Last week European markets were spooked by the twin woes of Brexit and controversy surrounding the Italian budget. Italy is the euro zone’s third largest economy and will assume that position in the EU once Britain has left. Hence what happens in Italy matters both to the euro and to the EU. The EU needs to manage an integrated economy; and as far as the euro is concerned, a currency where monetary policy is set centrally by the European Central Bank (ECB), but fiscal control remains at the discretion of the member governments. Therefore, national budgets need to be approved by Brussels. This is understandable because the countries sharing a common currency need to be in lockstep for said currency to have credibility in the market. In the aftermath of the European debt crisis, the European Commission put up some hard and fast rules on government spending. One of them is that annual budget deficits must not exceed 3 percent of gross domestic product. Italy’s new budget did not break that rule per se. However, as Italy’s public debt to GDP ratio stands at a whopping 131 percent, it is important that the country pays back some of this excessive debt burden. In the euro zone only Greece exceeds Italy’s debt burden relative to GDP. The outgoing Italian Government had drawn up a budget where the deficit was not to exceed 1.6 percent, which would have enabled the country to pay back some of the debt overhang. Then there were elections and in came the new populist government. It had made promises during the campaign which it now needs to live up to: They ranged from a citizens’ income over tax cuts to a lower retirement age. All of these plans need to be financed, so the budget deficit was increased to 2.4 percent. While one can sympathize with the Italian Government on measures taken in the light of an economy that has stuttered along for decades, the new budget will, in all likelihood, not have the desired impact on growth Cornelia Meyer European Commissioner for Economic and Financial Affairs Pierre Moscovici sent a stern letter to Rome. Italian Finance Minister Giovanni Tria did not budge, nor could he, especially after the coalition between the left-leaning Five Star Movement (M5S) and the right-wing Lega finally signed off on all parts of the budget over the weekend. The crux of the budget was that Tria needed to consolidate the visions of M5S, which is in favor of a minimum guaranteed income and a lower retirement age. Both proposals have to be seen against the backdrop of high unemployment which exceeds 50 percent for the young. The Lega has to please its voters with tax cuts. In other words, outgoings are rising on all fronts while there are no new revenues. Moscovici has a point when he labels this as fiscal imprudence. Italy is not the first country where the budget has incurred the wrath of the Eurocrats. France, Belgium and Spain are other culprits that have graced that list in the past. Theoretically, the EU could sanction wayward nations with a penalty of 0.2 percent of GDP. Last week already jittery markets became even more concerned about a potential standoff between the Italian Government and the European Commission. Respite for Italy came from an unlikely source after the close of trading last Friday. While the rating agency Moody’s downgraded Italy’s credit rating by a notch, it still left it at Baa3, which is the lowest point on the scale of investment grade rankings. There had been real fear in the equity markets of what the implications of a potential downgrade to junk of the Italian debt would have meant. Therefore, relief was great when European markets opened on Monday. In particular, the banking stocks responded positively. This does not, however, mean that Italy’s woes are over in any shape or form. While one can sympathize with the Italian Government on measures taken in the light of an economy that has stuttered along for decades, the new budget will, in all likelihood, not have the desired impact on growth. (The current growth forecast stands at 0.1 percent for 2019.) Why is the current tiff between Italy and the EU more than a storm in a teacup? As mentioned above, Italy matters to the euro zone as it is its third largest economy. Unlike the southern rim of Greece, Spain and Portugal, it also has a well-diversified economy with a good industrial base. An Italian crisis would therefore be far graver than a mere Greece 2.0. It goes to the core of how the euro zone and the EU economies perform, which in turn would have ripple effects on all investments in euro-denominated equity and debt instruments. This matters to a wide range of global investors. There is one thing that the Greece and Italy crises have in common, though: In the long run the ECB and the EU will need to give some thought to more sustainable mechanisms of managing the disconnect between centralized monetary policy and devolved authority over fiscal policy. Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources Disclaimer: Views expressed by writers in this section are their own and do not necessarily reflect Arab News" point-of-view