Italy understands it must tighten its public finances, its finance minister said on Friday after talks with EU authorities, signalling that ambitious spending plans set out by Rome would not conflict with Brussels' fiscal rules.
Giovanni Tria offered his reassurances after speaking with European Commission Vice President Valdis Dombrovskis on the sidelines of a meeting of European Union finance ministers.
The leaders of the parties in Italy's government, the far-right League and the anti-establishment 5-Star Movement, have been promising since forming their coalition in June to spend more and tax less, unnerving markets as well as authorities in Brussels.
Investors have heavily sold Italian debt as a result, prompting a more conciliatory tone this week from the government on its budget plans.
Dombrovskis said in a tweet that Tria had acknowledged that Italy needed to cut its structural deficit and start reducing public debt in its 2019 budget.
Very good meeting with Finance Minister Tria. We have a shared understanding of the economic situation and the objectives of the next budget to bring the debt on downward path and pursue an improvement of the structural deficit #Italy pic.twitter.com/Td9DwDut21— Valdis Dombrovskis (@VDombrovskis) September 7, 2018
The minister tweeted in turn that his meeting with Dombrovskis produced a common line on adopting "measures for economic growth which are in line with rules and allow an improvement of public finances".
However, Tria has consistently been the most fiscally conservative voice in the coalition, and new divisions might yet emerge within the government over its spending plans.
An improvement of 0.1 per cent of gross domestic product in Italy's structural balance would translate into a headline deficit of between 1.5 and 1.7 per cent, EU officials and economists estimated.
Sources in Rome said on Monday that Tria, an academic who is not a member of either of the governing parties, is pushing to keep next year's deficit below 2 per cent of GDP.
But the League is pressing for a fiscal gap at least 2 per cent to carry out its ambitious tax plans.
Italy already has a debt of 132 per cent of GDP, the second highest in the euro zone, and feeding that with a high deficit would fuel market concern about its ability to repay. Last week, Fitch rating agency changed the outlook for Italian debt to negative from stable because of expected higher borrowing.
But as the costs of borrowing for Italy rose, the coalition leaders toned down their rhetoric, pledging not to "blow up public accounts" and to phase in its economic programme. Yields started to decline in response.
Italy, like all other eurozone countries, will have to submit its draft budget for next year to the European Commission by mid-October for checks to see if it is in line with EU rules. Should the draft blatantly contravene them, the Commission has the option of sending it back to be changed.
EU rules oblige governments to keep cutting the structural deficit - a measure that strips out the effects of the business cycle and one-off income and spending - until the budget is in balance or in surplus.
Under EU rules, Italy should cut its structural budget deficit, seen at 1.7 per cent of GDP this year, by 0.6 per cent of GDP in 2019.
This might be difficult, because even with no change in policies, let alone higher spending and tax cuts, the structural deficit will rise next year to 2 per cent of GDP, the European Commission forecasts.