The Italian government will present the Budget by 15 October, following recently announced main fiscal targets. Fiscal policy will become expansionary in 2016. Instead of reducing the deficit by 0.5pp of GDP in structural terms, as required by EU fiscal rules, the structural deficit will increase by 0.4pp (which may become 0.6pp), taking full advantage of EU flexibility clauses.
The economic scenario is credible, with 0.9% GDP growth projected for 2015 and 1.6% for 2016. The deficit-to-GDP ratio for 2015 is at 2.6% as in April’s projections, while that for 2016 moves up from 1.8% to 2.2% (with possibility of 2.4% if extra flexibility is granted). Balanced budget in structural terms moves to 2018 instead of 2017. The debt/GDP ratio starts declining in 2016.
The Budget will likely contain permanent tax reductions, including abolishment of the TASI housing tax. Spending cuts risk being further reduced versus the already-softened 10bn indicated back in April, and flexibility may be used to fill the gap.
The Italian government is stretching flexibility of EU budget rules to the limit. The aim to support the still-fragile recovery, and prevent high-multiplier spending cuts to derail it, is understandable. However, the limited progress on spending cuts decreases the leeway for tax reductions, and especially badly needed reductions in the tax wedge on labour. The fiscal stance risks becoming pro-cyclical.