Playing With Fire

Before we start:

For our Italian-speaking readers, you can listen to our interview with the European Council on Foreign Relations on the situation in Italy and its potential implications for the future of the single currency.

Now straight to the point:

Two weeks ago, the Italian government unveiled its second austerity package in less than a month. It was immediately clear that not too many people were happy about the new measures, and not just among opposition parties. Unsurprisingly then, Italian Prime Minister Silvio Berlusconi met with key members of his own party and Lega Nord in his well-known villa in Arcore yesterday evening to try and hammer out a more satisfactory deal. Leave the final savings of €45.5bn for 2012-2013 untouched was the only rule, all the rest was negotiable.

In the end then, the result was, as one might expect, a rejigged package which has very little in common with the initial set of measures. For starters, the 'solidarity contribution' - an extra levy on high incomes, the introduction of which made Berlusconi's heart "drip with blood" (his imagery not ours), and even triggered a strike of Serie A footballers last weekend - has been scrapped, together with the almost €4bn it was expected to raise over the next three years. Lega Nord got it its way on cuts to transfers to local administrations, which in the new draft are reduced by around €2bn.

Crucially, it looks as if the Italian government is a bit confused on what to do to cover for these adjustments, which are clearly driven by political rather than economic reasons. Officials from the Italian Finance Ministry have warned that, at the moment, there's a 'hole' of at least €4.2bn in the package adopted yesterday compared to the previous version. Where will this money exactly come from? Well, the mooted VAT increase has been ruled out - Italian Finance Minister Giulio Tremonti was never too keen on it. Other, more ambitious proposals to abolish all Italian provinces and halve the number of parliamentarians are indeed impressive on paper, but they both require amendments to the Italian Constitution - i.e. several months of discussions in the Italian parliament and a two-thirds majority in both chambers if a referendum is to be avoided. In other words, neither of them could guarantee savings in the short term.

The government maintains that a new intervention on pensions plus stricter controls against tax evasion will be enough, but given the Italian government's history in tackling tax evasion we're sure you'll forgive us our misgivings in this case.

The draft package was presented to the Budget Committees of both houses of the Italian parliament this morning and will be discussed by the Italian Senate from next Monday. It's still unclear whether the opposition will be allowed to submit its own amendments - something which would likely make the debate even longer.

The general impression is that Italy's ruling coalition is playing with fire. As we argued here, if the Italian government fails to get serious on this, it may have to plan for a future outside of the eurozone. Unfortunately, so far, Italian governing politicians seem more focused on trying not to disappoint their electorates rather than grasping the gravity of the situation (the fact that they are only the latest in the long line of politicians to do so in this eurozone crisis does little to help their standing). Italy's problems are structural, and the markets won't forgive the Italian government for failing to address them indefinitely.