Italy government's spending plans have unnerved markets

Italy understands it must cut its structural deficit and start reducing public debt in its 2019 budget, European Commission Vice-President Valdis Dombrovskis said on Friday after talks with its Finance Minister Giovanni Tria.

The reassurances from Tria, on the sidelines of a meeting of European Union finance ministers in Vienna, follow remarks from other senior Italian politicians, who this week also sought to calm market concerns over Rome's fiscal plans.

However, the finance minister has consistently been the most fiscally conservative voice within Italy's ruling coalition since it took office in June, and new divisions might yet emerge within the government over its spending plans.

Dombrovskis and Tria had "a shared understanding of ...the objectives of the next budget to bring the debt on a downward path and pursue an improvement of the structural deficit," the commissioner said in a tweet.

An improvement of 0.1 percent of gross domestic product in Italy's structural balance would translate into a headline deficit of between 1.5 and 1.7 percent, EU officials and economists estimated.

Investors have heavily sold Italian debt since the coalition government of the far-right League and the anti-establishment 5-Star Movement was formed in June because the parties' leaders have been promising to spend more and tax less.

Sources in Rome said on Monday that Tria, an academic who is not a member of either of the governing parties, is pushing to keep next year's deficit below 2 percent of GDP.

But the League is pressing for a fiscal gap at least 2 percent to carry out its ambitious tax plans.

Italy already has a debt of 132 percent of GDP, the second highest in the euro zone, and feeding that with a high deficit would fuel market concern about its ability to repay. Last week, Fitch rating agency changed the outlook for Italian debt to negative from stable because of expected higher borrowing.

But as the costs of borrowing for Italy rose, the coalition leaders toned down their rhetoric, pledging not to "blow up public accounts" and to phase in its economic programme. Yields started to decline in response.

Italy, like all other eurozone countries, will have to submit its draft budget for next year to the European Commission by mid-October for checks to see if it is in line with EU rules. Should the draft blatantly contravene them, the Commission has the option of sending it back to be changed.

EU rules oblige governments to keep cutting the structural deficit -- a measure that strips out the effects of the business cycle and one-off income and spending -- until the budget is in balance or in surplus.

Under EU rules, Italy should cut its structural budget deficit, seen at 1.7 percent of GDP this year, by 0.6 percent of GDP in 2019.

This might be difficult because even with no change in policies, let alone higher spending and tax cuts, the structural deficit will rise next year to 2.0 percent of GDP, the European Commission forecasts.