Notably, Italian Prime Minister Giorgio Meloni was absent from this month’s star-studded economic forum in Lake Como. Instead of sharing her vision for the country’s pressing challenges with an influential audience, Meloni joined the crowd at the Formula 1 Italian Grand Prix.
Her decision to skip the prestigious Cenobio forum – where she attracted attendees last year – adds to growing unease among businesses and investors about Italy’s right-wing government’s ability to steer the debt-ridden country through Europe’s economic slowdown.
When he came to power last year, Meloni reassured global investors with promises of fiscal prudence. But this summer, her administration shocked markets by unexpectedly announcing a windfall profits tax on banks, which was quickly watered down after bank stocks tumbled.
Meloni’s three-party coalition now faces its biggest test as it prepares to unveil Italy’s next budget, trying to balance reduced government resources with delivering on some election promises to cut taxes and help struggling families.
Investors are watching closely to determine whether Meloni will stick to his pledge of fiscal discipline – even as Italy’s economy falters – or be tempted to adopt expansionary fiscal policy or other unconventional measures.
“There’s a renewed focus on Italy,” said Filippo Taddei, chief economist for Southern Europe at Goldman Sachs. “People are asking where the country is going to go. . . . They want to make sure there are no more policy surprises. .”
Lorenzo Codogno, a former Treasury official who now runs a macroeconomic consulting firm, said a series of recent interventionist moves have raised serious doubts about the government’s policy orientation.
The European Central Bank criticized the windfall profits tax last week, warning it could prevent banks from building additional capital buffers, make them “less resilient to economic shocks” and limit their ability to lend. Credit ratings agency Fitch warned that a proposal by Meloni’s party, the far-right Brotherhood of Italy, to allow defaulting borrowers to buy back their own bad debt at deep discounts could cause disruption and uncertainty.
“The honeymoon is over,” Codogno said. “Companies are working against the government. . . . There are forces within the alliance that are not really aligned with the interests of the market or investors.”
In her first months in office, Meloni won praise for passing a prudent fiscal budget that reassured jittery investors about her ability to transition from the antics of the populist opposition to responsible governance. . However, the budget was largely prepared by the team of her predecessor Mario Draghi, thanks to the timing of her victory in a rare autumn election.
But the budget to be unveiled in the coming weeks will bear Meloni’s stamp, giving Italian voters and investors a deeper understanding of her coalition’s own economic vision.
“This is the first budget in which the Meloni government must take full responsibility for these measures and face the potential reaction of public opinion,” said Lorenzo Pregliasco, founding partner of political pollster YouTrend. Pregliasco) said.
The situation is not optimistic. Italy’s current official economic growth forecasts of 1% and 1.5% for this year and next are generally considered too optimistic given the overall slowdown in the euro zone economy.
Italy’s gross domestic product shrank 0.4% in the second quarter, reflecting a slump in Europe’s manufacturing sector and a sharp slowdown in construction after Rome cut incentive programs that fueled a home renovation boom.
The weakness continued throughout the summer. Italy’s industrial output shrank by a larger-than-expected 2.1% year-on-year in July, nearly 73,000 jobs were lost, and the unemployment rate rose to 7.6%. Surveys show that the previously strong services sector contracted slightly in August.
“It appears the situation is deteriorating rapidly,” Codogno said.
As economic growth slows, investors question whether Italy can still meet its target of reducing the fiscal deficit to 4.5% of GDP in 2023 and 3.7% in 2024, or whether Meloni’s government will raise the deficit target this month .
The Italian economy should get a boost from the EU-funded €191.5 billion COVID-19 recovery package, given that Italy is the biggest beneficiary of the plan. But implementation has faltered and Roma is now seeking approval from Brussels for an overhaul of the scheme to help it free up outstanding funds.
Tadei said any significant increase in next year’s deficit target would signal Rome’s lack of confidence in its ability to meet all conditions and make full use of EU funds.
“There is some tolerance for fiscal downturns this year, but things will be different next year,” he added. “The government has repeatedly stated its commitment to making the recovery fund work and markets will take the fiscal deficit decision as evidence of that.
“If they push up the fiscal deficit, it shows they don’t really believe in the recovery fund,” he said. “Market participants will view this as a sign that the government is more committed to using domestic fiscal leverage.”
Meloni acknowledged that her pledges to cut taxes, boost pensions and increase health care spending will be difficult to keep amid the current economic slowdown.
She said last week: “My idea is to focus resources on a few big measures – those that deliver the biggest multiplier from an economic perspective – rather than spreading them across many potentially smaller impacts. In small measures.”
Meloni may be reluctant to abandon fiscal caution entirely, given that market turmoil could once again damage her image at home. “If the market reacts poorly, it becomes news and it hurts relations with voters,” Pregliasco said.
Pregliasco added that a fall in bank stocks triggered by the chaotic windfall tax announcement could increase her caution, as polls now show public confidence in the coalition government has declined since that event.
“It slightly reinforces the perception that the government is not fully aware of the consequences of its actions,” he said.
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