It's not yet a crisis, but the honeymoon is well and truly over. For the past two months, the financial markets' mistrust of Giorgia Meloni's government has been insidiously returning. Doubts have been rekindled by an windfall tax on banks, which took investors by surprise, a change in corporate governance rules and, above all, a larger-than-expected budget deficit. As evidence of these tensions, Italian statutory interest rates reached 5% in early October, almost two points higher than German statutory rates, which are at 3%. Two years ago, the gap was just 1 point.
"The Italian government is showing its true colors," wrote Nicola Nobile in a worried note from the Oxford Economics consultancy. "Investors hate surprises, and now, suddenly, the Meloni government is deviating from the fiscal prudence it demonstrated in the first year," added an investor based in the City of London, someone who knows Italian politics inside out. "Italy's problem is that it's a financially vulnerable country, where uncertainties recur regularly. This requires each government to be very clear in its message to the markets."
With a debt of 140% of gross domestic product (GDP), Italy is the eurozone's most indebted country, after Greece. "We don't think it's going to turn into a crisis in the short term, but long-term risks have clearly increased," added Andrew Kenningham of Capital Economics.
Everything had started so well. The government led by Meloni, of the post-fascist Fratelli d'Italia party, had been extremely careful in establishing its credentials when it came to power in October 2022. Her budget essentially followed that put in place by her predecessor, Mario Draghi, former president of the European Central Bank and a highly respected economist in the world of finance.
The first hiccup happened in August, when the Italian government unexpectedly announced a 40% windfall tax on banks. Italian banks immediately plummeted on the stock market, and the government had to quickly backtrack, eventually reducing the additional tax by half. At the time, observers were still giving her the benefit of the doubt. "Prime Minister Meloni seems intent on maintaining the surprisingly good reputation she has earned since coming to power," wrote Kenningham in a note at the time.
But then came the budget for 2024, presented on October 1. For 2023 and 2024, the Italian government has increased its deficit forecasts. Next year, the deficit is expected to be 4.3% of GDP, way above the Maastricht Treaty limit of 3% – the Meloni government is still doing better than France, whose deficit is forecast at 4.4% of GDP in 2024. "It's a way of protecting themselves, and showing they're not the worst," said a London investor.
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