In an effort to negotiate more constructively with Brussels, Italy’s Finance Minister Giovanni Tria presented a compromise 2019 budget to the European Commission on October 15, on schedule, that included some minor adjustments to both deficit projections and spending plans, approved by his real bosses: the Northern League Party’s Matteo Salvini, and the 5-Star Movement’s Luigi DiMaio.
*** But despite the concessions presented by Tria, and some further last minute back and forth, we are hearing from three separate sources close to the decision-making process in Brussels that the European Commission is itching to take the deliberate Salvini challenge to the EU’s authority head on and invoke a budget disciplinary procedure — the Excessive Deficit Procedure — in response to Italy’s non-compliant budget. That, we understand, could come as soon as on November 21. ***
*** On a recommendation by the Commission, a decision to impose this Excessive Deficit Procedure needs to be adopted by the Council of EU finance ministers, unless a “qualified majority” of Member States vote against it. This “reverse qualified majority” voting system not just takes blocking power out of small member states’ hands, but in the process makes the enforcement of the EDP almost semi-automatic if and once it is recommended to the Council by the Commission. ***
*** And what this choreographed process means to the politics is important: every EU source we have heard from indicates the current Italian government doesn’t have a single ally within the EU – making them a perfect case to push back on Rome’s open flaunting of EU rules, even if it is with full knowledge that the episode will be used to deliberately inflame the politics of the European Parliamentary elections in May next year. ***
The Commission’s willingness to confront Rome will entail considerable political risks, and potential market dislocation. It could, for one, trigger a populist backlash in the May European elections, especially since Salvini has already declared his intention to lead a new EU skeptic bloc in Strasbourg. And the Commission’s room to compromise may prove to be further limited in light of political shifts already underway in Germany (see SGH 10/30/18, “Germany: The Merkel Transition”).
The Process, and Further Potential Measures
The EDP has been started and ended may times before, against most EU countries, so starting the process itself, while an unmitigated escalation, in and of itself may not be that big a deal. But fining a country at the end of the process would for the Commission represent a “nuclear option” indeed, as that has never happened since the 1997 creation of the Stability and Growth Pact.
Here is how that would go:
If, as we expect, the Commission starts the EDP on Nov 21, it would entail issuing a report that Italy broke the rules, while in parallel issuing a recommendation on how to correct the breach, and within what deadline. EU finance ministers could then approve the Commission recommendation at their meeting on Dec 3-4.
It is, of course, ultimately a political decision. But the rules say that in the case of a particularly serious breach of the rules, the Commission will give the country in question three months (or six for less egregious cases) to take effective action to eliminate the excessive deficit. The three months (assuming it is that) for effective action would then pass at the end of February.
At that time, barring some miracle decision by Salvini to back down from the fight, EU finance ministers could then assess in a Commission report that Italy has not taken effective action at their meeting in March or April, and agree to move on to the next phase of a fine.
Critically, that means the whole process could take place before the European Elections in May, if that indeed would be a political fight the Commission and the EU should actively choose to engage in.
So technically speaking (bear with us) the EDP could end up with a 0.2% of GDP non-interest-bearing fine to be paid to the ESM bailout fund. Earlier steps could include the same money being held in escrow until the member state is on a credible path back to compliance with the Stability and Growth Pact metrics.
Or, as happened in the case of Spain and Portugal in 2016, the procedure can reach the phase of sanctions, but the Commission can then propose to cancel them.
A 2018, and not a 2019 Story
Normally, the EDP (as well as another intervening punishment, the “SDP,” or Significant Deviation Procedure) is reserved to show displeasure at actions already taken, such as budget misses, and not in anticipation of forward looking budgets and plans.
But the Commission has apparently already warned Rome that it is considering launching an EDP – in 2018 – for misses already from 2017 projections, given that the new budget plan, if anything, reverses the progress already promised and already missed under the 2017 plan in addressing Italy’s pervasive, roughly 130% Debt/GDP level.
Indeed the Commission will argue it let Rome off the hook earlier this year when the Salvini/DiMaio government failed to cut Italy’s public debt as required by EU rules, but this was only because they were still planning to reduce the structural deficit by 0.6%/GDP in 2019. Now they are proposing to, not decrease, but increase Italy’s structural deficit by 0.8%/GDP in 2019.
So the premise used to give the government a pass before no longer holds. And that means the excessive deficit procedure will be on the basis of Italy having already breached the debt criterion in 2017, which should have been invoked earlier, but wasn’t.
The SGP debt/GDP target is of course 60%, or less than half Italy’s 130%. The non-compliant member state – in this case Italy – is then expected to at least pretend to reduce grossly and pervasively offending deviations by 1/20th each year, despite their actual budgeted deficit numbers still falling well below the 3% SGP target. In other words, they need to be running even tighter than at a 3% deficit/GDP.
But more importantly, the rules say that Italy has to reduce its structural deficit — the balance that excludes one-off income and spending and cyclical swings in revenue and expenditure, like on unemployment benefits vs taxes — by 0.6 pct/GDP a year until it reaches a structural budget surplus.
Italy itself agreed to this EU ministers’ recommendation in July.