News ID: 253495
Published: 0203 GMT May 29, 2019

European Central Bank sends Italy a warning over debt

European Central Bank sends Italy a warning over debt
MICHAEL PROBST/AP
European flags blow in front of the European Central Bank in Frankfurt, Germany, on May 26, 2019.

The European Central Bank said that challenges to financial stability in the eurozone have risen amid global trade tensions, and warned that indebted countries such as Italy could run into trouble if they don’t heed rules limiting deficits.

The message in an ECB report released Wednesday came as Italy’s government is challenging the debt rules, intensifying conflict with the EU’s executive commission, AP reported.

The Italian government’s borrowing costs in bond markets rose this week – a sign of investor concern – as Deputy Premier Matteo Salvini repeated his opposition to the rules after his League party came in first in elections to the European Parliament.

The ECB said that “should downside risks to growth materialize, financing costs for vulnerable sovereigns are like to increase which may unearth debt sustainability concerns.”

ECB Vice President Luis de Guindos said that the economy’s performance would be key to financial stability. The central bank still expects growth to pick up in coming months after a period of weakness. But it is cautioning that external threats such as trade tensions could undermine that. Weaker growth saps tax revenues that help governments pay off bonds, and undermines bank profits as well.

“The environment is more challenging than six months ago,” de Guindos told journalists at a briefing after the release of the report.

He said that “a trade war is the main risk to the economy globally.” A dispute over tariffs and trade between the US and China has unsettled the global business environment through fears of higher import taxes that could slow trade and growth.

Italy’s debt is connected to the banking system because banks hold Italian bonds and their finances could take a hit from a fall in the bonds’ value or default. Banks are key to the eurozone economy since that is where companies get credit to operate and expand. Troubles over Italian debt played a large role in the eurozone’s debt crisis in 2010-2012, threatening to break up the currency union and helping topple the government of Prime Minister Silvio Berlusconi in 2011.

Italy’s situation appears the most complicated.

Its national debt rose from 131.4% of GDP in 2017 to 132.2% in 2018 and will go up to 133.7% this year and to 135.2% in 2020, according to the European Commission forecasts.

To make matters worse, Italy’s structural deficit, which under EU law should shrink by 0.6% of GDP a year until it is in balance, has instead been rising every year since 2015.

The European Commission, charged with enforcing the debt and deficit limits that come with joining the 19-country euro, has sparred with Italy over the government’s push to run larger deficits, spend more and cut taxes.

 

EU’s letter

 

The commission has also written to the Italian government asking it to explain a deterioration in the country’s public finances, an EU source said, a move that could pave the way for Brussels to begin disciplinary action against Rome next week, Reuters reported.

The commission’s letter is a legal obligation under EU law when a country has public debt above the EU ceiling of 60% of gross domestic product and is not reducing it as required.

The letter to Italy was sent on Wednesday after the weekly meeting of commissioners from the 28 European Union states, one EU official told Reuters.

Italy will have to reply by Friday. France, Belgium and Cyprus received similar letters about the state of their public finances. Each country will be assessed individually, with different conclusions on the following steps.

 

   
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