The new Italian government had its budgetary work cut out for it from the very beginning, with one coalition partner pulling for expansive new welfare spending and the other sweeping tax cuts. Looming over them was Italy’s mountain of debt, which has now more than doubled the size of the economy and is expected to reach 133.7% of GDP by the end of the year before growing further to 135% in 2020.

Rome’s blasé attitude toward its debt pile riled officials in Brussels, but the two sides hammered out an agreement to avoid punitive measures last year.

Now this agreement has collapsed under the combined strains of woeful economic data and pushback against Brussels-imposed austerity from the Salvini government. Earlier this week, the European Commission initiated an excessive deficit procedure against Italy, citing a lack of necessary structural reforms. In the unlikely event the glacial-paced sanctioning process is actually culminated, Italy could be facing up to 3.5 billion euros in fines.

Impact

• The Italian economy has gone from bad to worse. By all measures, the Italian economy is in worst shape than when negotiations were held last year between the European Commission and the Conte government. The original deal committed Rome to keeping the deficit below 2.04%, which meant delaying major spending programs that the government had campaigned on. And even then, many suspected that the projections were based on unrealistically sunny assumptions of the country’s economic health, which the Commission was willing to go along with in order to avoid a populist grudge match ahead of crucial EU Parliament elections. Now, several months later, time has vindicated this initial skepticism. The latest projections put the Italian deficit at 2.5% for this year and, even more troubling for the Commission, 3.5% in 2020. Faltering growth amid a wider continental downturn is the primary culprit behind this widening the fiscal gap: the Italian economy is expected to grow just 0.1% this year and 0.7% in 2020. Back in November, the European Commission was predicting 1.2% for 2019 and 1.3% for 2020.
• Both sides will be digging in. The European Commission signaled its intention to get back into the ring earlier this week when it officially initiated excessive deficit proceedings against Italy. The Commission is being pushed to take a tough line on Rome by the governments of the Netherlands and Germany, the two standard-bearers of the austerity dogma that’s riling populist movements up and down the continent. In Italy they see the potential for a repeat of the Greek financial crisis which, owing to Italy’s status as the euro zone’s third-largest economy, would be a far more destabilizing proposition and require a far larger bailout from creditor states. They want to sharpen the teeth of EU budgetary regulations in order to avoid the moral hazard of euro zone governments pursuing unstable borrowing and assuming that they are underwritten by the ECB, and by extension Berlin. These pleas are falling on deaf ears in Rome, where the Salvini government believes that it’s being unfairly victimized by the Union’s newfound quest for fiscal prudence. Salvini and his coalition partners are quick to point out that Italy isn’t the only euro zone government that’s flaunting budgetary rules. France, for example, hasn’t had a balanced budget since the mid-70s and now has a public debt of around 100% of its GDP. Paris is also on track to breach the 3% deficit limit for 2019. Italy’s leaders are arguing that more austerity is precisely what the country does not need right now if it wants to reverse the trend of moribund growth and get the economy back on track. Where the Commission is calling for austerity, Salvini is promising a “fiscal shock” to jolt the economy out of its torpor. Here we seem to have the classic irresistible force and immovable object; further deterioration in the relationship can be expected over the short-term.