Macron's concessions add fuel to Italy's debt fire

It seems that in Italy misery loves company. In the midst of their own budget travails, Luigi di Maio and Matteo Salvini, Italy’s two powerful deputy prime ministers, now seem to be rejoicing in France’s budget problems.

Before doing so, they might want to consider that far from reducing the chances that Italy will suffer another round of its sovereign debt crisis, recent French political developments heighten the chances that such an Italian debt crisis might occur sooner rather than later.

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Luigi di Maio and Matteo Salvini seem to be taking special delight in the fact that Emmanuel Macron, France’s beleaguered president, has had to make very costly budget concessions to pacify the rebellious yellow vest movement and to stop Paris from burning.

Those concessions, which include the rolling back of a fuel tax, the increase in the minimum wage and higher pensions for poorer retirees, have put the French budget deficit on a path to reach 3.5 percent of GDP in 2019.

Di Maio and Salvini are now pointing out that it would be a double standard for the European Commission to give the French a pass on its excessive budget deficit while throwing the book at Italy for presenting a 2019 budget that did not conform to the European Commission’s demands.

After all, they point out that France’s 2019 budget deficit is projected to be 3.5 percent of GDP while Italy's is likely to be under 2.5 percent of GDP.

Should they feel emboldened by France's increased spending and political uncertainty, Di Maio and Salvini would be mistaken in thinking that it is the European Commission’s attitude, rather than market forces, that will determine whether Italy is a headed for another sovereign debt crisis.

In particular, it has not occurred to them that even if the European Commission gave Italy a pass on its deficit-busting 2019 budget, the markets might balk at providing the Italian government the more than $250 billion it will need to roll over its debt next year.  And they might do so precisely because of the French developments’ influence on the Italian economic outlook.

One reason that the markets might take a harder line on Italy’s precarious debt situation than it did before the recent French political developments is that those developments might have taken the pressure off the Italian government to take greater care with its public finances than it did before.

Markets are likely to correctly surmise that, absent major budget revisions, Italy’s debt will continue to increase from its already high level of over 130 percent of GDP.

Markets may also become more skeptical about Italy because the recent French developments heighten the prospect that the European economy will experience a marked economic slowdown.

This is particularly the case now that the United Kingdom is on the verge of a messy exit out of Europe while German business confidence is declining because of domestic political developments and fears of heightened U.S. protectionism. A faltering Italian economy will make it all the more difficult for that country to regain control of its budget. 

Yet another reason why markets might become less patient with Italy as a result of the recent French developments is that those developments might make Germany less inclined to bail Italy out should it succumb to a financial market crisis.

The driving force for greater European integration has been Emmanuel Macron, whom the Germans will now argue cannot even keep his own house in order.

Rather than take pleasure in France’s present misfortunes, Di Maio and Salvini would do better to concentrate their efforts on reforming the Italian economy and putting the country’s public finances on a better footing. By so doing, they might spare Italy from yet another sovereign debt crisis.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.