Italy's deficit exceeds the 3% red line again! Energy shock "adds insult to injury" to fiscal repair process

Last year, Italy's fiscal deficit exceeded the EU-set limit, marking the biggest fiscal setback for the government of Italian Prime Minister Meloni since she took office in 2022. According to data released by the National Institute of Statistics in Rome on Friday, the fiscal deficit accounted for 3.1% of Gross Domestic Product (GDP), confirming previous preliminary estimates. Although this figure improved compared to 3.4% in 2024, it still exceeds the EU's 3% limit aimed at constraining public fiscal conditions. Meloni had originally hoped for a lower fiscal deficit level to open the door for Italy to exit the EU's Excessive Deficit Procedure (EDP). This mechanism is a surveillance system for countries with excessive deficits, to some extent carrying a sense of "name and shame". The final decision on whether to exit this program will depend on the formal ruling by the European Commission in June. Therefore, this result is another blow to Meloni. Currently, her government is under pressure due to the crisis in the Middle East and the recent failure of a referendum on judicial reforms. Meloni and Finance Minister Giolegati have been working to control the deficit size to help Italy escape the EU's oversight mechanism for its budgetary inflation. Getting rid of this review system would have made it easier for Italy to expand its defense spending. Currently, Meloni has promised to achieve NATO's goal of defense spending accounting for 5% of GDP to meet the demands from the Trump administration. According to the rules of the Excessive Deficit Procedure, countries with high deficits will face stricter scrutiny from Brussels. If they fail to meet the fiscal targets agreed upon with the European Commission, they may also face fines. Last year, around one third of EU member states violated these rules, with these countries accounting for about half of the EU's total population. This includes France, Belgium, Poland, and Austria. According to the French government's forecast, France's fiscal deficit exceeds 5% and may not be able to decrease to 3% until 2029. The impact of the Middle East war on various economies may further complicate the task of improving fiscal conditions, including for Italy. Insiders said last month that the Italian government may be prepared to lower this year's economic growth forecast to a minimum of 0.5%. Scope Ratings analysts stated in a report last month that if the war persists, Italy's economic growth may further weaken, causing this year's deficit to remain above 3%, making Italy's exit from the Excessive Deficit Procedure more complicated. This would be a serious blow to Meloni. So far, she has received positive ratings from multiple rating agencies for her efforts to improve Italy's finances. This includes Moody's rating, which last year upgraded Italy for the first time in over 23 years. Moody's said last week that if the conflict can be resolved soon, Italy's path towards fiscal recovery can still be viable. However, if the war drags on, given Italy's high dependence on energy imports from the Gulf region, the situation will deteriorate significantly. Currently, Italy is the second largest natural gas consumer in the EU after Germany, with natural gas accounting for approximately 40% of its energy structure. Meanwhile, investor concerns have significantly increased in recent weeks. The key indicator measuring regional risk levels - the yield spread between Italian and German 10-year government bonds - rose above 100 basis points last week, compared to 57 basis points in January. This spread fell below 90 basis points on Friday. Although this level is much lower than the peak of over 200 basis points when Meloni was first elected, it still sends a warning signal to the government, indicating that its financing costs will face upward pressure.