Italy’s New Government Will Challenge the EU at Its Heart

BRUSSELS — As Italy’s new populist leaders prepare to form a government, European leaders are bracing for potential new confrontations over migration and some of the core principles of the common currency, the euro.

They were already trying to tame a rebellion against Europe’s shared democratic values in the east, led by Hungary and Poland. They now face the prospect that Italy, a founding member and traditionally Europe’s third-largest economy, could be next to challenge the bloc’s cohesion, finances and democratic principles.

If nothing else, anxiety about the economic plans of the new Italian government may finish off the ambitious reform agenda for a more integrated euro area proposed by French President Emmanuel Macron.

“The new Italian government will give Germany every excuse not to do what Macron would like and it will destabilize the markets,” said Charles Grant, director of the Center for European Reform, a research institution. “It will increase the risk of another eurozone banking crisis, not reduce it.”

Last week Italy’s populist parties, the Five Star Movement and the hard-right League, said they would sharply increase spending and repeal reforms of the labor market and the pension system, violating financial limits imposed by Brussels and meant to apply to any country using the euro.

The plans would throw an already weak Italian economy into further debt. And the consequences are certain to ripple through the bloc, where leaders worry about another financial crisis just as Greece finally seems to be exiting from its eight-year bailout program.

But Italy is a much bigger problem than Greece, even if its economic troubles have it lagging behind Spain, whose economy is now bigger in terms of gross domestic product per capita.

“Even if they have retreated on leaving the euro, what they’re proposing in terms of the social program and minimum guaranteed salary will blow a hole through all the eurozone rules,” said Anthony L. Gardner, the most recent U.S. ambassador to the European Union. “I think investors are underestimating the risk.”

The French finance minister, Bruno Le Maire, warned Italy this week to respect bloc budget rules or put the euro in jeopardy again.

“Italians must understand that the future of Italy is in Europe and nowhere else, but there are rules to respect,” Le Maire said in an interview on Europe 1 radio.

“If the new government takes the risk of not meeting its commitments on the debt, the deficit, but also the cleanup of the banks, it is the entire financial stability of the eurozone which would be threatened,” he said.

Mujtaba Rahman, chief European analyst with the Eurasia Group, said that “even a fairly aggressive fiscal expansion will put Rome on a direct collision course with Brussels,” which had been predicting a more moderate Italian policy.

The crunch is likely to come in a new Italian budget next fall, Rahman said. The proposed expansion of spending is a direct challenge to “the whole philosophy of economic governance and rules governing the eurozone area,” he said.

The cumulative Italian debt is already about 130 percent of gross domestic product, more than twice what the eurozone is supposed to require, and probably too big to bail out if necessary.

The uncertainty around the Italian economy will also be a further major blow to the ambitions for eurozone stabilization and reform laid out by Macron, proposals that have already been sharply watered down by Germany.

With a critical EU summit coming in June, Rahman said, “this will be deeply unhelpful to Macron, because the Italians will be the excuse for Germany to do nothing serious on reform.”

“The window for eurozone reform, already narrow, is shrinking fast,” he said.

There are worries in security terms, too.

Italy’s coalition leaders have been clear about their desire to restore better relations with Russia, making it unlikely that European sanctions on Moscow stemming from its annexation of Crimea, initiated in March 2014, will be renewed in September. Those sanctions must be renewed every six months by the unanimous vote of all 28 member nations. Italy had already been reluctant last month to go along with any extra European sanctions against Iran for its ballistic missile program and support of terrorist groups in the Middle East, including in Syria.

France, Britain and Germany, as signatories to the Iran nuclear deal, had been discussing new sanctions against Iran as part of their effort to persuade President Donald Trump to keep to the Iran deal.

While the State Department wants to continue those talks about new sanctions despite Trump’s withdrawal from the deal, new EU efforts to tie further sanctions to Iranian behavior seem unlikely, especially with this new Italian government adding its dissent to Austria, Cyprus and Greece.

The economic situation in Italy is hardly good, which was a major contributing factor to the victory of the League and Five Star. Henrik Enderlein, a professor of political economy at Germany’s Hertie School of Governance and now in Florence, put four charts on Twitter showing poor Italian performance compared with the rest of the eurozone, with the comment, “Yes, I am worried.”

The charts showed poor economic growth, very high debt, very high levels of nonperforming loans in Italian banks and low popular support for the euro. Italian GDP per capita is lower now in real terms than it was nearly 20 years ago, when Italy joined the euro, noted Matthew Goodwin, a political scientist at the University of Kent.

The other factor that helped the new coalition was the strong feeling among Italians that the European Union had let them down over migration; Italy and Greece have become the primary landing spots for refugees and economic migrants from the Middle East and Africa.

Promises made during the campaign to deport up to 500,000 migrants could also bring Italy into sharp conflict with Brussels, Grant said. “Deportation of that size would be impossible without violating due process,” he said.

That could force Brussels to start an Article 7 process against Italy for breaking the fundamental commitments to the rule of law that would be “more serious” than the process begun against Poland for meddling with the independence of the judiciary.

In the end, Gardner and Rahman said, Italy is likely to be kept in line more by the financial markets than by Brussels itself. Brussels has been “lazy and complacent” in the face of the Italian election challenge, Rahman said. “But what will really decide if there is a crisis, are the markets,” he said.

And with Mario Draghi, an Italian, soon leaving as head of the European Central Bank, it is not clear that a successor would be as willing to provide a backstop to Italian debt in the way Draghi promised to do. “Don’t assume the ECB will be the same,” Rahman said.

Gardner added: “Every leader has to take account of the bond markets. Even Berlusconi had to.”