September 10, 2019 / 12:32 PM / a month ago

Italy plans to raise budget deficit, say sources, risking fresh EU tensions

ROME (Reuters) - Italy’s new ruling coalition plans to raise its budget deficit to around 2.3% of economic output next year, sources said, in a move that would risk reigniting tensions with the European Union.

    The new government, forged after the previous coalition collapsed in acrimony last month, will be hoping it can persuade Brussels to accommodate the budgetary expansion by building a stronger rapport with its EU partners.

Reinforcing those hopes, former Italian Prime Minister Paolo Gentiloni was named on Tuesday as the new EU commissioner for economic affairs, giving him a central role in assessing whether Italy’s budget plans meet EU rules.

“I will work above all to contribute to relaunching growth,” Gentiloni said shortly after getting the Brussels job, in comments likely to be welcomed by the Rome government that proposed him.

The 2020 deficit of around 2.3% of GDP, which three political sources told Reuters was being planned by the coalition of the anti-establishment 5-Star Movement and the center-left Democratic Party (PD), would be up from 2.04% this year.

It would also be sharply higher than the current 2020 goal of 2.1%, and would bring the budget shortfall very close to the 2.4% level that almost triggered an EU disciplinary procedure against Italy this year.

The Treasury said in a statement that work on setting goals for 2020 had only just begun, meaning that it was premature to discuss any possible new target.

“The government is committed to drawing up a budget law that pushes the country towards the prospect of solid growth, ensuring the sustainability of public finances,” it added.

The new government has put an expansionary 2020 budget at the top of its agenda to head off a risk of recession, and plans to hike the deficit to avoid an increase in sales tax previously scheduled for January, which could hit consumer spending.

The coalition that took office last week, led by Prime Minister Giuseppe Conte, has promised to mend relations with Brussels and keep public finances in order, but it remains to be seen how Brussels would view any hike in the deficit.

DEBT BURDEN

Italy has the second-largest debt burden in the EU as a proportion of GDP, and has urged Brussels to ease the “excessive rigidity” of current EU fiscal rules.

Only two months ago, Italy’s previous government of 5-Star and the hard-right, eurosceptic League, cut the 2019 deficit goal to 2.04% from 2.4% after a long tussle with Brussels.

Then, the Commission said 2.4% was an “unprecedented” breach of EU rules that require high-debt countries like Italy to make steady progress towards a balanced budget.

Mario Centeno, head of the euro zone finance ministers, told Reuters in an interview at the weekend that it would be counterproductive for Rome to challenge EU fiscal rules.

Former Austrian chancellor Sebastian Kurz said on Twitter on Monday that EU deficit rules should be toughened rather than loosened, and added that Austria was “not prepared to pay the debts of Italy”.

Next year, under an unchanged policy scenario that would include the scheduled sales tax hike, Italy’s deficit would fall to 1.6% of GDP, well below the 2.1% officially targeted, sources told Reuters.

The positive trend is due to a recent sharp fall in yields on government bonds and lower-than-expected spending on early-retirement and poverty relief schemes introduced by the previous government, which have proved less popular than expected.

    The new administration’s first challenge will be to find 23 billion euros ($25 billion) of extra funds to avoid the sales tax hike, which was promised to the EU to guarantee compliance with fiscal rules, unless alternative savings could be found.

Under the promised VAT increase the main rate would rise to 25.2% from 22%, which the PD and 5-Star both say would hurt already weak household spending and domestic demand.

The higher deficit will also help the government in its intention to cut labor taxes by 4-5 billion euros, one of the sources said.

The government will have to present its new forecasts in the Economic and Financial Document (DEF), which sets the framework for the 2020 budget, by Sept. 27.

Reporting by Giuseppe Fonte; Additional reporting and writing by Gavin Jones and Giselda Vagnoni; Editing by Crispian Balmer and Alex Richardson

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