This week, tensions between Brussels and Rome intensified, reflecting another battle between the newly-formed populist Italian government and the European Union establishment.
Italy presented its 2019 budget draft, but despite earlier warnings to cut spending, it violated EU rules around debt levels. Consequently, the EU rejected the budget and gave Rome three weeks to resubmit it.
The newly elected Italian coalition party has taken on a bold rebellion against the EU, because its proposed budget is based on political promises made in May after the election. Italian Prime Minister Giuseppe Conte says that Rome doesn't have a “Plan B." The deputy PMs are communicating via Facebook and have been including smiley faces in messages to show they're not backing off.
In a nutshell, Italy wants to cure its already large debt with more debt. The Italian finance minister said that boosting economic growth is his priority, but the country's policy also includes outsized spending with generous unemployment benefits and pension increases. He blames the EU for putting Italy in this position to begin with.
The EU, on the other hand, has no incentive to accept this budget draft. Reminiscent of the Greek crisis a couple of years ago, international investors lost confidence in Athens' ability to recover its debts. As a result, it was the other member states within the eurozone that had to organize expensive rescues to turn things around, and this has cost them both time and money.
The tricky problem is that the EU is also holding parliamentary elections next May. Part of Italy's wishful thinking may be that a populist wave will sweep Brussels and offer support.
Our View: Setting aside Italian voters and EU politicians, international investors have voted in the financial markets and they don't think the populist government's numbers are adding up. To reflect this, Italian government bond yields have risen to their highest levels in five years, raising borrowing costs even further. This is precisely what the populist government said it can avoid, but the reality is that no one can control global capital flows.
In the end, the majority of Italians still want to stay within the EU. Their current cost of borrowing is still cheaper than if they were an independent state. Mario Draghi, president of the European Central Bank and an Italian, told Italy to calm down and avoid policies that will push borrowing costs higher. No matter how bold the populist government behaves, a reality check from global financial investors may give them a more 'global perspective.'
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