Italy is 'sleepwalking into instability': EU recommends sanctions over budget

"With what the Italian government has put on the table, we see a risk of the country sleepwalking into instability," Commission Vice President Valdis Dombrovskis told a press conference in Brussels.

"We conclude that the opening of a debt-based excessive deficit procedure is... warranted," he added, referring to the EU's official process to punish member states for over-spending.

The conclusion was not surprising, coming after the commission already rejected Italy's 2019 budget last month in a first for the EU. But Italy refused to back down after the Brussels veto, setting the stage for Wednesday's final opinion at the commission.

The Italian budget was found at fault for scrapping EU-pushed cost-cutting agreed by the previous government and instead promises a spending spree, including a basic monthly income for the unemployed and a pension boost. The commission on Wednesday deplored "a marked backtracking" on past reforms, "in particular on pension reforms".

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Italian Prime Minister Giuseppe Conte (C) with his deputies Luigi Di Maio (L) and Matteo Salvini (R). Photo: Filippo Monteforte/AFP

With its opinion, EU member states now have two weeks to decide whether to allow the commission to trigger the excessive deficit procedure, a months-long process that could lead to fines. Once activated, the procedure allows Rome the opportunity to negotiate and correct its ways before Brussels can inflict a sanction that can come as high as 0.2 percent of Italy's GDP.

Expectations are low in Europe that Italy's right-wing populist coalition will concede on the matter, at least until European elections next May, where the government hopes to ride a wave of anti-EU sentiment. The coalition government, made up of the League and the Five Star Movement, insists the budget will help kickstart growth in the eurozone's third largest economy and reduce debt.

"Has the EU letter arrived? I am also waiting for Santa Claus," said the deputy prime minister Matteo Salvini, adding: "We will respond to the EU in an educated way."

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Photo: Gerard Cerles/AFP

All eyes now are on the markets, which could raise the pressure on Rome to kowtow to Brussels, and even split the ruling coalition in Italy.

"While the government's stance may be tenable in the short and medium-term, it will only be sustainable if market conditions don't deteriorate significantly," said Mujtaba Rahman, a political analyst at Eurasia Group. 

The closely watched "spread" -- the difference between yields on 10-year Italian government debt compared with those in benchmark Germany -- reached 316 basis points on Wednesday, down from 326 late on Tuesday. It has more than doubled since May when negotiations to form the coalition government in Rome began, but is lower than the roughly 400 mark that Italy argues is the danger zone.

In its budget, Italy intends to run a public deficit of 2.4 percent of gross domestic product in 2019 -- three times the target of the government's centre-left predecessor -- and one of 2.1 percent in 2020.

Brussels forecasts Italy's deficit will reach 2.9 percent of GDP in 2019 and hit 3.1 percent in 2020, breaching the EU's 3.0 percent limit. 

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By AFP's Alex Pigman and Céline Cornu