Italy Says No More Fiscal Cuts Despite Debt Mountain

Rome, Italy
Getty Images

A deeper-than-expected recession is hurting Italy's public finances but it can still keep the budget deficit below 3 percent of output without more fiscal tightening, Economy Minister Fabrizio Saccomanni said on Thursday.

Saccomanni, a former Bank of Italy official, said in parliament that the economic slump was weighing on tax revenues and in particular sales tax, as consumer spending slumps.

However, when asked if corrective measures would be needed to meet this year's deficit target of 2.9 percent of gross domestic product, just a notch below the EU ceiling, he told Reuters: "I don't think so."

(Read More: Soros: Italy Market Calm May Be Short-Lived)

Data so far this year point to a sharply widening fiscal gap, fuelling concerns that the deficit could significantly exceed last year's level of exactly 3 percent.

Prime Minister Enrico Letta is struggling to balance Italy's commitments to the EU with coalition promises to cut taxes.

At the insistence of Silvio Berlusconi's centre-right, a crucial part of the ruling coalition, Letta has suspended a housing tax on primary residences and is also under pressure to block an increase in sales tax due to take effect next month.

But Saccomanni said scrapping the housing tax on first homes altogether and permanently blocking the sales tax increase would cost 8 billion euros ($10.6 billion) per year.

"That would require severe measures to compensate the shortfall and these cannot be found at the moment," he told the Senate. He said the government would do all it could to avoid or delay the hike in sales tax, but he could not guarantee it.

(Read More: Millions of Italians Stuck in Poverty: Report)

The European Central Bank said in its monthly bulletin on Thursday it was "crucial" that Italy hold the deficit below 3 percent, warning of risks deriving from recession's impact on tax revenues and spending.

"Yes, absolutely," Saccomanni said when asked if the 2.9 percent goal would be met. He added that he had "already reassured the ECB."

The pressure on the Letta government has yet to seriously perturb financial markets. However, Italy's 3-year borrowing costs reached the highest level since March at an auction on Thursday, part of a widespread retreat from riskier assets in the wake of central bank stimulus doubts.

Debt Mountain

Italy's public debt, at an estimated 130 percent of GDP this year, is the second highest in the euro zone after Greece.

Most analysts expect the economy to shrink at least 1.6 percent this year and the Organisation for Economic Cooperation and Development and ratings agencies Moody's and Fitch all forecast a GDP fall of 1.8 percent.

Italy is mired in its longest post-war recession, with no sign of any let up.

(Read More: Will Italy Waste ECB Breathing Space?)

At the end of May, the state sector deficit was 56 billion euros, 20 billion euros higher than last year and already above the government's full year target of 55 billion.

The state sector deficit is a narrower measure than the "general government" deficit used by the EU to assess government finances, but it normally provides an indication of the trend.

In addition, the large fiscal surplus normally registered in June, when mid-year tax returns are due, is likely to be depleted this year due to the suspension of the housing tax.

The European Commission recommended last month that Italy be taken off its list of countries with excessive budget deficits, but it risks being put straight back on in 2014 if present trends are not reversed.

Former Economy Minister Giulio Tremonti, who kept a tight rein on public finances, forecast this week that without corrective measures the deficit would hit 4 percent this year.