Novice prime minister, populist government could put Italian economy in danger | Business| Economy and finance news from a German perspective | DW | 22.05.2018
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Novice prime minister, populist government could put Italian economy in danger

Ambitious spending plans by Italy's new coalition, and potentially a political unknown as prime minister, have put investors on edge. Some commentators think the effects will also be felt by the entire eurozone.

The nomination of Guiseppe Conte as Italy's next prime minister has set alarm bells ringing among international investors, as skepticism grows over whether he has the acumen to prevent the country from becoming the next Greece.

Conte, a 54-year-old law professor, has never held political office, and if selected, would have the job of managing Europe's first populist government — a potentially unwieldy alliance between the anti-establishment Five Star Movement and the far-right League, formerly known as Northern League.

Even before his nomination was announced, the two parties finalized a coalition deal last week that included plans for huge tax cuts and far-reaching public spending increases.

In the 58-page "Contract for the Government of Change," the two parties vowed to roll back austerity measures by cancelling a plan to raise the pension age, while at the same time guaranteeing all citizens a monthly basic income, which alone is expected to cost some €17 billion ($20 billion). All this in the EU's second largest indebted country after Greece.

Read more: Opinion - EU panic over Italian populism only exacerbates tension

Deal targets EU rules

The coalition deal, which some analysts have costed at €170 billion, has unnerved Brussels because it comes with demands for a review of European Union budget rules that limit debt and deficit levels among member states.

Italy's €2.3 billion of debt is 132 percent of gross domestic product (GDP), and is forecast to remain at 130 percent of GDP this year — more than double the EU's 60-percent ceiling. The new government's spending plans would add significantly to that debt pile, costing the equivalent of 10 percent of GDP.

The Italian business daily Il Sole 24 Ore estimates the plan will push the budget deficit to 5.8 percent, well above the EU's agreed ceiling of 3 percent.

Shopping center in Milan (Imago/Manngold)

Italy's economy is now expected to grow 1.4 percent in 2018, compared to an earlier forecast of 1.5 percent

Although it may be some days before Conte's selection is approved by Italy's president and parliament, bets are already being taken on how long the new government will survive, partly because Italy has experienced 65 governments since 1945 — averaging 1.2 years, but also because analysts expect the financial markets will punish the coalition if its economic plans are deemed profligate.

"I don't expect the government to last, so therefore I don't expect the full coalition agreement to come into force," Emanuele Bracco, an Italian Professor of Political Economy at the UK's Lancaster University, told DW.

Bracco believes Italy's new leaders will only achieve some "moderate tax cuts, and moderate reforms to the pension system," a far cry from the huge promises made to the Italian electorate. Those would likely be paid for by a tax amnesty or another easily achievable measure, he said.

Italy is more likely to follow Greece's example, where the ruling Syriza party proposed ultra-leftist policies during the election campaign, before its proposals were toned down in government, Bracco predicted.

Read more: EU urges Italy to tackle reforms after 'excessive economic imbalances'

Contrasting priorities

Conte, if selected, will lead a coalition of two disparate political movements with contrasting priorities, whose main affinity is their opposition to immigration and their euroskepticism. 

Braccro noted that both parties have a "strong mistrust of the EU elite, which glues them together very well."

He said the president may pressure the two partners to nominate another finance chief; their preferred candidate is 82-year-old Paolo Savona, who has described the single currency as a German cage that constricts the other European partners.

A more moderate candidate would likely "tame the beast," Bracco predicted.

Some analysts, meanwhile, think Conte will struggle to rein in Five Star leader Luigi Di Maio, and firebrand Matteo Salvini of the League; both are tipped for key ministerial posts in the new cabinet.

Left-wing newspaper La Repubblica branded Conte "a prime minister who will not count."

"What authority will he have when he goes to meet Angela Merkel and Emmanuel Macron?" the paper said in an editorial.

Bracco insisted that Conte would be a strong leader, noting that "he previously was in charge of disciplinary action against judges, and has taken harsh measures against those who have misbehaved."

But he acknowledged that it "would be difficult for someone who is willing to put at stake his reputation and career to be a 'yes' man, and to support an agreement that he has had no part in forging."

The final coalition deal was published without its initial threat to pull Italy out of the euro common currency, but its aggressive demands for EU reforms puts the new government on a collision course with Brussels that some commentators think could potentially bring about a new crisis in the eurozone.

Read more: IMF wants 'rainy day fund' for eurozone

Markets await formal approval

So far, the market's response has been muted. The Italian 10-year bond yield has risen from 1.74 percent last month to 2.29 percent, but remains far below the 7 percent rate it reached in 2011 at the height of the euro debt crisis.

A major spike in bond yields could leave Italy struggling to arrange long-term financing. It currently pays around €60 billion a year to service its existing debt.

Any move towards irresponsible policies, or signs that the administration is following through on threats towards Brussels, would likely see an aggressively response from international investors.

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Italy's political uncertainty weighs on the economy

Italy's coalition party leaders had earlier called for the EU to cancel €250 billion in Italian public debt. But that demand was missing from the final version of the deal, indicating a softening in stance.

European Commission Vice President for the euro Valdis Dombrovskis on Tuesday called on Italy to pursue a "responsible" budget policy that will continue to bring down its massive debts in line with EU rules.

In an interview with German business daily Handelsblatt, he noted that the coalition's plan to drastically slash taxes and reverse pension cuts will be costly.

"We can only advise it to stay on course in terms of economic and fiscal policies, to stimulate growth through structural reforms and to keep the budget deficit under control," Dombrovskis said.

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