Kickoff for the budget season in the EU

SINCE May, there has been an awaited collision between the Italian government and the European Commission. The battle is, of course, Italy’s fiscal budget for 2019, where the budget deficit is set to increase from 0.8 percent of GDP to 2.4 percent. Back in May, it became clear to the financial markets where Italy’s budget deficit for 2019 was heading, therefore Italian government bonds were sold down. The interest rate on a 10-year government bond exploded from 1.75 percent to 3.15 percent just for the month of May alone. This is significant in the world’s ninth-largest economy, and the third largest in the Eurozone.

Italy’s economy turned back to positive GDP growth in 2014, long time after other countries came back in plus, post the financial crisis. The Italian economy did not develop positively based on its own strength, but was simply a result of the general higher global economic growth. Last year the GDP growth reached 1.5 percent, though Organisation for Economic Co-operation and Development estimates a decrease this year. The latest assessment for Italy was 1.4-percent GDP growth, which I think is too optimistic now, as growth in the second quarter was just 0.2 percent or equal to 1.2-percent growth compared to the same quarter last year.

It’s also worth to notice how many European economic key numbers are currently pointing in the wrong direction, indicating a lower growth, including Italy. One could argue that the development in Italy wasn’t a surprise, so why did the financial market sell the Italian bonds again in October, pushing the 10-year interest rate up to 3.70 percent? One reason is the “game of magic numbers” that the government in Rome is playing, which is making investors nervous.

I will not be surprised if Italy’s economy this year lands so hard, that the 2019 growth outlook will be dangerously close to zero percent. This will be in strong contrast to the Italian government’s forecast of 1.5- GDP growth for 2019, that is the base for the new budget—an even higher growth than this year. If the dream doesn’t become reality, the budget deficit as percentage of GDP will be even be greater than the expected 2.4-percent deficit.

I regard the budget presupposition as very unrealistic, and it is exceptionally bad timing for a government to put its credibility at stake.

Throughout the past 10 years since the financial crisis, investors have bought almost all financial assets uncritically. But the tide has changed its direction this year, and the demand for quality is strong, so the government in Rome should not    underestimate how fast investors currently tend to leave a country. I argue that Italy’s economic size doesn’t count a lot for investors, and instead, they will act as consistently and quickly as many emerging market countries have lately experienced. The negative reaction is actually happening and can quickly be strengthened if foreign investors get even more worried about, for example,wrong budget assumptions.

In Spain, the uncertain political landscape makes it doubtful whether the 2019 fiscal budget can be approved,and how it would look like. Spain’s GDP growth is decelerating and there are indications that the country chooses to join the game of magic numbers for their 2019 budget. The government plans to increase spending, financed by higher taxes, and at the same time, the government expects to reduce the budget deficit from 2.7 percent of GDP this year to 1.8 percent in 2019. The more realistic assessments suggest a budget deficit of 2.2 percent next year.

But I am sceptical, and expect further pressure on the GDP growth next year, which is one reason I argue that the Spanish government’s goal is unrealistic. The increased noise surrounding Italy comes at an unfortunate time for Spain, as global investors might sharpen the focus on Southern Europe as a whole.

Concerning France, it’s a political dimension that is challenged by the Italian noise. President Emmanuel Macron has long sought to reform the whole eurozone, but now in minimum order tries to create a mutual rescue fund for the banks in the eurozone. With a German government that is blowing itself up into atoms, an Italian budget deficit that echoes throughout the EU, and an election to the European Parliament in about half a year, the rescue fund remains a dream for now. It is not necessarily based on pure mercy for Italy that President Macron puts all his efforts in the rescue fund.

It is no secret that the Italian banking sector has been severely affected by bad loans since the financial crisis. If Italy’s economy becomes more uncertain again, then the fear of an Italian banking crisis will have some basis.

There are rescue opportunities for banks within the eurozone, but it ends with a bill to taxpayers in other countries, such as France and Germany, which would be an unwelcome election theme in six months’ time. In the eurozone, the French banks are the largest direct lenders to customers in Italy, with loans amounting to around €130 billion ($150 billion), which is an unpleasant risk for France.

I expect the intense verbal exchange between the government in Rome and the EU Commission in Brussels to continue for a while. This will send interest rates of the Italian government debt further up, but what I also give attention to is how much the noise will reel France and Spain toward the center of the storm.

The author is the founding CEO of Lundgreen’sCapital.


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