Italy grumbles over new EU budget rules but has relief reasons

Italy reacted grudgingly to a European Union deal on more lenient budget rules for the 20-nation eurozone, but details of the new-look pact show Rome has good reasons for relief and faces only modest pressure to reduce its mammoth public debt.Prime Minister Giorgia Meloni said the new rules — to be effective from 2025 — were better than the old ones but she was disappointed they had not excluded strategic investments from countries’ deficit and debt calculations."This is a battle we will in any case continue in the future,” she said in a statement issued late on Wednesday, hours after the deal was struck.Economy Minister Giancarlo Giorgetti said the new Stability Pact had "some positive things and some less so”, adding that only time would tell if it would work effectively.The market reaction suggests Italy may be putting a grumpy face on a good deal.The closely-watched gap between Italian and German 10-year bond yields tightened on Thursday to its narrowest since June. Rome’s 10-year BTP yield is set for its biggest one-month drop since 2013, fuelled by hopes of European Central Bank interest rate cuts.Christopher Dembik, senior investment advisor at Pictet AM, said the new pact was "more realistic” on debt reduction and allowed more scope for investments."This is especially positive for Italy which may face higher scrutiny from investors in the coming months as the debt level keeps increasing and growth is slowing. We believe this pact will help reduce potential pressure on Italian bonds,” he added.Since the previous Stability Pact was suspended in 2020 due to the Covid-19 health crisis, pandemic recovery programmes and an EU drive for spending to keep its climate, industrial policy and security goals on track have inflated national debt levels.The pact’s benchmark requirements of a budget deficit within 3% of gross domestic product and debt no higher than 60% look almost unattainable for many countries, and especially Italy.The euro zone’s third largest economy posted a deficit-to-GDP ratio of 8% last year, bloated by costly tax breaks on energy saving home improvements, and a debt of 141.6%.The deficit is targeted at 5.3% this year and the debt at 140.2%.Rome’s latest economic plan aims to reduce the debt-to-GDP ratio by a negligible 0.6 percentage points between 2023-2026, while the new EU rules prescribe a minimum average annual amount of at least 1 percentage point per year.On the face of it, this should spell trouble for Italy — but the details suggest another story.The 1 point reduction does not apply when a country has a deficit above 3% and is under an EU disciplinary procedure to cut it.Paradoxically, this would allow Rome to benefit from having an excessive deficit, as the European Commission is likely to place it under an infringement procedure next year, according to a Rome government source.Moreover, under the new rules the maximum period granted to countries to cut their deficits is extended to seven years, which is expected to apply to Italy provided it implements its post-Covid recovery plan in a timely fashion.Given the frequency of economic and financial crises, this raises a risk that the consolidation path may constantly be interrupted and never reach the intended finish line.Another boon for Italy is the fact that until 2027, interest payments will be excluded from the deficit cuts required to bring deficits down to 3% of GDP, leaving more money in national governments’ coffers for investment."The deal gives more breathing space to Italy, at least for the 2025-2027 period,” said Antonio Cesarano, chief global strategist at Intermonte."For this reason it will be positive for BTPs in a medium term perspective.”