EU Commission forecasts Italy to break deficit, debt targets

By Jan Strupczewski

BRUSSELS (Reuters) - Italy will break EU rules on budget deficit and public debt reduction this year and next, the European Commission forecast on Wednesday, ahead of publishing its formal opinion on Rome's 2017 draft budget assumptions next week.

Each year, the Commission assesses draft budgets of euro zone countries for the following year to make sure they are in line with EU law, which calls for bringing budgets into balance in structural terms and reducing debt each year in overly indebted countries.

Italy, where Prime Minister Matteo Renzi faces a constitutional referendum on Dec. 4 which might decide his political future, sent the Commission a draft budget which breaks previous promises of budget discipline.

The Commission will issue its formal opinion on the Italian budget, along with other euro zone countries on Nov. 16.

Commission President Jean-Claude Juncker expressed understanding for Italy's position in a speech in Berlin late on Wednesday. "When it comes to the migrant problem and the reconstruction costs after the earthquake, our place is at Italy's side, and not against it," he said.

He said blind adherence to euro rules could invalidate them, and there were occasions when it was necessary to change the way such rules were implemented.

The forecasts on Wednesday showed that unless Rome makes changes, its budget deficit would not change at all next year from the 2.4 percent of gross domestic product expected this year and would even rise to 2.5 percent in 2018.

Italy promised in May it would bring the shortfall down to 1.8 percent in 2017. In a recent letter to the Commission, Rome said the deficit would be higher because of lower than expected economic growth.

Its structural deficit, which excludes one-off items and economic cycle swings in income and spending, has been rising every year since 2014 and is to jump to 2.2 percent in 2017 from 1.6 percent in 2016 and then further to 2.4 percent in 2018.

This goes clearly against EU rules which say that countries have to cut their structural deficit by at least 0.5 percent of GDP every year until they reach balance or surplus.

Italy says the higher structural deficit is due to extraordinary spending on migration and post-earthquake reconstruction. But the structural deficit indicator does not take into account such one-off items and the Commission called the explanation "not constructive".

To make matters worse, Italy's debt which has been rising for a decade, is to continue rising to reach a new high of 133.1 percent of GDP next year from 133.0 percent expected this year.

EU rules, however, say that Italy has to reduce its debt each year by one twentieth of the difference between its actual debt to GDP ratio and the EU's maximum allowed debt of 60 percent of GDP on average over 3 years.

That would imply Rome has to cut its debt by 3.65 percent of GDP, rather than increasing it by 0.1 percent next year.

Italy says the lack of success in debt reduction is due to ultra low inflation, although the Commission forecasts price growth in Italy will pick up strongly to 1.2 percent next year from zero this year.

Another country on a collision course with the Commission was Poland, where the government has promised and to some extent already introduced some costly social programmes like child support, a higher minimum wage, lower pension age, free medicine for the elderly and a higher tax-free income amount.

The Commission forecast that Poland's budget deficit would therefore jump to the EU limit of 3 percent of GDP next year from 2.4 percent this year and cross the EU threshold in 2018 with a gap of 3.1 percent, unless policies changed.

Portugal, which was asked by EU finance ministers to bring its deficit below 3 percent this year is on track to do so, the Commission forecast and the shortfall will fall further next year to 2.2 percent.

Spain which has until 2018 to bring its budget gap below 3 percent will miss that target unless it makes changes to the draft submitted to the Commission in October, which was constructed on a no-policy-change basis by a caretaker government.

(Reporting By Jan Strupczewski; Additional reporting by Andrea Shalal in Berlin; Editing by Richard Balmforth and Susan Fenton)

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