Italy opts to play cat and mouse with EU

European Union President Donald Tusk (far left) with Italian Prime Minister Giuseppe Conte in Rome last month. Rome seems to have no inclination to adhere to the rules of the euro zone. But until the elections for the European Parliament next May, Br
European Union President Donald Tusk (left) with Italian Prime Minister Giuseppe Conte in Rome last month. Rome seems to have no inclination to adhere to the rules of the euro zone. But until the elections for the European Parliament next May, Brussels wants to avoid a new crisis at almost any cost.PHOTO: AGENCE FRANCE-PRESSE

It is banking on the fact that an Italian financial crisis will be too costly for EU partners to save

Greece was the first major financial disaster for the euro zone but it would be small change compared with a crisis involving Italy, a fact the government of Prime Minister Giuseppe Conte in Rome is banking on.

The government, a coalition of the nationalist League - rebranded from the Northern League ahead of the general election in March this year - and the populist Five Star Movement, seems to have no inclination to adhere to the rules of the euro zone. It sent shock waves through Brussels by announcing a budget plan last month that set the public deficit at around 2.4 per cent of gross domestic product (GDP) for the next three years - in a clear breach of what the European Union had asked the country to do in July.

Italy, a member of the G-7, is in a different class from Greece - too big an economy to be allowed to fail and, at the same time, too costly for its European partners to save. This predicament is making its euro zone partners look helpless.

The Italian government, which is crucially important in dealing with the thousands of refugees coming across the Mediterranean into Europe, will probably be playing cat and mouse with the EU for the time being. Until the elections for the European Parliament next May, Brussels wants to avoid a new crisis at almost any cost.

With Brexit and other trouble spots, Italy's European partners simply cannot afford to have another showdown, tainting the narrative of a successful union. But, even after the vote, Brussels cannot play hardball with Rome since Italy poses a threat of epic proportions.

The threat is at least twofold: First, the sheer size of Italy's economy. It is 10 times that of Greece's and the third largest in the euro zone. But it has been faltering. Unemployment in August was at 9.7 per cent. Although slowly improving, the figure is still far from the 5.8 per cent prior to the financial crisis in 2007.

Its GDP is 5 per cent below pre-crisis levels. The government recently downgraded the forecast for GDP growth this year to 1.2 per cent.

The biggest headache, however, is its huge debt. Italy has the dubious distinction of being the third largest debtor country in the world - after the United States and Japan - with an outstanding debt of €2.4 trillion (S$3.8 trillion). Italy's government debt-to-GDP ratio stands at over 130 per cent, exceeding by more than two times the upper ceiling set by the Maastricht treaty, which laid the foundations for the European Central Bank and the euro.

Nothing is keeping Rome from taking on more debt as the right-wing populist government seems to be well aware that a default could trigger a European banking crisis. Brussels will therefore do anything to avoid a worst-case scenario.

The tone and attitude of the Italian government is more than worrisome. Italian Deputy Prime Minister Luigi Di Maio, who is head of the Five Star Movement, has accused the EU of "creating terrorism on the markets". He was referring to critical remarks by EU commissioner Pierre Moscovici on Rome's latest budget plans, which sent jitters through the market.

Italy's borrowing costs soared on Monday, bank stocks declined and the market tumbled to its lowest since April last year.

But it was not only Mr Di Maio's language that was highly irritating. After clinching the budget deal with Finance Minister Giovanni Tria, who has no party affiliation and who opposed the new borrowings, Mr Di Maio appeared on the balcony of the prime minister's building with his fist clenched and then punched the air. The symbolism was unmistakable for many observers, who were reminded of dictator Benito Mussolini. Hitherto, balcony-politics had been a no-go in Italian politics.

The government in Rome is in need of new cash to deliver on the many promises it made in the election in March.

The most costly one is pension reform. Italy wants to do away with the so-called Fornero reforms, named after a former minister of social affairs. In 2011, Ms Elsa Fornero abolished early retirement regulations to cut spending and return confidence to financial markets. The new government now wants to reverse course and enable 400,000 Italians to retire as early as next year. The plan would add up to an extra €8 billion next year alone.

"The Italian government's choice to mark a break in the fiscal adjustment path was partly expected but the scope and, more importantly, the persistence of the deviation is a reason for concern", said economist Paolo Pizolli from Dutch bank ING. "The possibility of a downgrade and risks of medium-term debt sustainability have just gone up."

The government, however, is more popular than ever. Recent polls indicate that it enjoys the support of roughly 60 per cent of Italians.

By making frequent use of social media, the government has been able to circumvent the established media. The government is also trying to bring the country's biggest media organisation - state broadcaster RAI - under its control by appointing Mr Marcello Foa as its head. Mr Foa, who is known for spreading conspiracy theories, is from the camp of former conservative-populist prime minister Silvio Berlusconi.

A version of this article appeared in the print edition of The Straits Times on October 11, 2018, with the headline 'Italy opts to play cat and mouse with EU'. Print Edition | Subscribe