By Jan Strupczewski
BRUSSELS (Reuters) - Italy is facing excessive economic imbalances and the policies of its government are making matters worse, posing a threat to other euro zone countries, the European Commission said on Wednesday.
However, the EU executive arm, whose job is to analyse the economic performance of each of the EU's 28 countries and warn of trouble ahead, said it would wait until it receives Italy's reform programme in April before taking action.
"Italy is experiencing excessive imbalances. High government debt and protracted weak productivity dynamics imply risks with cross-border relevance, in a context of still high level of non-performing loans and high unemployment," the Commission said.
Last year, Italy narrowly escaped an EU disciplinary procedure over its very high public debt, which under EU rules should be falling every year.
In an unprecedented standoff, the Commission rejected in October the initial 2019 draft budget of Italy's ruling eurosceptic and populist coalition, which would have raised borrowing to cover election promises.
Rome and the Commission eventually reached a compromise over the deficit but it was based on an economic growth forecast of 1.2 percent. In February, the Commission revised that down to 0.2 percent.
"The government debt ratio is not expected to decline in the coming years, as the weak macroeconomic outlook and the government's current fiscal plans, though less expansionary than its initial plans for 2019, will entail a deterioration of the primary surplus," it said.
ITALIAN DEBT SEEN RISING
Italy's borrowing costs surged in the second half of 2018 as investors grew worried about the extra borrowing needed to finance generous policies of tax cuts and spending on welfare and earlier pensions.
The Commission said Italian public debt was likely to rise this year, rather than fall as forecast by Rome, because the country was unlikely to secure large privatisation revenues in 2019, on which the debt reduction depends.
"Italy is in a special situation because it is a country with a very high debt level and it is critical that debt does not start growing again," European Commissioner for Economic and Financial Affairs Pierre Moscovici told a news conference.
"It is therefore absolutely essential to implement a credible medium-term debt strategy that starts with 2019, but we will also in spring need to reflect on what 2020 will look like," he said.
The Commission said Italian reforms broadly stalled last year and some, like the pension reform of the previous government, were reversed, which would make public finances less sustainable and hit productivity and potential GDP growth.
"Cost competitiveness is stable, but weak productivity growth persists," it said, blaming a poor functioning of labour, capital and product markets and weaknesses in the public administration and justice system.
While Italian banks have significantly reduced the number of their bad loans, keeping that up could be a challenge in a slowing economy, the Commission said.
How bad Italy's imbalances become depend on what the government does next, Moscovici said, adding: "The urgency is all the greater given Italy's weakening economic outlook."
(Reporting By Jan Strupczewski; editing by Philip Blenkinsop and Gareth Jones)