Italy stands firm on its budget targets — but it could now pay the price

Key Points
  • Italy's Deputy Prime Minister Matteo Salvini could be willing to revise its 2019 budget in face of European opposition to its spending plans, an Italian newspaper reported Wednesday.
  • Italy's FTSE MIB index was trading 1.2 percent higher and bond yields fell.
Italian Interior Minister Matteo Salvini speaks during a statement after a bilateral meeting prior to the European Union member states' interior and justice ministers conference on July 11, 2018 in Innsbruck, Austria. 
Andreas Gebert | Getty Images News | Getty Images

Italy's populist government is standing firm on its new budget proposals, but it could now pay the price for doing so with the EU launching disciplinary measures against the country.

The European Commission — the EU's executive arm — said that Italy's 2019 draft budget does not comply with the EU's requirement that member states work to reduce their debt piles. As such, the Commission will now launch what's known as an "Excessive Deficit Procedure" that could lead to Italy being fined.

Italy's Deputy Prime Minister Matteo Salvini remained defiant after the news, saying he will talk to the Commission "politely, as always, but will carry on."

He said Italy would explain its structural reforms and investment plans to the EU. He said he hoped EU sanctions would be avoided and that if not, these would be "disrespectful" to Italians, Reuters reported.

Italian Prime Minister Giuseppe Conte, who is largely seen as a technocratic leader under Salvini and his co-Deputy Prime Minister Luigi Di Maio, said the government is convinced over its budget. He said he will discuss the matter with European Commission President Jean-Claude Juncker on Sunday.

For its part, the EU's Vice-President for the Euro and Social Dialogue, Valdis Dombrovskis, said Italy is of common concern and that all euro zone countries are "on the same team and should play by the same rules." He also said that Italy's budget plans could harm the country's growth prospects and could mean more austerity at a later date.

Italy now facing a fine

Earlier Wednesday, Salvini said he was not willing to discuss the country's budget deficit target envisaged in the government's controversial draft spending plans for 2019. He added that he's open to dialogue on investments "but not on the budget deficit or pension reform," the news agency added.

Since Italy submitted its 2019 spending plan to Brussels in October, it has been widely tipped to cause a confrontation with European officials. The Commission said Wednesday that it had "re-examined Italy's compliance with the debt-reduction requirements. And today's analysis ... suggests that the debt criterion should be considered as not complied. We conclude that the opening of a debt-based Excessive Deficit Procedure is thus warranted."

By refusing to amend its budget plans, Italy is now facing a fine by the European Commission.

How this works is that the Commission recommends to the EU's finance ministers that an "Excessive Deficit Procedure" (EDP) is launched against Italy. Basically, "the EDP requires the country in question to provide a plan of the corrective action and policies it will follow, as well as deadlines for their achievement," the European Commission states. It adds that "Euro area countries that do not follow up on the recommendations may be fined."

Markets react

Earlier in the morning on Wednesday, Italian newspaper La Stampa reported that Salvini could be open to reviewing the government's controversial 2019 budget, which has gone against previously agreed lower budget deficit targets with the European Commission.

The draft budget, which envisages a basic income for the poor, tax cuts and changes to pension reform, was rejected by Brussels which could decide to punish Italy if it doesn't change course.

La Stampa said Salvini was ready to reduce the planned spending on citizens' incomes and the unwinding of a previous pension reform, Reuters reported. However, Italy's Lega party, which makes up part of the coalition government in Italy and which Salvini leads, denied that he's seeking budget changes, according to an earlier report by Reuters.

Italy's FTSE MIB rallied on La Stampa's initial report and was trading 1.25 percent higher. Markers more broadly were recovering form heavy losses seen in the previous session. After the denial, Italian stocks quickly pared gains. After Salvini's latest comments, Italy's index was still up around 1 percent.

A spokesperson for the Lega party was not immediately available for comment when contacted by CNBC.

- CNBC's Silvia Amaro contributed reporting to this story.