Italy’s Electoral Puzzle Raises Hard Questions on Euro Reform


By Viktoria Dendrinou and Alexander Weber

France’s Emmanuel Macron’s ambitious plans for the euro area will get a reality check on Monday when the bloc’s finance ministers meet for the first time since Italy’s bombshell election further complicated efforts to reform the single currency.

The Brussels meeting comes a week after Italian voters overwhelmingly chose anti-establishment parties that are wary of the euro area, casting doubt on what reforms the bloc can muster, despite a reinvigorated push from Macron and German Chancellor Angela Merkel.

European Union President Donald Tusk set a June deadline to enact reforms that would better shield member states from financial crises, seeking to use the momentum from a stronger economy and supportive governments in Paris and Berlin to take politically difficult action. But the election in Italy, the bloc’s third largest economy, could put those plans on hold.

“It’s an unfortunate challenge for eurozone reform,” said Gregory Claeys, a research fellow at Bruegel, the Brussels-based think tank. The formation of a coalition government in Germany created a “window of opportunity,” but it’s difficult to predict the impact without knowing what the government in Italy will look like, he said.

While many ideas on what should be done to boost the euro-area have been floated, including the creation of a common budget to boost investment or a finance minister for the bloc, the two most urgent changes are the completion of a banking union — a supervision and resolution framework for the region’s largest banks — and strengthening the euro-area bailout fund.

Reducing Risks

But uncertainty in Rome could exacerbate skepticism in countries that are loathe to move further with risk sharing in the euro area before banks take sufficient steps to reduce risks, for example by cleaning their balance sheets of soured debt — a major sticking point in talks to complete the banking union.

The European Commission warned Italy last week that it needs to reduce it’s pile of bad debt, which is the second-highest in the euro area after Greece, standing at more than 130 percent of gross domestic product. Italy is one of two euro-area countries experiencing “excessive economic imbalances,” according to the commission, and the strong electoral performance of anti-establishment parties may fan concerns that these imbalances could be exacerbated in coming months.

“The Italian election result doesn’t make things easier for Europe,” Holger Bingmann, head of Germany’s BGA export industry association, said in a statement. Italy’s national debt “remains a big burden” on the euro’s stability, he said.

Even without the Italian factor, divisions are becoming more entrenched. In a joint declaration published March 6, eight finance ministers from smaller, fiscally hawkish countries said that any changes to the euro-area rule book should focus on “real needs” and stressed that budget rules should be followed. While they supported the completion of the banking union through a common bank-deposit insurance scheme, they said that this could only come after further risk reduction.

An important step in this direction is planned for Tuesday, with a potential agreement by EU finance ministers on a large set of banking regulations meant to curb risks in the system. Yet last-minute discussions on the issue are proving so intense that an agreement this week is in peril, according to two EU government officials.

Stumbling Block

Beyond that, the long-lingering issue of how to treat banks’ holdings of their home state’s debt is still proving divisive, Finland’s Finance Minister Petteri Orpo said in an interview. He said it’s the major stumbling block on the path to complete the banking union and bringing deposit guarantees in the euro area closer together. The overarching aim of those measures is to break the “doom loop” between public finances and banks.

Meanwhile, the delay in forming a German coalition has set back plans for a joint Franco-German position on euro-area reform, even though the two countries are still expected to put forward a common paper ahead of a euro-area summit later this month.

But even if Paris and Berlin reach a common position, that may not be enough, Claeys says, as the two major economies no longer speak for their close allies in the bloc and, especially in the case of Germany, the joint position of the eight countries showed it now has less support from its traditional allies.

“Now it’s necessary but not sufficient to have a Franco-German agreement.”

— With assistance by Raine Tiessalo, and Kati Pohjanpalo



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