How EU’s budget rules sparked showdown with Italy

For nations of the eurozone, the annual budget process isn’t over when a budget is drawn up.

The European Commission also gets a say. In Italy’s case, the response from Brussels took less than three days. In a letter to the Italian government, the EU leadership said the draft included an unprecedented “deviation” and it demanded an explanation.

With no evidence that Italy is willing to reconsider its plans to spend big, signs point to an escalating standoff.

1 Why does the EU have a say on Italy’s budget?
EU countries have to follow a set of fiscal rules spelled out in what’s called the Stability and Growth Pact. Focusing on deficit and debt, the rules are designed to force members to maintain sound public finances and co-ordinate their spending policies. Monetary policy is the responsibility of the European Central Bank, and matters such as taxation are up to each country. But the EU expects its 28 members to heed the economic stability of the region as a whole.

2 What are the EU rules?
No country should have a budget deficit larger than 3pc of GDP or debt above 60pc of output, and governments must set annual targets to show they’re moving in the right direction. The EU made the rules for eurozone countries stricter in 2013 following the sovereign debt crisis. The updated rules require nations to pursue a balanced budget by law, aimed at keeping mounting public debt in check.

3 How are the rules enforced?
The European Commission (EC), the EU’s executive arm, monitors the finances of member states, reviews annual spending plans, identifies imbalances and issues recommendations every spring. These have to be endorsed by finance ministers and incorporated into the budget plans for the next year.

4 Who has a problem with the EU rules?
France, Belgium and Spain are among those that have received warnings or reprimands from the EU in recent years, though never a formal rejection of their draft budget plans or any sanctions.

Italy is now the nation in the EU’s crosshairs. In a showdown that was building for weeks, the EC declared Italy’s spending plans to be excessive. If Italy’s explanation is deemed insufficient, the commission could take the unprecedented step of essentially rejecting the budget and asking for revised plans. Italian leaders have spoken of wanting the commission to tweak how it calculates deficits.

5 What exactly is Italy seeking to do?
Its budget calls for a deficit equal to 2.4pc of GDP, compared with a 0.8pc shortfall planned by the government that was swept out of power in March.

This first budget plan by a government of two populist parties makes assumptions about growth that Italy’s own budget watchdog considers overly optimistic. It proposes accepting a wider deficit as the cost of delivering on promises such as a “citizen’s income” for the poor, tax cuts and a lower retirement age. Under Italy’s plan, the structural deficit is projected to deteriorate by 0.8pc, far from the 0.6pc improvement Brussels wants.

6 What happens to a nation that breaks the EU rules?
While Brussels ultimately has no real power over national budgets, governments are expected to take the commission’s opinion into account and avoid a reprimand that could affect financial markets.

If the commission finds a country persistently breaks deficit rules, it could eventually open a so-called excessive deficit procedure – a process where the country has to reduce its deficit by a set deadline or risk sanctions of up to 0.2pc of output. The EU’s enforcement credibility has come into question, such as when it opted not to penalise repeat offenders Spain and Portugal in 2016. France, too, has received leniency while Germany went unpunished when it broke the rules.

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