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Italy replies to Brussels’ letter stressing recession must be avoided at all costs

by Dino Pesole

The reality of hard numbers is behind the decision to implement an “expansive” monetary policy, even if this results in a “momentary deviation” from objectives agreed up by the European Union. In the letter sent yesterday morning to Jyrki Katainen, Commissioner for Economic Affairs and vice president of the EU Commission, that Economy minister Pier Carlo Padoan reminds the commissioner that Italy's GDP has suffered a 9% contraction since 2008. The Italian economy is being squeezed by recession for the third year in a row, and must take into account “a serious risk of stagnation and deflation. A fourth year of recession must be avoided at all costs.” At the same time, he reiterates the government's commitment to a 4.5 billion euro package of measures that will correspond to a correction of the structural deficit equal to 0.3% of GDP. That's the compromise solution that evolved over days of unofficial discussion with both the old and new European Commission in response to the substance of the letter sent by Brussels last Thursday.

A command by Brussels that the government was forced to obey?

In truth, it is a compromise solution that allows Italy not to modify the substance of the framework of the Stability Law now being examined by the Chamber of Deputies; and it allows the European Commission to reaffirm itself, in its partners' eyes, in its role as “guardian” of public finances. In detail, 3.3 billion of the package come from a special fund earmarked to reduce fiscal pressure. Another 500 million will result from lowering the national contribution component to resources destined for “cohesion” funds; and finally 730 million will arrive thanks to the extension of the so-called “reverse-charge” on VAT. The latter is included in the group of measures against tax evasion, so it gets a preemptive green-light from European institutions.

Certainly, subtracting 3.3 billion in potential interventions to reduce taxes will decrease the “expansionary” possibility of the budget, but it also allows it to slip through without being nixed by the European Commission.
In any case, the “real” negotiation was with the new commission of Juncker that will assume office on Nov. 1 . He has been seen as more attentive to growth and more sensitive to the need for flexibility in balancing European budgets. Italy does not seem to have any other option than to aim for a “growth-friendly” policy. In his letter, Padoan reminds the European Union's economic chiefs that the decision to postpone its medium-term objective of balanced budgets to 2017 is due precisely to the protraction “of an extremely unusual set of economic circumstances.” A situation - this is the government's line - so extreme as to call for recourse to “exceptional circumstances” at least for the current year and in 2015. At the same time, “the huge effort” required “to implement” those long-awaited structural reforms - according to the Treasury - which will have additional costs in the short term, needs to be evaluated.”

This all assumes that the deficit/GDP ratio will remain, also in 2015, under the maximum allowed ceiling of 3%. The makeup of the budget will sustain the process of structural reforms “that will continue with additional adjustments in the labor market and in the civil justice system that have been anticipated sine the start of last year.”
With public debt seen hitting a record 133.4% of GDP in 2105, it is necessary to work on a “path to get it down - in part to an ambitious privatization plan equal to a 0.7% of GDP annually.” “Some delays - writes Padoan - due to adverse market conditions will be worked out over the next few months.”