That’s bad news for Italy’s banks, which own much of the country’s debt. As my colleague Matt O’Brien put it, raising rates could force banks to “cut back on their own lending; in the worst case, it might make some of them need a bailout. But, in any case, it would make the Italian banking system as a whole more dependent on, you guessed it, aid from the [European Central Bank].”<doc-sep>The European Union took the unprecedented step Tuesday of rejecting Italy’s draft budget as incompatible with the bloc’s rules on fiscal discipline, escalating a battle between Europe’s establishment and populists in Rome. Following a meeting of the European Commission—the EU’s executive arm—Commission Vice President Valdis Dombrovskis said the Italian government was “openly and consciously going against commitments made” to drive down the country’s debt and deficit levels. The Italian government’s effort on Monday to explain why it had planned its budget in breach of rules was unconvincing, Mr. Dombrovskis added. The government—a coalition of the antiestablishment 5 Star Movement and the nationalist League—vowed after Mr. Dombrovskis’ rejection to press ahead with its plans to cut taxes and expand welfare and pension entitlements, insisting that Italy’s economy needs a fiscal boost. The battle is the new front line in disputes pitting the EU’s political mainstream against rebels across Europe that have gained voter support following the region’s economic and migration crises. Insurgent movements in Italy and elsewhere want to loosen EU constraints on member countries. Victory in the budget battle would bolster the League and 5 Star ahead of elections to the European Parliament in May, a contest in which populist movements around Europe hope to make gains. Italy, a founding member of the EU and Europe’s fourth-biggest economy, is testing whether a rebel government can defy the bloc’s rules and skirt pressure from financial markets to back down. Investors have dumped Italy’s government bonds and bank stocks repeatedly since the League and 5 Star agreed to govern together in May. Italy’s combination of high government debt and chronically weak economic growth make it vulnerable to capital flight. The extra yield that investors demand to hold 10-year Italian bonds over safe German bonds hit 3.3 percentage points last week, the widest gap in more than five years. That has battered shares in Italy’s banking sector, which is heavily exposed to its national debt. However, markets remain far more stable than during the eurozone debt crisis of 2010-2012. Back then, the spread between Italy and Germany peaked at 5.6 percentage points. Most investors expect Rome and Brussels ultimately to reach a compromise over the budget. Plus, today’s economic backdrop is better than before. Italy’s economy is expected to grow by around 1% in 2018, in contrast to its sharp contraction during the debt crisis. League and 5 Star leaders have brushed aside investor pressure to compromise over the budget. The Commission had hoped that this pressure, coupled with its courting of Italy’s pragmatic finance minister, Giovanni Tria, would nudge Rome into compliance. “Markets love Italy more than some European institutions do,” 5 Star leader Luigi Di Maio said. He predicted “weeks of strong exchange with the European Commission, but both the Commission and the markets will come to understand that this is a government that believes in what it is doing.” The Commission has much to lose. Failure to stop a flagrant breach of agreements on fiscal discipline would weaken economic-governance rules created after Europe’s debt crisis that are already tarnished by the waiving of regulations for France. Some member countries have indicated they believe the Commission has already been too lenient with Italy. Officials also know that disciplinary proceedings against Italy will play into the hands of 5 Star and League politicians, who routinely paint Brussels as a remote bureaucracy hostile to the needs of ordinary Italians. Under the EU’s protracted procedures, Italy has three weeks to submit a revised budget and the Commission then has three weeks to respond. The budget fight could thus come to a head in early December. That will likely be a sensitive time for Italy, since the European Central Bank has said it plans by the end of 2018 to cease its bond purchases, which have been vital in moderating Italy’s borrowing costs. If Italy refuses to adopt a compliant budget, the resulting EU disciplinary proceedings could lead to fines equal to 0.2% of Italy’s gross domestic product and the freezing of some funding. Those fines can grow over time if Italy continues to defy Brussels. Defiance toward Brussels has lifted the Rome government’s popularity. Over 60% of Italy’s electorate support the League or 5 Star, according to recent polls. A similar share of voters say they support the draft budget. To go into effect, the budget must be approved by the Italian parliament before the end of the year. The government’s weakest spot is the vulnerability of Italy’s banks, and thereby its economy, to investor flight. Further pressure on Italian bonds could erode the capital of Italian banks and force them to restrict their lending to the country’s businesses and households. —Valentina Pop in Brussels contributed to this article. Write to Laurence Norman at laurence.norman@wsj.com, Giovanni Legorano at giovanni.legorano@wsj.com and Christopher Whittall at christopher.whittall@wsj.com<doc-sep>The European Commission, the EU's executive arm, told populist lawmakers in Italy that it must make revisions to its draft budget proposal. Rancour between Rome and Brussels has grown in recent weeks after a controversial draft Italian budget for 2019 proposed a deficit equal to 2.4 percent of the country's annual output. A previous Italian administration had promised a deficit goal of just 0.8 percent of GDP (gross domestic product). In a press statement in Strasbourg, the European Commission Vice-President for the Euro and Social Dialogue Valdis Dombrovskis said there was no alternative but to reject Italy's current proposals, before adding that the country's government now had three weeks to come up with another plan. "Unfortunately the clarifications were not convincing to change our earlier conclusions of particularly serious non-compliance," said Dombrovskis before adding: "The Italian government is consciously and openly going against commitments made." The commissioner also said that Italy risked becoming trapped by debt and claimed that in 2017, Italy spent the same servicing its debt pile as it did on education. "Breaking rules can appear tempting at a first look, it can provide an illusion of breaking free. It is tempting to cure debt with more debt, but at some point the debt weighs too heavy," he added. It is the first time that the European Commission has effectively rejected a draft budget proposal by a member country.