The European Union on Wednesday began a push to discipline Italy over its draft 2019 budget plan, which Brussels described as a “particularly grave” violations of the fiscal rules that underpin the euro.
Despite the development, the currency held firm on the foreign exchanges, buoyed by a suggestion in La Stampa newspaper that the Italian right-wing Matteo Salvini was open to discussions over a compromise with the EU over the stand-off. The currency was trading up almost half-a-per cent above $1.14 in the hours after the announcement.
The expansionary budget plan, which raises the deficit to 2.4 per cent of the gross domestic product, is considered to be in non-compliance with the rules by the European Commission.
Brussels’ rejection on Wednesday formally deepens the rift with Rome's populist government and paves the way for unprecedented sanctions.
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.
The procedure allows Rome the opportunity to negotiate and correct its plan before Brussels can inflict a sanction that can come as high as 0.2 per cent of Italy's GDP.
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"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 overspending.
The commission already rejected Italy's 2019 budget last month in a first for the EU, giving Italy the chance to backtrack.
“We won’t play sly foxes with the deficit,” Luigi Di Maio. Five Star Movement (M5S) leader and deputy prime minister, said as the deadline to revise the budget plan expired on November 13. “But at the same time we will maintain commitments to Italians made in the government contract. There will be all the cuts of waste, cuts of useless military spending and there are the social measures to give back social rights to Italians.”
Brussels instead forecasts Italy's deficit will reach 2.9 per cent of GDP in 2019 and hit 3.1 per cent in 2020, in breach of the EU's 3.0 per cent limit.
For the coalition government, made up of Mr Salvini's League and M5S, an expansionary budget would help kickstart the stagnating economy and fulfil electoral promises including a universal basic income and lowering retirement age.
The Commission rejects Rome's argument that by expanding the budget it can boost economic growth and revenues.
Mr Salvini, who serves as deputy prime minister, has so far been scornful of EU reprimands. "Has the EU letter arrived? I am also waiting for Santa Claus," he said, referring to his back-and-forth with Brussels.
But market shakeups could perhaps push Italy to reconsider its position or even split the governing coalition. The spread reached 316 basis points Wednesday, down from 326 late on Tuesday. Since May – when negotiations to form the coalition government in Rome began – this figure has more than doubled, but it has kept below the 400 mark that Italy argues is the danger zone.
Italy's debt, at more than 130 per cent of GDP, is proportionally the second highest in the euro zone after Greece's.