Eurozone finance ministers are expected to side with the European Commission on Monday in slamming Italy’s resolve to stick to its controversial budget. Brussels rejected Rome’s 2019 fiscal plan, demanding changes.What's the fuss about?
Italy's coalition government, made up of the far-right Lega party headed by Matteo Salvini and the anti-establishment Five Star Movement led by Luigi Di Maio, wants to cut taxes, roll back pension reforms and introduce a universal income.
Rome is demanding more fiscal freedom to implement policies promised before the election earlier this year.
This is expected to raise Italy's budget deficit to 2.4 percent in 2019, moving toward the 3 percent limit set by the EU's Stability and Growth Pact, after the previous government's target of 0.8 percent.
Italy's debt load — currently at €2.3 trillion ($2.6 trillion) or more than 130 percent of gross domestic product (GDP) — is the highest in the EU and debt maturities are among the shortest. Some 27.5 percent of its debt (35.6 percent of GDP) comes due before the end of 2020, meaning that a higher interest refinancing burden could undermine growth.
Moody's cut Italy's rating to one level above junk status. The 10-year bond yield hit 3.77 percent, while the 30-year bond yield hit a more than four-and-a-half-year high of 4.22 percent.
Luigi di Maio has said Rome's controversial 2019 budget would still be executed even if the spread rose to over 400 basis points.
Does Rome have a point?
If monetary policy is not working, there is an argument for fiscal policy — taxes and spending — to play a bigger role in generating demand. Stronger growth should eventually lead to higher tax revenues and a low deficit.
The Italian banking system is heavily burdened with bad debts and that has meant its capacity to lend has been undermined.
Why is it important?
Contagion fears — if the situation deteriorates, some kind of contagion in other peripheral economies is likely. Italy's problems could spill over into the rest of the eurozone, since banks in other countries, most notably France, are big holders of Italian debt.
Banks — Italy's banking system is fragile after two decades of low growth. Italian banks have been big buyers of the bonds sold by the government, and their financial position becomes shakier if those bonds go down in value. The markets are worried about a "doom loop" of weak growth, a rising deficit, losses on bonds and failing banks. The Italian banking sector owns a total of €387 billion worth of domestic sovereign debt, according to the European Central Bank.
Politics and optics — Italy, and in particular its Deputy Prime Minister Matteo Salvini, is not planning to back down, and seems even to relish the opportunity to thumb its nose at Brussels.
Another Greece? — The situation is reminiscent of the Greek debt crisis, except Italy is a much bigger and more central eurozone economy, making a bailout difficult.
What happens now?
Italy has until November 13 to submit a revised budget, and President Sergio Mattarella has promised a "constructive dialogue" with Europe's institutions.
If Italy's budget is rejected, a three-week negotiation period follows in which an agreement could be found on how to lower the deficit.
If that's not reached, punitive action could be taken against Italy.