Italy: Renzi’s Push for Further Stimulus

Published on January 26, 2016

News wires have been reporting for the past month or so on a war of words between European Commission President Jean-Claude Juncker and Italian Prime Minister Matteo Renzi that only escalated last week, adding pressure to Italian stocks and sovereign bonds already hit by fears over worse than expected data on Italian bank Non-Performing Loans.

Last Thursday, both ECB President Mario Draghi and Single Supervisory Mechanism Chair Danielle Nouy dismissed some of the negative rumors about the Italian banks. But the Italy-EU relationship remains tense, and the reason has been Renzi’s aggressive push for greater flexibility to deviate from the Stability and Growth Pact (SGP), which has not been well received in Brussels.

*** That being said, from what we hear, and for all the bad blood, both the Italian government and the Commission are eager to tone down at least the public rhetoric and try to work on a solution. While a specific final figure is still hard to come by, we expect that Renzi will obtain a large part of what he has asked for in additional fiscal space, which would amount to the biggest government spending expansion in a long time, and a complete change of course since the austerity years in post-crisis Eurozone. ***

*** And while the size of the final exemption Italy eventually gets is ultimately a political issue, we expect at a bare minimum it will include an increase in spending of about 10 billion euros. Whatever is allowed on top of that will be further stimulus that will only add to an already expansionary FY2016 budget. ***

The Fight for Exemptions

Renzi is trying to get a green light from Brussels on an Italian FY2016 budget that includes, on top of the 0.4% of GDP, or 9 billion, increase in government spending approved by the Commission last spring, an additional 9 billion – or a further increase of 0.4% of GDP in spending.

Commission officials are cautious to comment as the matter is subject for review, but in any case point out that the maximum available leeway or Italy is 0.75% of GDP, which is slightly below what Renzi is asking.

In addition to this, and outside of the scope of the above mentioned flexibility rule, Renzi has already budgeted roughly 4 billion euros “for migrant crisis related expenses,” and is asking the Commission to sign off on, and exempt, that too. But Brussels reiterates that these kind of expenses will only be evaluated “ex-post” – in other words, the Commission will give its assessment at the end of fiscal year 2016. In addition, FY2015 will be used as a benchmark, meaning only the migrants-related expenses exceeding those from the year before will be considered for exemption, and, according to Commission projections, in the case of Italy that figure should stay more or less the same.

What was however seen as the biggest provocation by Brussels was the Italian plan to spend – and request to exempt from the SGP – an additional two billion euros on, according to the Italian government, “security,” which, and that’s what really upset DG ECOFIN, includes 500 million that will be used to renovate public school buildings and 500 million for “culture.”

An Easy Adversary

In the process Renzi has resorted to blunt attacks and public scolding that have surprised even for those in Brussels who remember the funny and tragic years of former Prime Minister Silvio Berlusconi.

Indeed Berlusconi, officials say, despite the clownish attitude on display at European summits, was always very careful in private not to go all out against the Commission, who, as a good businessman, he felt he needed to ultimately keep on side. Renzi, on the other hand, has ironically been more consistent in his public and private adversarial stance, managing even to upset the peaceful Juncker, who is no friend of the SGP himself and had been previously keen on helping the Italian government – and other, fiscally profligate countries like France – so long as he could save face.

The Italian Prime Minister, not content with obtaining, last spring, agreement to use the so-called “flexibility clause” to justify a further increase of 0.4% of GDP as a “reward” for swiftly tabling and approving structural reforms, also included in the budget’s final version the European Commission cleared with “reserves” last November more spending for a total of 0.8% of GDP, or approximately 18 billion Euros, of fiscal expansion compared to FY2015.

The further stimulus should be exempted, according to Italy’s requests, partly as a reward for its further reforms efforts (0.1%) and partly under the “investment clause” (0.3%).

Without getting too specific about the merits of the request, Commission officials point out that, of the total of 0.8% of GDP that Italy would like to be seen exempted from the straightjacket of the SGP, Brussels can technically only allow a total of 0.75% of GDP. In other words, it cannot and will not sign off on all that and the further 0.4% that has been added on top of that at the end of last year.

Technically speaking, the criteria used to make the decision of awarding further space are: the pledge to stick to a credible adjustment of the budget deficit, that the fiscal space is used for investment, and of course that there are structural reforms being put in place.

The further spending related to migrants and security (around 6 billion in total) is also an issue: but for the migrants’ part, it will only be dealt with toward the end of 2016, when the final figure will be clear. For now, Renzi can spend it and kick the can down the road. And as to further “security” expenses, the figure is rather small, so relatively unimportant.

What’s more, even a Commission rejection of the Italian budget might not stop Renzi from going forward with the widest possible fiscal expansion.

While the subsequent negative headlines could have an impact on what has so far been a very positive assessment in the international context of Renzi’s job, that won’t deter the Italian Prime Minister, who is eyeing the much more important – for him – October 2016 referendum back home on the recently approved constitutional reform, a vote that he has said will determine whether he stays in power or not.

Taking on Brussels

The biggest political casualty of Renzi’s recent offensive against the European Commission has been Stefano Sannino, a longtime head of the Italian Permanent Representation in Brussels and esteemed career diplomat who Renzi “banished” to Madrid for not being tough enough in negotiating with the Commission. As his successor, Renzi appointed Carlo Calenda, an economist who is closer to the Prime Minister, does not come from the diplomatic ranks, and is less ingrained in the Brussels bureaucracy.

And it is now clear that Renzi is taking on Brussels and the GSP full steam, willing to go as far as needed to get his way, buoyed, or pushed, by a need to find a grip on national public opinion that sees defying Brussels as a positive, in light of the upcoming October referendum.

And in the past month alone Renzi has gone a long way to ensure that he is seen, internally, as the guy standing up to Brussels, from the request to hold a political debate on the renewal of Russian sanctions, to the refusal to accept to pay off Turkey to stem the flow of migrants, to the defiant attitude now towards fiscal rules.

Hopes for a softening of the tones – officials point out – are tied for now to a bilateral meeting between Renzi and German Chancellor Angela Merkel planned for January 29, when the two will try to find a comprehensive solution on a wide range of issues, including Italy’s participation in the 3 billion euro fund earmarked for Turkey to reinforce its borders.

But we suspect Renzi will not give up attacks on Brussels until he clears the hurdle of the referendum, after the summer.

Renzi attaches enormous importance to this vote, his first real test after the 2014 European elections that so strongly reinforced his leadership.

And for Renzi, it is imperative to deliver on promises to restart the economy at any cost, and even PD voters who are sympathetic to Europe despise the SGP if it stands in the way.

So either the Commission gives him a green light for the biggest chunk of his projected fiscal expansion, or he gets some kind of slap on the wrist – but even that, too, will be used to his advantage in the internal arena and is unlikely to stop him from stretching the limits of the SGP anyway.

Officials in Brussels lament that Renzi could have – with a more considerate, long-term strategy – become the legitimate leader of a Europe-wide pro-growth “new age” by taking advantage of a retrenching United Kingdom and a troubled Merkel.

Instead, the Italian leader has chosen the path of strengthening his national standing at the expense, at least for now, of Italy’s standing in Europe. It may at least in the process provide an extra boost to the sluggish Italian economy.

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