REPEAT: MNI: Italy Seen As Battlefield in Banking Union 'War'

Repeats Story Initially Transmitted at 08:30 GMT Nov 20/03:30 EST Nov 20

--Italian Differences with EC Over 2018 Budget Increase

--Commission Torn By Different Views on Fiscal Leeway 

--EC Hawks, Doves Clash Over Strict Budget Rules 

--Output Gap Evaluation Method Is "Key" To Analyse Budgets

By Silvia Marchetti

     ROME (MNI) - Differences between Italy and the European Commission over

fiscal targets puts Rome in the frontline of the battlefield over the wider

banking union that pits EC "doves" against "hawks", several senior Italian

officials have told Market News.

     On Wednesday, Brussels is expected to issue its first assessment of Italy's

2018 budget -- as it does for all member states -- and Rome predicts yet more

"nagging" feedback from the EC calling for greater fiscal adjustment. 

     In recent weeks, an intense exchange of letters has been conducted between

Rome and Brussels with clarification requests over the budget. Italy is,

however, confident it will ultimately pass the test.

     "We are optimistic. Our government has done its homework well and the new

budget  respects European fiscal rules by curbing debt. Italy's economy is

growing more than expected, so there is no reason why we should fail in sticking

to our commitments," said a top government source.

     According to Democrat party deputy Gianpaolo Galli, member of Italy's Lower

House budget committee, the fiscal differences between Rome and Brussels are

just a reflection of the wider problem the commission faces in interpreting, and

therefore granting to member states, fiscal leeway.

     Tensions have been mounting lately between Rome and Brussels following

mixed messages sent out by senior officials in Brussels.

     Dovish Economic Commissioner Pierre Moscovici and EC Vice President Valdis

Dombrovskis have more than once acknowledged Rome's significant progress in

balancing fiscal, reform and growth efforts, ruling out the risk that the

country might face a procedure for macroeconomic imbalances.

     On the other hand, Jyrki Kaitanen, another EC vice president and

potentially a contender to be the next Eurogroup head, has warned Rome that more

needs to be done to stabilise finances, arguing that the 2018 budget law did not

meet set fiscal goals.

     Rome has pledged to cut its structural deficit by 0.3% of GDP in 2018, but,

according to Brussels, the fiscal adjustment would be of just 0.2%. The Italian

government source brushed away as the difference as a "petty, bureaucratic

difference of percentages that fail to grasp the bigger picture that Italy's

debt is finally starting to drop".

     Although Kaitanen is the messenger, many believe the message is coming from

elsewhere.

     "Kaitanen and other hawks are backed by Germany, and we all know that

behind all this lies Berlin's reluctance in moving on with the banking union's

third pillar -- the common deposit guarantee scheme -- over fears of greater

burden and risk-sharing with indebted southern peers," said Galli.

     Germany is also pushing to place a limit on the amount of government bonds

held by banks and to put an end to the zero-risk era of sovereign securities,

both of which Italy opposes, added Galli, although Berlin considers this a

pre-condition to completing the banking union.

     The uncertain political situation in Germany is boosting tensions at the

centralised European level. "The obstacles Berlin is facing in forming a new

government following the elections reflect in the commission's unruly power

politic game," argued Galli.

     Two weeks ago, Kaitanen even dared to comment on Italy's upcoming

elections, said the government official, when he warned Italian voters that

"they should be told the truth about their country's public finances because

their government was lying to them, and this is unacceptable: with those

political words Kaitanen clearly overstepped his commission mandate".

     One thing is certain, though: Within the Commission there are contrast on

how fiscal leeway is interpreted and to what extent member states are granted

flexibility in their adjustment paths, explained a Treasury official. "This

internal row is coming to light now in a clearer way, translating into a

contradictory approach with regards to Italy's situation".

     Rome has more than once delayed its medium-term-objective (MTO) of a

structural balance -- now set for 2020 when the current debt rule would be fully

met --  citing the need to balance both budget consolidation and growth along

the so-called "Narrow Path" strategy. Yet for several EC representatives such

fiscal leeway is considered excessive.

     "It's always the same drill. As it's been in the last three years, each

autumn we expect the Commission to call for greater fiscal commitments from

Rome, even though Brussels will give its definitive verdict over our budget in

May. Plus, our 0.3% fiscal commitment was taken in accordance with Moscovici

months ago," said the government source.

     "We have nothing to fear. At at the end of the day, Brussels will take into

account the reform efforts and give our budget the green light. The Commission

is aware that any final evaluation of the budget is subject to when it comes

into effect, therefore not before next year," explained the official.

     Also, waiting to see the outcome of Italy's general elections next spring

will give the commission an even clearer picture of the political impact on

maintaining fiscal targets, he added. 

     The thorny issue regarding opposing methods used by Rome and the EC to

calculate the output gap, the difference between actual and potential GDP, used

to determine the degree of fiscal adjustment required, explained the Italian

Treasury official.

     "Brussels believes Italy has already reached its potential GDP and for such

reason it demands additional fiscal efforts from us. But we are not yet there.

Economic recovery has not yet turned into a long-term structural growth, proven

by the prolonged unemployment rate, among Europe's highest, and by the fact that

wages aren't growing so we still have a long way to go", argued the Treasury

source. 

     And if Italy's outlook continued to improve, "by the end of this year we

might even reach a 1.6% growth", higher than the 1.5% predicted by government,"

he added.

     The government source saw also critical of how the output gap was being

used in the discussions.

     "Even though the difference in fiscal effort is minimal between the EC and

Italy's evaluations, harmonising the output gap calculation method across the

union remains paramount going forward,, said the government official.

     In his view, "the output gap is an artificial, tricky method, an invention

made by economists to help guide the definition of government economic policies,

albeit on very slippery ground".

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com