Italy’s first priority is to assess the possible impact on public accounts and growth of the victory of the “no” vote in the referendum in Greece. The impact is difficult to estimate at the moment, since it strongly depends on the outcome of Greece’s debt negotiations in the coming weeks. The bill could be hefty.
The second priority is to try to further stretch deficit in 2016 from a planned 1.8% to 1.9-2%. A leeway would bring additional measures for €1.6 to €3.2 billion. At the same time Italy should open a negotiation with Brussels about activating the flexibility clause for productive investment.
After the referendum in Greece, with an eye on the reaction of the markets and bond yields, the government will first have to estimate the fiscal impact of the “no” victory, but also try to redefine soon the agenda of priorities to be discussed with Brussels, in order to prepare between September and October a budget oriented to growth. This is an uphill but mandatory road, also in view of the limits imposed by a new budget law already carrying the heavy burden of finding at least €10 billion from the spending review. These resources have already been factored in. Otherwise, the value-added and fuel taxes will increase next year, as indicated in the budget blueprint, or DEF, approved in April.
On the European front, further room of maneuver must be found as indicated in the “communication” about flexibility rules approved by the European Commission on January 13. Once we have exhausted the margins granted this year because of “exceptional circumstances” (the effects of the prolonged recession), which allowed us to cut structural deficit by 0.25% of GDP instead of 0.5%; once we have obtained for 2016 the flexibility clause on the reforms, which will ensure a margin of €6.4 billion (deficit is estimated at 1.8% against annual 1.4%), we can only play the card of investment. This clause could apply to co-funding of national investment projects, and could be boosted when the European Union finally moves toward the partial or full deduction in deficit calculations of capital expenditure used to fund primary investments with a clear impact in terms of potential GDP growth.
For now, the strategy of the government hangs “in the balance” ahead of developments in the Greek crisis. However, the prime minister’s office and the Economy ministry are starting to think about the effective possibility of introducing an additional “discount” in the Stability Law. From a strictly technical point of view, since the flexibility clause for structural reforms says that in 2016 Italy can limit its fiscal adjustment to 0.1% of GDP (instead of 0.5%), the government will have to show that the eventual new nominal deficit target (1.9% or 2%) is “coherent” with the structural deficit cut.
In sum, the effects of a higher deficit should be “neutral” compared with the indicator that European rules now see as primary. Italy will also need to persuade the European Commission that the eventual use of a small deficit margin does not call into question the path toward “the medium-term objective” of a balanced budget, a target that the government has pledged to achieve in 2017.
If the Commission seems oriented toward giving more flexibility to countries outside of excessive deficit procedure, the government will need to update Brussels with facts and figures about progress in single reforms.
The true match clearly is with growth. This is why the investment chapter returns to be a priority. At the moment there are no evident additional margins to support domestic demand. Margins to significantly reduce taxes are thin, unless the government and the Parliament bring selective expenditure cuts to around €15 billion. This is a difficult bet, and in any case it will require the scalpel since spending cuts (unless carefully balanced) can have a recessionary impact as much as higher taxes.
Resources for €6.4 billion coming from the flexibility clause for the reforms will have to replace the safeguard clauses in 2016, in addition to €10 billion from the spending review. Once the Greek referendum is over, all these issues will dominate the government’s agenda.
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