Italy-EU im­passe head­ing for cri­sis

The Daily Telegraph - Business - - Front Page - By Am­brose Evans-Pritchard

THE EU has no le­gal means to force the ca­pit­u­la­tion of Italy’s rebel gov­ern­ment and the bud­get show­down is likely to es­ca­late un­til there is a mar­ket cri­sis, warned a vet­eran euro fire-fighter.

Vi­tor Con­stan­cio, the Euro­pean Cen­tral Bank’s for­mer fi­nan­cial sta­bil­ity chief, said the high-stakes clash with Italy is ex­tremely dif­fi­cult to han­dle and Brus­sels is ef­fec­tively pow­er­less against a net con­trib­u­tor to the EU.

This means there is no mech­a­nism to com­pel com­pli­ance by the Lega-Five Star in­sur­gents other than a sober­ing blow-up in the bond mar­kets. By then there would be se­ri­ous fi­nan­cial blood on the floor, with re­vived fears of “re­de­nom­i­na­tion risk”, the tech­ni­cal terms in bank­ing cir­cles for euro break-up.

“Fi­nan­cial mar­kets will dic­tate the out­come. Italy can­not win against the mar­ket,” he told a fo­rum in Brus­sels. Mr Con­stan­cio said there will be no help of any kind un­til Rome sub­mits to the EU bailout ma­chin­ery un­der strict con­di­tions.

Re­ly­ing on the bond vig­i­lantes to dis­ci­pline Italy is a gam­ble for the euro­zone. It al­lows the sys­tem to be buf­feted around by hedge funds and fast-mov­ing cap­i­tal flows. The events of 2010 to 2012 showed how quickly

this can spin out of con­trol. There is no sign yet of any truce in the bud­get fight be­tween Brus­sels and Rome. The Euro­pean Com­mis­sion said yes­ter­day that Italy’s fis­cal plans are based on im­plau­si­ble growth as­sump­tions and that the vi­o­la­tion of the Sta­bil­ity Pact is even worse than feared.

Its au­tumn eco­nomic fore­cast said the deficit will hit 2.9pc of GDP next year and 3.1pc in 2020 as costs mount for uni­ver­sal ba­sic in­come and the roll­back of pen­sion re­form. The “struc­tural bud­get deficit” is de­te­ri­o­rat­ing dra­mat­i­cally, from 0.5pc of GDP in 2015, to 1.8pc this year, and 3.5pc in 2020.

The pub­lic debt ra­tio will barely sta­bilise at 131pc of GDP, a pre­car­i­ous sit­u­a­tion a full decade into an age­ing global ex­pan­sion. Debt dy­nam­ics could turn toxic in the next world down­turn. “This is hugely dan­ger­ous. Italy is miles away from the re­quired debt re­duc­tion,” said Lorenzo Codogno of LC Macro Ad­vi­sors.

Fi­nance min­is­ter Gio­vanni Tria dis­missed the Com­mis­sion’s anal­y­sis as “tech­ni­cal in­com­pe­tence”, vow­ing that his gov­ern­ment would stick to the tax and spend­ing plan agreed by the Ital­ian par­lia­ment. It looks in­evitable that Brus­sels will ac­ti­vate its “ex­ces­sive deficit pro­ce­dure” and take the fate­ful step of im­pos­ing pun­ish­ment fines on Rome, risk­ing a vol­canic po­lit­i­cal erup­tion.

Iron­i­cally, the en­forcer is eco­nom­ics com­mis­sioner Pierre Moscovici. He was on the other side five years ago as France’s so­cial­ist fi­nance min­is­ter, declar­ing then that elected gov­ern­ments were right to defy the “neo-lib­eral or­tho­dox­ies” of Brus­sels.

