EU Opens Way for Easier Budgets After Austerity Backlash

European finance ministers opened the way for looser budget policies after a backlash against austerity thrust Italy into political limbo and shattered months of relative stability in European markets.

Italy’s deadlocked election, France’s refusal to make deeper budget cuts and protests against the shrinking of the welfare state across southern Europe escalated the rebellion against the German-led prescription for fighting the debt crisis.

Economic strains “may also justify in a certain number of cases reviewing deadlines for the correction of excessive deficits,” European Union Economic and Monetary Commissioner Olli Rehn told reporters late yesterday after a meeting of euro-area finance ministers in Brussels.

The euro-zone economy will shrink 0.3 percent in 2013, making for the first annual back-to-back contraction since the currency’s birth in 1999, the European Commission forecast last month. The currency-bloc prediction masked a widening north-south divide, with growth in countries like Germany, Finland, Belgium and Luxembourg set against dwindling output in Italy, Greece, Spain and Portugal.

France is straddling the middle, set to eke out a 0.1 percent expansion after the economy stagnated in 2012, according to the commission. Deeper budget cuts are out of the question, French Finance Minister Pierre Moscovici said.

‘Right Rhythm’

“We do not want to add austerity to recession,” Moscovici said. “If our rules are intelligent, they are also flexible. We have to find the right rhythm and the right balance without weakening the little growth left.”

France is counting on estimates that it has made sufficient reductions in the “structural” deficit -- a figure that factors out the effect of the economic cycle -- to escape a European order to cut more.

French President Francois Hollande became a spokesman for southern European opposition to belt-tightening last year after ousting Nicolas Sarkozy, who toed German Chancellor Angela Merkel’s anti-crisis line.

German officials backed the commission’s approach, indicating that the Berlin leadership is sensitive to criticisms that budget cutting has been overdone. Euro budget rules include “the necessary flexibility to respond to economic developments,” Finance Minister Wolfgang Schaeuble said.

‘Troubled Countries’

“Merkel and her allies have exhibited more flexibility toward the troubled countries of southern Europe than is often acknowledged,” Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington, said in a blog post yesterday. “The euro area has considerable leeway in its new fiscal surveillance framework.”

Italy’s political stalemate -- with a quarter of the vote in the Feb. 24-25 election going to a protest movement headed by Beppe Grillo, a former comedian -- dramatized the stakes in the recession-hit European economy that has yet to shake off the financial crisis.

The biggest vote-getter in the lower house of parliament, Pier Luigi Bersani of the Democratic Party, is trying to form a government by outmaneuvering Grillo’s blocking minority in the upper house. A second election -- analogous to Greece in 2012 -- figured as a possibility.

Unity Government

Italian bonds rebounded from a two-day slide today. Ten-year Italian yields fell 12.7 basis points to 4.75 percent, paring the extra borrowing costs over German levels to 329 basis points. The spread, an indication of the perceived risk of Italian investments, remained above its pre-election level of 288 basis points.

Italians revolted against the budget cuts spearheaded by technocratic Prime Minister Mario Monti, even though no one in Europe called for additional savings. The apolitical Monti, tapped to head a unity government in November 2011, picked up 10 percent of the vote.

“Austerity doesn’t work, the impact on Italian consumers is catastrophic,” Sergio Marchionne, chief executive officer of Italian carmaker Fiat SpA, said at the Geneva Motor Show. “I understand austerity, but we can lose weight until we die.”

Messages from the Brussels-based commission have catered to two audiences, with pro-austerity rhetoric aimed at northern Europe contrasting with policy decisions to ease the strains on the unemployment-plagued south.

Deficit Deadlines

With the northern public in mind, Rehn said it is wrong to characterize the more flexible approach as “leniency.” He said the budget rulebook “is not stupid, but it focuses on the structural sustainability of public finances.”

The commission last year recommended -- and governments including Germany endorsed -- extensions of deficit-reduction deadlines for Portugal, Greece and Spain. It is considering giving France extra time to get its deficit down to 3 percent of gross domestic product, the euro-area limit. Portugal and Spain are also clamoring for additional relief.

Spain is heading for deficits of 6.7 percent this year and 7.2 percent in 2014, the year it is supposed to get down to the limit. Economy Minister Luis de Guindos looked forward to another extension is in the offing, without spelling out the new target.

“The path must be feasible and credible,” de Guindos said. “We have to make compatible the reduction of the public deficit with its impact on economic activity.”

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