By Gavin Jones and Giuseppe Fonte
ROME (Reuters) – Italy’s surprise decision to sharply cut its budget deficit goal does little to address the problems of its finances or a deeper debate over EU fiscal rules, but may serve the real purpose of easing market pressure and playing for time.
Prime Minister Giuseppe Conte told the European Commission on Wednesday he was lowering next year’s target to 2.04 percent of gross domestic product from 2.4 percent to avoid disciplinary action by Brussels.
Rome has yet to detail how it will achieve the lower target, and many economists believe it won’t. The new goal probably still breaks European Union rules, but the Commission signalled it should be enough to halt its threatened “excessive deficit procedure” and markets celebrated.
Italian two-year bond yields hit their lowest level in six months on Thursday and the closely-watched Italy/Germany 10-year spread was at its tightest since late September, at 261 basis points, down about 80 points from highs reached in October.
If maintained, that means lower borrowing costs which will help the economy and reduce the deficit, taking pressure off the coalition of the anti-establishment 5-Star Movement and the right-wing League.
“What they have done wins some time, it opens a channel of communication with the Commission and it shows some pragmatism which the markets may appreciate,” said Wolfango Piccoli of the London-based political risk consultancy Teneo.
European Economic Affairs Commissioner Pierre Moscovici said after an “extremely constructive meeting” in Brussels with Economy Minister Giovanni Tria that Italy had made a “significant effort” and a deal was possible.
“We are working with the aim to reach a common position … we want to do it quickly,” he said, adding that there was still some “technical work” to be hammered out.
Lorenzo Codogno, head of LC Macro Advisors and former chief economist at the Italian Treasury, believes the government may meet its new target by delaying implementation of welfare and pension measures, but this was of little importance.
“What matters is that the budget still entails a structural increase in spending which risks making Italy’s public debt unsustainable,” he said.
Even under the revised target the structural deficit, adjusted for economic growth and one-off items, still rises significantly next year, so Italy remains “non-compliant” with EU rules, Codogno added.
The main reason for Rome’s move was market pressure that was squeezing the banking system and businesses in the League’s northern Italian heartland, government and coalition sources told Reuters.
The government had justified the previous 2.4 percent target as the way to throw off austerity and unleash growth in the euro zone’s most chronically sluggish economy, so it loses some face over the climbdown. However, opposition parties are in disarray, with the League and 5-Star together still commanding around 60 percent support in opinion polls.
“Still at work for the Italians, keeping our promises on work, pensions, health and security, aiming to avoid sanctions and problems with the EU and the markets,” League leader Matteo Salvini tweeted after the new target was announced.
Salvini, who has softened his eurosceptic policies to capture the political middle ground, ignored advice from his hardline economics adviser Claudio Borghi to keep the deficit no lower than 2.2 percent.
Ministers have said some of the savings will come from costly flagship reforms: an income support scheme known as the “citizens wage”, and a lowering of the retirement age.
Neither measure will take effect at the start of 2019, and the take-up of the early retirement option will be less than budgeted, yielding savings of “a few billion euros”, Deputy Industry Minister Dario Galli said.
To find the rest of the roughly 7 billion euros needed, the government will sell public real estate and cut spending, and is considering a new tax on internet companies planned by the previous government but never implemented, sources said.
Some economists say that with the economy teetering on recession, the deficit will overshoot. “If the 2.4 percent target was hard to hit, then 2 percent looks like fantasy,” said Piccoli.
Barclays Capital said in a note to clients that it still expected a deficit of 2.8 percent next year, though there was now a slight chance it would be a little bit lower.
Brussels looks set to put Italy on a looser leash, having already indicated leniency towards France over its spending concessions following violent street protests.
“It will be very hard for the Commission to play hard ball with Italy given what is going on in France and now that Rome has shown some initiative,” said Piccoli.
He forecast that Brussels would play for time by delaying its final verdict on Rome’s budget until April, when final end-2018 data are available.
Gustavo Piga, economics professor at Rome’s Tor Vergata University, said considering the unrest in France the Commission would be mad not to accept Italy’s concessions.
“It would show that they don’t understand that economics feeds politics and they would be asking for trouble,” he said.
(Additional reporting by Massimiliano Di Giorgio; editing by David Stamp)