoff Drags On

The political standoff in Italy continued over President Sergio Mattarella's refusal to approve the eurosceptic coalition's choice for economy minister, AFP reported.

Three days after being appointed by Mattarella as prime minister, Giuseppe Conte, 53, has still not been able to form a government.  

Writing on Facebook late on Friday, League chief Matteo Salvini, who insists on naming the noted eurosceptic Paolo Savona, 81, as economy minister, was blunt. "I am really very angry," he raged.

The far-right leader doubled down on Saturday, tweeting images of cartoons in German media lampooning Italy, writing: "The newspapers and German politicians insult us: Italian beggars, idlers, tax evaders, freeloaders and ungrateful. And we should choose an economy minister that suits them? No. Thanks!"