Sustainability of Italy’s public finances under question post budget announcement (Thursday, October 18, 2018)

Banking, Finance, Reports — By on October 18, 2018 at 12:46 PM

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Global Economic & Market Outlook – Focus Notes (Thursday, October 18, 2018)

Sustainability of Italy’s public finances under question post budget announcement

Executive Summary

The Italian government’s Draft Budgetary Plan 2019, based on its earlier multi-year Economic and Financial Document, was submitted to the European Commission on 15 October as mandated by the European Semester, keeping the budget deficit target for 2019 at 2.4% of GDP. Although the planned fiscal relaxation is expected to boost overall economic activity in the short-term, fiscal expansion could lead to a lower positive contribution on real GDP growth than currently envisaged by the government, as a sizeable increase in bond yields, a tightening in financial conditions and a negative impact on confidence could potentially crowd out private investment and hurt consumption growth. Given the overly optimistic GDP growth path and the government’s unwillingness to introduce large spending cuts ahead of the European Parliamentary elections in May 2019, the risk of significant fiscal slippage in the following years seems to have increased. All in all, we expect the Italian government to have a severe confrontation with the European Commission, while risks of a downgrade by rating agencies have increased significantly, putting further pressure on Italian assets. To illustrate our point, the Italian Sovereign Systemic Stress Composite Indicator -an ECB calculated index- has been on an upward trend since May 2018, and actually surged to a 51/2 year high of 0.64 in September 2018, not too far from its historical high of 0.92 in November 2011 (Figure 1).

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