–France, Italy Expected to Win More Time to Consolidate
BRUSSELS (MNI) – The summer of gloomy economic data in Europe is adding to the growing sense that France and Italy will be granted more time to reduce their budget gaps, that further targeted tax cuts – most likely aimed at companies – will be enacted across the region and that more EU investment-led stimulus schemes will be promoted.
Until recently, fiscal austerity was the bloc’s primary, non-monetary response to the crisis – the argument being that growth can only be re-launched by balancing budgets and lowering debt levels. But with the advent of a new Commission and political change filtering through Paris and Rome, the debate on loosening the euro’s fiscal reins is set to intensify into the autumn, centered primarily around the time that will be given to Paris and Rome to adjust their deficits, senior Eurozone officials said.
The most important element of the debate will revolve around how much leeway Germany will allow its two largest Eurozone partners. And the answer, according to officials, will probably boil down to how much France and Italy commit to opening up their product, labour and service markets.
“We had a similar (economic) situation in 2008 at the start of the crisis when the heads of state agreed to push consolidation out by a year or two given the prevailing economic downturn,” one Eurozone government official told MNI, speaking on condition of anonymity. “I suspect we’ll see the same again. Italy and France will push for something soon. Spain would be happy with that. But Germany will want something in return.”
Another senior official added: “There’s something hanging in the air, but before any (fiscal) decisions are taken, we’ll have a serious haggle over structural reform. It will come down to whether to offer more (fiscal) leeway – not a fundamental change to the Stability and Growth Pact”
Berlin, on the other hand, will come under pressure to loosen its fiscal stance as well as take a less stringent approach to its neighbours. Germany reported Monday a robust budget surplus figure of E16.1 billion for the first six months of the year.
On the fiscal side, the debate over France and Italy is likely to come to a head at a leaders’ summit on European growth planned for October. With activity remaining flat, and with France and Italy’s new administrations making common cause against further short-term deficit reduction, it is becoming more likely that their arguments will prevail.
Before that, a broader debate on whether fiscal expansion can be enacted without counterbalancing spending measures is taking place. “We can expect a technical discussion on growth. There are some who think tax cuts are the way forward and others that think more should be done on the expenditure side” a third European official said. “The question is what you can do in a high-debt environment.”
That discussion will resume at an informal meeting of finance ministers in Milan next week, which will debate revenue-neutral fiscal measures, especially reducing the tax wedge – the difference between labour costs to the employer and the net take home pay of the employee. A preliminary discussion on this has already taken place in the Eurogroup at the start of the summer.
In a July research note, JP Morgan analyst Marco Protopapa found that nonfinancial corporates in France and Italy bear a higher burden than the rest of the euro area and reducing tax levies would improve corporate profit margins and reduce the competitiveness gap. Those kind of views are gaining traction in Brussels and some euro area capitals.
Some fiscal steps have already been outlined in Italy and France. In January, Paris announced that it would cut payroll taxes by E30 billion. Two months later, Matteo Renzi’s new Italian government announced income tax cuts worth E10 billion for salaries below E1,500 per month. Other countries including Spain are considering similar measures.
Importantly, though, the tax proposals flagged so far would in theory be balanced with public-spending cuts. Italy says it will reduce spending by an extra E7 billion this year and save a further E2.2 billion thanks to lower debt yields.
Those measures have been criticised by some, including the Italian employers’ federation, which feels that it won’t impact consumption, focusing on low incomes. Many EU officials agree, worrying that any tax gifts to consumers will be saved rather than spent.
It is not just governments that have been shifting their view on the fiscal stance. In Jackson Hole at the end of last month, Mario Draghi, president of the European Central Bank, called for a “more growth-friendly composition of fiscal policies.” He suggested that the region should consider public investments and tax cuts to complement the ECB’s stimulus.
The Eurozone growth outlook is now sufficiently poor – “We’re entering a proto-Japanese scenario, we’re getting there,” one of the senior EU officials said – that a range of levers are being considered.
Apart from loosening the fiscal reins, the other potential driver would come via investment, using EU funds (probably primarily via the EIB), and fresh proposals in that area are expected from the new European Commission even though the incoming president, Jean-Claude Juncker of Luxembourg, has yet to make his key appointments.
Many in Brussels and beyond, though, have grown cynical of demand-driven initiatives that involve recycling old money from existing budget lines and where leakage has been high. And they note that there is reluctance from the EIB to take on more risk for fear of losing its AAA rating.
The other lever – and, again, it is longer term – involves ideas to expand credit for and lending to SMEs, in a large part by opening the door to more securitization. That issue too will be discussed in Milan.
Meantime, a number of officials are looking enviously at the giant US mortgage guarantee institutions Freddie Mac and Fannie Mae, which provide a secondary market in home mortgages, purchasing mortgages from originators and securitizing them.
The Europeans wonder how the EU might be able to replicate the institutions’ success in revitalizing US consumption, noting, for example, that in the euro area there has been little if any pass-through from the collapse in 10-year yields to consumers with medium and longer term fixed mortgages.
With a plethora of ideas on the table and time limited, policymakers will be hoping that third quarter growth figures do not disappoint. The country most likely to drag the region down is France, analysts say.
“We’ve thought that France is definitely the weakest link in the euro story,” Hetal Mehta, European economist at Legal & General Investment Management, an asset management company with headquarters in London, said in an recent interview. “It’s big in size but it lacks the reforms. Hollande’s political unpopularity has meant he has been unable to get a lot done.”