The President of the EU Commission had some choice words to say about the Italian budget dispute. Jean-Claude Juncker argues that Italy has to keep to strict budget limits on spending and borrowing that has been laid down by the EU. He went so far as to suggest it would mean the end of the euro if Italy insisted on further special treatment. This exaggeration went down badly in Italian government offices. Deputy Prime Minister Matteo Salvini responded strongly against unwelcome EU interference. Mr Salvini then upped the rhetoric by sharing a joint platform with Marine Le Pen in France and calling for a “common-sense revolution”. He also accused the EU Commission of being in a bunker, generating fear and insecurity. This is unlikely to help crystallise a compromise on the budget.
At the heart of their dispute lies the issue of how much money the Italian state should be allowed to borrow. The EU looks at the way Italy has a state debt more than twice that allowed under euro and EU rules, and argues for a 2019 budget with little or no additional borrowing. There is no time like the present, it reckons, to start to erode the mountain of state debt. Mr Salvini and Luigi Maio, the leaders of the two governing parties, think the slow-growing Italian economy needs a fiscal boost. They want to spend more on a new basic income scheme, on infrastructure replacement and improvement, on an easier tax code and on less severe pension changes. The EU sees this as imprudent and unacceptable. They pressed for the cuts to pensions and for high taxes to end the budget deficit.
The EU’s austerity agenda is driven by the realisation that any country could free ride on the good discipline of the rest of the zone and borrow too much money at low interest rates if unchecked. There is also the more immediate issue of the day to day financing of the deficit countries. This is achieved by the European Central Bank (ECB) lending large sums at zero interest rate to Greece, Portugal, Spain and Italy which are in deficit. Italy is now borrowing €450bn this way. Germany, which deposits huge sums with the ECB from its surplus, does not wish this all to be lent on to sustain high deficits when Germany herself runs a very tight budget at home.
This issue came to a head when the Greek state wanted to borrow more, and when the Cyprus banks were in financial difficulties. On both those occasions the ECB and the other euro-member states decided enough was enough and declined to go on financing the excess deficits. This forced a more austere budget on the Greeks, and hits to bondholders and depositors in Cypriot commercial banks.
On the other side of this sits a struggling Mrs Merkel. The German leader lost heavily in the last German general election and has only survived by rebuilding a grand coalition with the SPD as well as with her sister party in Bavaria, the CSU. In the recent Bavarian state election the CSU and the SPD lost lots of seats thanks to voter unease, to the benefit of the Greens, the AfD and the Free Voters parties. Meanwhile, at Federal level the anti-euro AfD are proving to be a troublesome opposition, and the CSU partners are unhappy with what Mrs Merkel’s coalition has done to them. In December, Mrs Merkel may face a vote about whether she should continue as Chairman of her party, the CDU, which is the source of her authority as Chancellor of the German state. The forces against her are circling, unhappy with the way her migration policy was handled.
None of this is a good background for EU investment. The traditional parties continue to do badly at the polls. The challenger parties do not accept fundamental parts of the euro and EU scheme. We assume Italy and the Commission will in due course find a way of settling their differences. If they do not the ECB can do considerable damage to the Italian banking system, which will undermine markets further and do damage well beyond the borders of Italy.
The above article was previously published by Charles Stanley on 16th October 2018