Analysis. Jean-Claude Juncker is not willing to get into a fight, as the Italian case will not be discussed at the European Council on Thursday and Friday, and he has emphasized that it is imperative not to put Italy in the dock.

Juncker tiptoes into battle over Italy budget deficit

While the situation is still evolving, the markets don’t seem to have been too displeased about the Italian government’s draft budget: the stock market is up and the spread is trending downwards, now under 300 points. The European Commission, however, did not like it at all—but the situation is a delicate one, and it demands tact and prudence.

President Jean-Claude Juncker this week summoned the Italian journalists and again criticized the larger budget deficit proposed by the yellow-green government, but did so only in indirect terms, speaking not explicitly on behalf of the Commission but rather about “some countries” which “would cover us with insults and abuse, accusing us of being too flexible with Italy” if the Commission “accepted the [deficit] overshoot.” The trouble was not with the Commission, he seemed to say, but only with those unnamed countries which have their deficits in order and which would not tolerate the Italian backsliding.

The two heads of the Italian government hit back immediately. According to Luigi di Maio, “Juncker should clearly say on behalf of whom he is speaking. But he can keep complaining, he still has time until May.” Matteo Salvini, in turn, was even more dismissive: “We approved the draft. Juncker can get over it.” This time, the official from Luxembourg has his hands tied. He has been emphasizing that he doesn’t want to judge the merits of the choices made by Italy, and swears that he doesn’t want to criticize the reforms themselves, but just the deficit. Juncker is not willing to get into a fight, as the Italian case will not be discussed at the European Council on Thursday and Friday, and he has emphasized that it is imperative not to put Italy in the dock.

That possibility is not at all a remote one. Dutch Prime Minister Mark Rutte is chomping at the bit to let loose on Italy. The Nordic countries are in agreement on this, and the Italian government has no allies to balance them out. Juncker, however, can count on the support of France and Germany for his chosen tactic, which ultimately aims to allow some more time to pass. A letter from the Commission asking Italy for “clarifications” has already been prepared, but will probably not be sent before the end of the Council. On Thursday, the European Commissioner for Economic and Financial Affairs, Taxation and Customs, Pierre Moscovici, will be in Rome and will meet with the Minister of Economy, Giovanni Tria, and should also be received by President Mattarella.

Two days afterwards, on Saturday, the budget law will be sent to the Chamber of Deputies. It will not, however, be perfectly clear in the details—particularly with regard to the citizenship income, the subject of a meeting between Conte, Tria and Di Maio on Tuesday, whose shape is still to be determined. The budget law will, however, be more detailed than the draft sent to Brussels on Tuesday, which itself offered plenty of surprises: the flat tax is limited to 15 percent for incomes up to €65,000 per year without being increased to 20 percent for incomes up to €100,000, no funds are included for the reimbursement of those who were defrauded by the banks, and resources are carved out to cover the expenses of banks and private businesses.

It is not clear, however, what the EU’s ultimate goal is in vying for more time. No one really entertains the hope that Italy will give up on reforming the Fornero law—the government’s most high profile target—or even on the citizenship income. The truth is probably that the Commission has not yet decided on how to proceed. Between Oct. 26 and 31, the verdicts from the ratings agencies on Italian sovereign debt will come in: first from Standard & Poor’s, then from Moody’s, and these will help set the course for what follows. Immediately afterwards, the Commission will have to decide whether to attempt the most serious option, never before tried, of rejecting the budget draft as a whole and give Italy three weeks to rewrite it, or instead to postpone the final decision until Nov. 21 and proceed according to the usual manner in such cases: sending a letter with requests for modifications, and then, if these are not implemented or are deemed insufficient, initiating the infringement procedure.

This latter course would be a victory for the yellow-green government. It will have managed to show that it can challenge Europe and do whatever it wants while incurring little damage; furthermore, the infringement procedure, which would come before the European Council in May, would be a treasure trove for populists in the electoral campaign for the European Parliament.

Both the Commission and the main leaders of the Eurozone, especially Angela Merkel and Emmanuel Macron, are well aware of the dilemma. They do not like either of the two options: to wage a head-on battle against a country that is crucial for the fate of the EU, or to allow a government that is seen among European cabinets as not Eurosceptic but downright anti-European to take a victory lap. Until November, they will have to find a way to cut the Gordian knot.

All this assuming that the situation does not destabilize earlier than that, either on account of a too-negative verdict from the rating agencies or because of a failure on the weakest front: that of the Italian banks, and the European banks holding large quantities of Italian debt.

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