Lorenzo Bini-Smaghi, the chair­man of So­ci­ete Gen­erale, said Italy has al­ready slipped into re­ces­sion this quar­ter and the pic­ture is far worse than the tame Com­mis­sion fore­cast, which sticks to the “soft patch” the­ory of Europe’s lat­est slow­down. “Italy is go­ing straight into a wall. The crash is go­ing to be vi­o­lent,” he told Avvenire.

Eco­nomic growth stalled in the third quar­ter. The early-warn­ing PMI in­di­ca­tors point to out­right con­trac­tion over re­cent weeks. There are signs of an in­cip­i­ent credit squeeze for small firms as ris­ing bond yields erode the cap­i­tal buf­fers of Ital­ian banks, forc­ing them to cur­tail lend­ing. A mildly ex­pan­sion­ary bud­get would nor­mally be the ad­vis­able pol­icy in such cir­cum­stances, at least for wealthy coun­tries with their own

If Brus­sels takes the step of im­pos­ing pun­ish­ment fines on Rome, it risks a vol­canic po­lit­i­cal erup­tion

cur­rency and cen­tral bank. The per­verse logic of Europe’s half-built mon­e­tary union is that Italy should tighten fis­cal pol­icy “pro-cycli­cally” into the slow­down. Mr Con­stan­cio said the Ital­ian show­down kills off any chance of mean­ing­ful euro re­form in the fore­see­able fu­ture. There will be no move to­wards a euro­zone fis­cal en­tity or risk-shar­ing ap­pa­ra­tus. The Macron re­form plan lies in ru­ins.

Ger­many and the Nordic Dutch-led “Hanseatic League” say open de­fi­ance by the Lega-Five Star al­liance shows why it would be an er­ror to share debts. Last­ing dis­ci­pline must first be es­tab­lished. Be­hind this mantra, of course, is the peren­nial in­ter­est of the cred­i­tor states. Mr Con­stan­cio said the euro­zone will have lim­ited tools if there is a global down­turn or re­ces­sion over the next 24 months. It will have to rely on ECB mon­e­tary stim­u­lus, mean­ing fur­ther bond pur­chases, go­ing be­yond the 33pc limit on each is­sue. It will also need a co-or­di­nated fis­cal stim­u­lus, backed by com­ple­tion of the EMU bank­ing union and the cre­ation of a “Euro­pean safe as­set”, all of which is like pulling teeth.

Mr Con­stan­cio says the banks have stronger cap­i­tal buf­fers than in the last cri­sis, while fis­cal and cur­rent ac­count bal­ances are health­ier. “The euro area will with­stand and over­come the next cri­sis,” he in­sists. It is not clear whether mar­ket pres­sure can be di­rected sur­gi­cally against Italy with­out set­ting off a chain re­ac­tion through south­ern Europe. Mr Moscovici said there has been no con­ta­gion yet. In fact there have been spillovers to Spain and Por­tu­gal each time risk spreads on Ital­ian 10-year bonds punch above 300 ba­sis points.

The Com­mis­sion it­self warned that the con­ta­gion ef­fect may merely have been “de­layed”, while the In­ter­na­tional Mon­e­tary Fund said in its re­gional out­look yes­ter­day that “con­ta­gion from fu­ture stress could be no­table, es­pe­cially for economies with weaker macroe­co­nomic fundamentals and lim­ited pol­icy buf­fers”.

French bank ex­po­sure to Italy is equal to 12pc of French GDP. “In a sce­nario where we go down, France will take the hit too,” said Clau­dio Borghi, the Lega’s eco­nom­ics chief and an ex-Deutsche Bank trader.

“If I were still trad­ing, the ob­vi­ous trade would be to go long Ital­ian debt and short French debt, be­cause ei­ther Ital­ian spreads are right at 300 points or French spreads are right at 40. They can’t both be right,” he said.

Italy’s fi­nance min­is­ter Gio­vanni Tria: he dis­missed the Com­mis­sion’s anal­y­sis as ‘tech­ni­cal in­com­pe­tence’ and said his gov­ern­ment would stick to its tax and spend­ing plan

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