Financial experts from Switzerland's major UBS bank are warning of Italy's considerable risks in the case of a recession in the euro zone and they do not rule out the country's exit from the euro. If there is a recession, Rome must expect credit downgrades, UBS notes. Its national debt could easily soar out of control, and leaving the euro possibly could no longer be avoided. A fierce dispute is looming between Berlin and Brussels, on the one hand, and with Rome on the other, because Italy's budget deficit is higher than expected, due to its significant economic slump. Brussels and Berlin are currently only hesitant about engaging in the dispute because of the conflict over the Brexit and particularly because of the approaching EU elections, according to observers. At the same time, Germany is, itself, also moving toward stagnation, not least of all, because of a slump in Germany's export-dependent automotive industry.
The Next Crisis Surge
As the euro zone's economy slows rapidly, tensions over economic policy are again rising between Rome and Brussels, as well as with Berlin. The Italian government has broken its "promises to the EU," German business papers headlined in reaction to Rome's increasing its budget deficit forecast for the current year. Announcing a budget deficit hike is another provocation by Italy's government, commentators note, it is an "announced violation of the rules," an "open affront" vis-à-vis the EU. With Rome breaking "all budget promises," the "danger of contagion" within the euro zone is again growing, threatening the entire Union with a new crisis surge. Meanwhile, the German functional elites are developing a narrative that blames Italy for a potential new euro crisis. Employer-affiliated German economic research institutes describe Italy as the "biggest threat" to the EU's economy. The conflict with Rome bears a higher risk for the European economy than a "hard Brexit," writes the German Institute for Economic Research (DIW). In less than ten years, the Mediterranean country is going through its third recession.
Recession and Stagnation
Once again, the austerity policy is at the center of the budget dispute between Italy and Brussels. This policy had been imposed on the euro zone by Berlin in the wake of the euro crisis, rendering economic recovery within the euro zone more difficult in the years that followed. Previous disputes between Rome, on the one hand, and Berlin and Brussels, on the other, over the economic policy in the EU's crisis-ridden third largest economy were temporarily settled in late December 2018, when both sides agreed on a compromise. The government of the deeply indebted Mediterranean country promised to limit the 2019 deficit to 2.04 percent to avoid Brussels' looming penalties. However, last week, Rome announced an increase in its budget deficit projection to 2.4 percent because of a massive slash in its economic growth forecast. According to the latest prognosis, the Italian economy will grow by only 0.2 percentage points this year instead of the previously projected 1 percent. In its prognosis, the International Monetary Fund even expects a stagnation of Italy's economy, which would lead to a budget deficit of 2.7 percent. Italy already had been in a short-term recession in the second half of 2018. The slowdown in economic growth will lead to a decrease in tax revenues and an increase in social spending, which, in turn, will increase the budget deficit.
"Ceasefire" in the run-up to EU Elections
And yet, for the time being, observers are not expecting an uncontrolled escalation in tensions between Berlin, Brussels and Rome. Italy can "consider itself lucky that the EU has its hands full, at the moment, with the Brexit negotiations," and that the "European elections are coming in May," according to commentaries in Germany's flagship media. The Union has other things to do than "engaging another dispute with the boot country." Therefore, it is not to be expected that the situation will openly escalate before the elections. However, the ceasefire between Brussels and Rome will not be long lasting. Italy could "also become a hot issue again on the markets by the middle of the year, at the latest," economic analysts explain, referring to low-risk premiums on Italian state bonds, following Rome's announcement of a higher deficit forecast. The German government traditionally used the crisis-related increase in the crisis countries' interest burden, to extort financial and economic policy compromises. However, the interest rate differential that Italy has to shoulder with Germany on ten-year government bonds on the financial markets is still very high - at around 2.5 percent. With government liabilities of nearly €2.35 trillion, that Mediterranean country has accumulated one of the highest mountains of debt in Europe, equivalent to more that 130 percent of its annual economic output.
Downturn Made in Germany
The beginning economic slowdown - because of the reappearing crisis surge - seems to affect not only the euro zone in general but Germany, in particular. Several times over the past few months, the German government has had to significantly slash its growth forecasts. In the meantime, Berlin is expecting only a 0.5 percent increase in its GDP for 2019. In January, the forecast was at 1.0 percent for the current year, whereas in its forecast last fall, it had even expected a 1.8 percent rise for 2019. The economic downturn in the euro zone was mainly caused by the slump in Germany's export oriented industrial production, particularly in the automotive sector, experts conclude. According to internal ECB analyses, the European downturn will also continue during the second quarter of 2019.
Possible Exit from the Euro
A recession could also lead to the collapse of the euro zone, with a fault line along the southern border of the Alps, warn financial experts of Switzerland's UBS Bank. If the EU suffers an economic crisis, Italy would face credit downgrades and an increase in debt servicing costs, sending its debt burden up out of control. The national debt could rapidly increase from 130 percent "to between 140 and 150 percent in comparison to its GDP and, therefore, reach new record levels." The EU's third largest economy would have to "impose an austerity program," which in turn would "exacerbate the economic situation." In that case, further economic stimulus programs would be hardly possible, due to the high interest burden and the massive national debt. Even "leaving the monetary union" could no longer be ruled out. Credit markets underestimate "the danger of a recession," USB warns.
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