Italy may soon find that time is running out if it wants to escape swift punishment for violating the European Union’s tough rules against excessive budget deficits. The nation’s debt-to-GDP ratio of more than 130 percent is well above the EU debt limit of 60 percent. In the past, Italy was spared the EU’s Excessive Deficit Procedure (EDP) because it promised to improve its fiscal balance over time. But with the new budget plan to reverse fiscal consolidation and implement a fiscal expansion of 0.8 percent of GDP, the presumption that it would do what was necessary to respect the requirements of the preventive arm of the EU’s Stability and Growth Pact (SGP) has vanished.
Rather than having to wait for April 2019 to launch an EDP and another half-year for sanctions, as is commonly argued (see, for example, The Economist), the standoff between the European Commission and Italy could happen much earlier. The European Commission not only can recommend launching the EDP within the next three weeks but also at the same time could impose a sanction in the form of a non-interest-bearing deposit of up to 0.2 percent of GDP to be lodged with the Commission.
A useful starting point for understanding the intricacies of the SGP is a recent post by Gregory Claeys and Antoine Collin, which lays out the procedures prescribed by the European fiscal framework. The SGP is composed of a preventive arm and a corrective arm, with different fiscal requirements and possible corrective procedures and sanctions.
As these authors note, both levers could be activated in the case of Italy but with one important caveat: The activation would have to be based on fiscal outcomes rather than on fiscal plans. With budget data outturns for 2018 becoming available only in 2019, the general informed view was that the Commission would have to wait until next year to open a Significant Deviation Procedure (preventive arm) or an Excessive Deficit Procedure (corrective arm).
A recent letter from the European Commission to the Italian government, however, challenges this understanding. Instead, it suggests that an EDP could be launched in 2018 rather than in April 2019, based on a revision of its assessment of compliance with the debt rule for 2017. That is, an EDP could be launched this year because of fiscal plans for next year based on last year’s data.
To understand why, first rewind to May 2018. The European Commission then considered that launching an EDP against Italy was not warranted despite prima facie evidence of noncompliance in 2017 with the debt reduction rule of the SGP. In its Article 126(3) report, it wrote that “an EDP is […] not warranted at this stage, having regard in particular to Italy's ex-post compliance with the preventive arm in 2017” and thanks to “some progress in adopting and implementing growth enhancing structural reforms.”
Now fast forward to October 2018. In its Letter to the Italian government, the European Commission states that “the conclusions of that Article 126(3) report may need to be reviewed.” In particular, it writes that Italy could be found noncompliant with the debt reduction rule of the SGP “if such broad compliance [with the preventive arm of the SGP] can no longer be established in light of the planned significant deviation.”
If Italy is eventually found not compliant with the debt rule for 2017, the European Commission could recommend that an EDP be launched against Italy as soon as early November 2018, when the Commission will publish its autumn forecast. This would be accompanied by recommendations on appropriate measures for improving public finances and complying with EU rules.
What about sanctions? A widespread perception is that imposition of sanctions would necessarily have to wait until the end of this process. In practical terms, this would mean that sanctions would not kick in until the second half of 2019 even if an EDP was launched in November.
This is incorrect. The European Commission can, in fact, recommend an immediate sanction if it identifies particularly serious noncompliance with the rules of the SGP. This sanction would take the form of a non-interest-bearing deposit to be lodged with the Commission. According to the rules, such decision by the Commission would be considered adopted unless the Council decides to reject the Commission’s recommendation within ten days, using qualified majority voting.
The imposition of an immediate sanction would be unprecedented but is possible under European budget rules. In fact, a refusal by Italy to amend its Draft Budget Plans over the next few weeks would constitute additional grounds for the Commission to recommend an immediate sanction (Article 12 of Regulation 473/2013).
It is clearly possible to both launch an EDP and impose a sanction on Italy now based on last year’s data. Whether or not the Commission decides to do either of these, and how such decisions will be communicated, is another question.
1. In EU-speak, the terminology “excessive deficit” encompasses either the breach of the deficit criterion or the breach of the debt criterion or both.
2. An exception is the 3 percent of GDP deficit rule under the corrective arm that can be activated “whenever the planned or actual government deficit exceeds the reference value of 3% of GDP.” But the government projects Italy’s fiscal deficit for 2019 to be below that threshold at 2.4 percent of GDP.
3. In addition, the European Commission writes in its Opinion on Italy’s Draft Budget Plan “that the measures included in the 2019 draft budgetary plan indicate a clear risk of backtracking on reforms that Italy had adopted in line with past Country-Specific Recommendations, as well as with regard to the structural fiscal aspects of the recommendations addressed to Italy by the Council on 13 July 2018.”
4. According to the European Commission’s Vade Mecum (p. 84) on the Stability and Growth Pact, “following the Council’s adoption of a decision […] establishing the existence of an excessive deficit, the Commission may issue a recommendation for a further Council decision requiring the Member State to lodge a non-interest bearing deposit. This will [happen] on a case-by-case basis if the Commission identifies particularly serious non-compliance with the budgetary policy obligations laid out in the SGP.”