Market action was nervous in the early days of August as key Italian Government figures met to have a discussion around the main guidelines for the Budget Law.
The main outcome for this meeting was the reinforcement of the idea, by the Finance Minister Tria, that the flagship fiscal reforms, i.e. flat tax and universal income will be implemented in a way that does not compromise the budget.
This meeting is expected to be followed by another one, more in-depth specific discussion on single hot topics, on Wednesday this week, although the law will be written by the Ministerial office and presented according to a precise schedule.
- Frictions between Finance Minister Tria, M5S and Lega articulate along multiple lines.
- EU budget rules yes or no.The Finance Minister keeps reassuring the Budget law will be drafted within the limits allowed by EU agreements and treaties, while the two parties appear to be pushing to have some fiscal room to implement their flagship reforms, notwithstanding the EU budget rules, and the rhetoric is maintained confrontational by the M5S and Lega.
- Different Prioritisation: It was also recently reported by newspapers that the Finance Minister expressed the idea of not fully sterilising the VAT hike, to create some room in the budget, but this looks like a non-starter for both Lega and M5S as they both promised in the “Contract” a full sterilisation. Also, priorities of the two parties are different, as it has always been in their electoral programs: the M5S pushes for the universal income while the Lega supports the flat tax.
- Timing and Horizon are different. While both parties would have incentives to start delivering on the fiscal front in anticipation of the European elections next year, the Finance Minister has been stressing that the government would need to work on a multi-year plan (i.e. over the entire parliamentary term) to implement their program round the pillars of flat tax, universal income, Fornero’s law on retirement and pensions (impact estimated around 100 bn), as the only way to act within the current EU framework in a sensible way.
- Negotiation vs Confrontation. While the rhetoric of both Lega and M5S remains confrontational against the EU rules, the Finance Minister has reportedly started a dialogue with the EU to obtain some additional flexibility to set a target of structural balance in line with 2018 ( instead of -0.6% of GDP in 2019) to avoid too strong measures in this slow-down phase and at the same time avoiding excessive deficit procedure.
- Changing the rules vs acting within the rules. In last week meeting (key Government figures) reportedly the key word has been “change of paradigm”, with the underlying ideato implement fiscal reforms (to support family income and businesses expenditures) and subtract these reforms burden (as well as investments expenditure) from the computation of deficit/GDP ratio. Such an approach would not be applicable in the short-term (implying changes to the overall EU treaties architecture). The new paradigm of Minister Tria, instead, appears more pragmatic, acting within current EU framework, looking for more flexibility while establishing a constructive dialogue with the EU authorities, able to show a longer-term plan. The hearth of the programme of the Finance Minister would be a new equilibrium between Public Administration current expenditures and investments, the former to be freezed in nominal terms in order to leave room for increased Investments, and therefore create an endogenous stimulus. This would mean, though, avoiding 10.3 bn of increased expenditure next year (net of interest) and avoid and increase of 33.3 bn in 2019-2021).
The key, basic reason why nervousness is increasing is that, while the government seems lacking a vision and an economic project so far, Italy’s economic performance is slowing down, making the growth projections included in April’s DEF less likely (1.5% in 2018 and 2019); this would reduce further the room for fiscal manoeuvre and increase the likelihood of government crisis. Even worst, should a stronger deceleration or recession hit, monetary policy by the ECB should be associated to a fiscal policy, but Italy would have very limited room and it is not clear what the Government would be able and prepared to do.
These are the numbers* around which the budget discussion will articulate in September:
- 12.4 bn to avoid VAT hike (0.65% of GDP)
- 3.5 bn to cover for not-deferrable expenditures (0.2% of GDP)
- 2.5 bn cost from lower GDP growth (0.1% of GDP)
- 3.5 bn interest expenditure (likely to be increased as from last DEF in April the spread increased) (0.2% of GDP)
==> Total of 22 bn (conservatively, or 1.2% of GDP) to be found.
On top of this, it should be considered that 70 bn is the estimation of the cost of the implementation of flat tax and universal income in full, 100 bn if including the change in Fornero’s Law and other measures included in the contract. Estimations from the INPS (*) are heavier than those provided by the Osservatorio dei Conti Pubblici, but the bottom line remains a quite difficult task to find room in this year budget.
*estimates by INPS
The numbers above show clearly that there is little room and flexibility for the Budget in September.
Finance Minister Tria is likely to try and negotiate with the EU Commission the target of not worsening the structural balance of 2018 (-1% of GDP in 2018 vs -0.6% in 2019), freeing some room for a partial implementation of flat tax and universal income, in the range of 8-10 bn. He already reportedly said he started talks in this sense with the EU. Finance Minister Tria is addressing the public finance/building-up of fiscal room with a medium-term perspective. While he said he’s not expecting any request for a “manovra correttiva” (budget for correcting the budget law after a negative opinion from EU commission), the risks of escalation in rhetoric and confrontation with the EU (especially by the Vice Prime Ministers) is very high as September approaches. Risks of increasing pressures within the government coalition and with the finance minister are high, as differences of view and incentives to create confrontation with the EU are strong. Although as of now we do not expect a government crisis finally, nervousness in the markets will stay for the months to come and is set to increase should the macro and activity numbers keep deteriorating.
What are the key dates?
Parliamentary activity rushed in these weeks to catch-up with the time lost between the election date and the government formation, with the Summer recess approaching (this Friday) and little details on the actual fiscal plan the government would like to discuss in September.
Before August Recess this week two key themes will be discussed:
a) the Decreto Dignità, to be discussed and voted in the Senate between the 6 and 7th of August, set to become law this week, including new limits on the use of temporary contracts, new rules on business relocation, new law on gambling; this should become law with no need of “voto di fiducia”;
b) Budget law: this week on Wednesday, new meeting with more specific discussions. We do not expect details to be revealed. Text of the Law to be presented to the Ministers Cabinet likely not before October.
27th of September: NADEF ( nota di aggiornamento al documento di economia e finanza) to be presented: update to the economic and finance document (DEF). The DEF was presented in April by previous government, under current law assumptions (hence without the new government program). This document will include the update of the programmatic goals (hence the new assumptions/projections on GDP and Deficit and Debt dynamics)
20th of October. Based on the NADEF, the Government then will present the new budget law by the 20th of October, starting the parliamentary session on the Budget for 2019. The Budget Law must list in detail all measures to implement and their economic quantification, in order to implement the NADEF.
15th of October. By the 15th of October, the Government must submit to the EU Commission the Draft Budgetary Plan for 2019 , summarising the goals of 2019 Budget and describing how their impact in the EU recommendations framework (DBP for 2018 available here: https://ec.europa.eu/info/business-economy-euro/economic-and-fiscal-policy-coordination/eu-economic-governance-monitoring-prevention-correction/stability-and-growth-pact/annual-draft-budgetary-plans-dbps-euro-area-countries/draft-budgetary-plans-2018_en )
30th of November: by this date, the EU Commission will assess the adherence of the Draft Budget Plan to the EU framework and submit their comments. In the last two years, the comments were given by the end of November (and final assessment by the following spring), in order to allow for new economic projections in autumn.
31st December: by this date the Italian Parliament must approve the budget law.
*Sources: il Sole 24 Ore, Osservatorio dei Conti Pubblici Italiani