What is at stake when Italy plays chicken with markets, EU
What is at stake when Italy plays chicken with markets, EU
The Italian government is playing a game of hens with European authorities and financial markets about plans to spend large sums, and it is not clear if the country can avoid a collision that would spread the remains throughout Europe and the rest of the world.
Financial markets have been falling in Italy and the risk is that the dispute may rekindle the latent concerns of investors about the stability of the country and the future of the euro.
Italy is the fourth largest economy in Europe and integrated into the global financial system. Serious problems could hinder the business around the world.
Here is a look at the risks posed by Italy's budget shock with the executive committee of the European Union.
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Q: HOW DOES THE FIGHT BEGIN?
A: The new government of Italy decided to increase spending dramatically, raising the deficit to 2.4 percent of GDP, three times more than previously planned. The Commission rejected the budget under a process of EU review. He warned that the higher spending would prevent Italy from reducing its debt, as promised. With 133 percent of GDP, it is the second highest in Europe after Greece.
The populists of Italy refuse to back down. Matteo Salvini, leader of the anti-immigration League party, skeptical of the EU, promised that "one euro will not be lost" from the 2019 budget.
Tensions are already having an impact on the Italian economy. The rating agency Moody's has reduced its credit score for Italy to the lowest investment grade level, a measure that has cost Italy's fragile banks dearly, since they hold a large part of the public debt in the form of government bonds. Standard & Poor's is the next to make its evaluation.
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Q: WHY IS ITALY GASTA SO MUCH?
The populist Five Star Movement of Italy and the League point out that Italy has lagged behind in Europe's economy, and they blame austerity, spending limits observed as part of being in the euro.
His recipe: put money in the hands of Italians through social welfare programs that will mainly benefit young people seeking employment and at the same time restore pensions that had been cut by a previous government. They say that spending and investments will mean growth that will then help reduce the deficit. But many analysts say that Italy needs mainly to change the way the economy works, reducing bureaucracy, for example.
And as much as the populists insist that they do not want Italy to leave the EU or the euro, a confrontation with Brussels is an electoral sweet that reinforces their credibility against the establishment. Their popularity is increasing, as polls show they would take 60 percent of the votes in an election today. Both parties are fixed in the elections to the European Parliament in May.
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Q: WHAT CAN THE EU DO?
A: The European Commission is aware that throwing the book at Italy could only make things worse by fueling a populist reaction against the EU. But a more lenient response would upset more states that respect the rules, particularly in northern Europe, and challenge the credibility of the bloc's fiscal rules.
The commission wanted to point out that Italy has the right to choose its spending priorities and supports the need to address poverty. And they have highlighted the role of Italy as a founding member of the EU.
Italy has three weeks to respond to the rejection of the EU. If it does not review its budget, the EU could invoke a formal procedure to align Italy, which could eventually result in a fine. That is likely to only exacerbate the dispute and worry markets more about Italy's commitment to the EU and the euro.
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Q: WHAT HAPPENS IF ITALY IS DOWNLOADED?
A: Low ratings mean that bonds are riskier and their prices go down. That hurts the banks, which have many of those bonds. Downgrading emphasizes your finances and restricts your ability to lend. Interest rates would rise. Rates of government bonds influence the rates of other loans, so businesses and consumers would pay more for loans. The economy would suffer.
And if the bonds are lowered to a level below the investment grade, Italian banks could no longer use them as collateral to obtain cheap credit from the European Central Bank. They would lose their reliable source of cheap financing to continue doing business. Banks in trouble are a frequent part of broader economic crises, such as the Great Recession a decade ago, because of the key role banks play in the economy.
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Q: WHY SHOULD ANYONE BE OUT OF ITALY?
A: Although much of Italy's debt is held by Italian investors, a sudden or default drop could affect other financial markets as fears spread. For example, French banks have 316 billion euros (360 billion dollars) in exposure to Italian debt, which means that losses in a crisis could jump to the border quickly.
If Italy seems unable to pay its huge debts, investors could begin to bet that the country will stop paying, and that could raise doubts about the breakup of the euro. That would probably have a big impact on the global economy by depressing confidence, disrupting trade and making banks distrustful of lending the money necessary for finance and business to function.
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Q: CAN NOT YOU DANCE TO ITALY AS GREECE?
A: It would be much more difficult because Italy is much bigger. The rescue fund of the eurozone has 410 billion euros ($ 465 billion) in reserve loan capacity. Italy will need 240 billion this year alone in financing. Therefore, the rescue fund is barely two years old, and Greece was on life support for eight years. In addition, other governments may refuse to face Italy's problems.
That leaves the European Central Bank. The ECB has a backing: a promise to buy unlimited amounts of bonds issued by a country facing extreme borrowing costs. But that comes on condition that the country signs an agreement that promises budget cuts and tax increases. It is unlikely that the populists in Italy will do that.
Therefore, a rescue of the ECB would probably require the collapse of the current government first.
That could come too late to stop a crisis.
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McHugh reported from Frankfurt, Germany.
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This story corrects the French exposure figure to Italian debtors to 316 billion euros.
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