But is strict EU policy a death sentence for Italy's economy?

Financial markets watched with bated breath as the

'Italy vs EU struggle' unraveled. With over 2 months of 'little-to-no

negotiation' behind us, it finally seems that parties may be willing to reach a

consensus.

What was the fuss all about?

Disaster struck, as Italy announced its plans earlier this year to run a budget deficit of 2.4% of GDP not only for 2019, but also for two consecutive years thereafter.

In comparison to the 0.8% deficit initially planned for, the proposal could hardly appeal to European officials. Drowning in political and economic crisis, some already started to refer to Italy as the potential 'New Greece' of the European Union.

An error of ways

Currently third largest economy of the Eurozone after Germany and France, Italy has been in a pickle for over two decades. Between severely limited economic growth and a collection of bad debts, the country's banking system became extremely fragile.

The money creation program and the lowering of interest rates hardly had a strong impact on the economy. Italians argued that if monetary policy had failed, the fiscal one might do the trick.

Through stronger growth - higher tax revenues and a lower deficit could be achieved over the course of a few years. Even more so, according to them, the deficit rise to 2.4% of the GDP in 2019 - in comparison to this year's 1.8% - is simply required for the country not to fall back into recession.

The European Union, however, remained skeptical

Italy has been insisting on heavy-spending budgets for a while, with no success in getting rid of their debts, while the European Commission stands strong on making sure Member States' budget deficits do not exceed 3% of GDP.

Although Italy's proposal was technically below that, officials saw it as an ongoing pattern, which would inevitably drive Italy to collapse, along with other Member States, holders of Italian debt.

Perhaps things wouldn't have taken such a dramatic turn, if it weren't for Italy's new populist government - the coalition of the League and the Five Star Movement. In all fairness, the right-wing's and anti-establishment parties' success is hardly surprising, given the state of the country.

Looking to raise pensions, introduce a basic income, and deal with unemployment, Matteo Salvini, Italy's Deputy Prime Minister, blatantly stated that all of these matters more to him than the views of "EU bureaucrats".

Can we blame the EU though? After all, Italy does already boast government debt more than double of Eurozone's limit. A 'bottomless' budget deficit, paired with such a level of debt does pose significant risk.

On November 21st, the budget was refused. As Rome denied stepping back from its course of action, the EU put forth a threat to fine Italy with 0.5% of the country's economic output, adding up to an average of €9 billion.

Potential solution

The past weeks of negotiation and the G20 summit brought along quite some positive results. In order to avoid Brussels' sanctions, the Italian government considered stepping back with their demands and opting for a budget deficit of either 2.0% or 1.9%, as the Italian Finance Minister - Giovanni Tria had confirmed in his interviews.

Valdis Dombrovskis, European Commission Vice-President, had also agreed that the tone with Italy had changed, and the two parties are finally open to constructive dialogue.

What does this mean for markets and for Italy?

With news that negotiations moved ahead, Italy's bond market bounced back. Borrowing costs fell to their lowest in the last 2 months. Additionally, with G20 summit results that the trade war between China and U.S. has been put on hold, demand for risk assets - among which Italian government bonds - increased.

Nevertheless, the rally in the markets can't last forever. Some experts are wondering if the EU made a mistake by putting the Italian government in a position, where they are forced to give up on their plans.

After all, Italy's economy had not just slowed down, it recorded a decrease of 0.1% in GDP as of the third quarter of 2018. Furthermore, its unemployment in October 2018 already reached 10.6%, and youth unemployment 32.5%.

The figures are frightening, and some believe that two consecutive quarters of such GDP contractions could indeed be enough to throw the country into a technical recession. This would, of course, impact way more stakeholders than just Italy itself.

Would a budget deficit increase to 2.4% of the GDP, be of any help?

According to Bloomberg, there are many factors behind Italy's shrinking numbers. Aside from the uncertainty surrounding this plan, there is also a rapidly falling global demand for Italian manufacturing services, and the actions of its populist government, that are by far not beneficial for the country's economy.

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This article was submitted by Stratton Markets.