<doc-sep>European Union reject Italy budget in attack on populist government top stories direct to your inbox SUBSCRIBE Invalid email Sign up to receive our rundown of the day'sdirect to your inbox When you subscribe we will use the information you provide to send you these newsletters. Sometimes they'll include recommendations for other related newsletters or services we offer. Our Privacy Notice explains more about how we use your data, and your rights. You can unsubscribe at any time. The bloc's budget chief rejected the plans as he declared "public debt is the enemy of the people" as he justified their action against Italy's populist government. The European Commission was keen to warn Rome against any illusions of "breaking free" with its fiscal stimulus programme, which involves running their budget at a larger deficit. After careful consideration, Brussels’ powerful executive says Rome’s plan present a “serious deviation” from recommendations set by the European Council in July. The Commission has asked Italy to submit a revised draft budget for 2019 within three weeks. Brussels bosses argue the proposal poses “serious non-compliance” with the bloc’s tight fiscal policies. EU needs to give Italy 'leeway' in budget negotiation says expert Pierre Moscovici, the EU’s finance chief, said: “The opinion adopted today by the Commission should come as no surprise to anyone, as the Italian Government's draft budget represents a clear and intentional deviation from the commitments made by Italy last July. “However, our door is not closing: we wish to continue our constructive dialogue with the Italian authorities. I welcome Minister Tria's commitment to this end and we must move forward in this spirit in the coming weeks." Italy's populist government, made up of right-wing Lega and anti-establishment Five Star Movement, are planning to run their budget at 2.4 percent of GDP as of 2019. Brussels has rejected the plot as they fear Italy's growing public debt is a potential contagion for a Eurozone financial crisis. This is the first time the EU has used its strict austerity rules to refuse a national budget since they were introduced in 2014. Valdis Dombrovskis, the EU commissioner in charge of the euro, added: "The euro area is built on strong bonds of trust, underpinned by rules that are the same for everybody. It is our job and duty to uphold common interest and mutual commitments taken by the member countries. "Italy's debt is among the highest in Europe, and Italian taxpayers spend about the same amount on it as on education. "In this spirit, we see no alternative but to request the Italian government to revise its draft budgetary plan for 2019, and we look forward to an open and constructive dialogue in the weeks to come." Sebastian Kurz issues warning over Italy's debt crisis<doc-sep>
The European commission is at loggerheads with Rome after taking the unprecedented step of rejecting the Italian government’s draft budget in a move designed to force the country’s populist government to rein in its spending. Italy was presented with a three-week deadline to provide a revised financial plan, and the commission’s vice-president, Valdis Dombrovskis, noted that Italy already spent more servicing debt than it did on education. The commissioner, a former prime minister of Latvia, threatened to begin a procedure that could lead to the EU imposing fines on Italy unless the new government reconsiders. Dombrovskis accused Rome of “openly and consciously going against commitments made”. “Today, for the first time, the commission is obliged to request a euro area country to revise its draft budgetary plan,” Dombrovskis said. “But we see no alternative … Breaking rules can be tempting on a first look. It can provide the illusion of breaking free. It can be tempting to try to cure debt with more debt. But, at some point, the debt weights too heavy and you end up having no freedom at all.” Italy’s deputy prime minister, Matteo Salvini, was unrepentant. “We won’t subtract one single euro from the budget,” he told reporters during a visit to Bucharest. “I personally am available to go even tomorrow to meet the president of the European commission to explain how Italy’s economy will grow thanks to this manoeuvre. But no one will take one euro from this budget.” The Italian government, led by the prime minister, Giuseppe Conte, and made up of a coalition of the anti-establishment Five Star Movement and the far-right League, says it needs €17bn (£15bn) to fund election campaign promises, including tax cuts, a universal basic income and pension changes. The reaction of the markets to the commission’s announcement was instant, with the cost of borrowing on international bond markets rising and the Milan stock market falling by 1%. Italy’s public debt is worth more than 130% of the country’s GDP, the second-highest level in the EU after Greece and more than double the bloc’s limit of 60%. Italy was allocated €44.7bn between 2014 and 2020 as part of the EU’s stability and growth pact to support the competitiveness of its small and medium businesses, on the proviso that it lived up to fiscal commitments designed to avoid a repeat of the 2007 financial crash. The new government’s proposed budget, however, aims to have a deficit of 2.4% of GDP in 2019, more than three times what it had previously promised. Dombrovskis said the level of Italy’s debt amounted to €37,000 per inhabitant and that the proposed budget would mean first-time home owners were faced with impossible interest rates on their loans and Italian companies unable to access funds for growth. “The ball is now in the court of the Italian government,” he said. Pierre Moscovici, the commissioner for economic and financial affairs, said the commission would hold talks with Rome with an open mind. “The opinion adopted today by the commission should come as no surprise to anyone, as the Italian government’s draft budget represents a clear and intentional deviation from the commitments made by Italy last July,” he said. “However, our door is not closing. We wish to continue our constructive dialogue with the Italian authorities.” As Moscovici was leaving the press conference, an MEP for the League party, Angelo Ciocca, grabbed the commissioner’s notes and hit them with his shoe. He later tweeted that he had slammed “with a sole made in Italy” a “mountain of lies”. Moscovici later responded that Ciocca had no respect for his function as a parliamentarian.