Italy is targeting a budget deficit of 2.4% of GDP for 2019 – notably above the level previously communicated by Finance Minister Tria, and at the higher end of market expectations. While the Italian government insists that it remains committed to reducing its debt burden, which currently stands at 132% of GDP, in our view the planned fiscal expansion would in fact trigger a rise in public debt.
For one, nominal GDP growth would slow due to elevated political uncertainty and higher refinancing costs weighing on economic activity. Notably, our 2019 GDP forecast of +0.8% stands in sharp contrast with the government’s growth projection of +1.6%, which in the context of slowing eurozone GDP growth and tightening financial conditions, appears clearly out of reach. In addition, higher spending coupled with a weaker growth outlook would push Italy’s primary surplus below 1% of GDP. The prospect of deteriorating debt dynamics has financial markets worried: The yield on 10yr Italian debt has risen to 3.4% – the highest in four years. Unless the government rediscovers a fiscally more responsible path, a cut in Italy’s sovereign debt rating before year-end remains a key risk.