(Bloomberg) -- It was only a matter of time, but the “R word” is making an appearance in the debate about Italy's future.
The comments from former International Monetary Fund official Ashoka Mody come amid a clash between the coalition government in Rome and the European Commission over the former's expansive budget. Investor concern about the proposals, which the commission rejected this week, has pushed sovereign bond yields to the highest in more than four years.
But for Mody, a critic of the post-crisis austerity policies in Europe, the recession risk isn't from a loose fiscal policy, but from efforts to force Italy into the opposite path.
“If the Italian economy is stalling, fiscal stimulus may be the only way to avoid a dangerous recession, which could tip Italy into an unmanageable crisis. Certainly, the EC's insistence that the Italian government honor its predecessor's commitment to shrink the budget deficit is completely unreasonable. Austerity will worsen the slump.”
Mody, writing for Bloomberg Opinion under the headline that Italy's budget “isn't as crazy as it seems,” says weaker growth would just increase the debt burden and “aggravate rather than ease market tensions.” He does, however, acknowledge that the government's growth projections are overly optimistic and it should pull back on some spending promises to keep the 2019 deficit at the current 2.4 percent target.
So far, the impact of the budget is being felt in 10-year bond yields, which have jumped to 3.5 percent compared with about 2 percent at the start of the year. The premium on Italy's 10-year debt over German bunds is at the widest since 2013.
But any weakness in the economy may be confirmed as soon as next week, when third-quarter data on gross domestic product is released. The median forecast in Bloomberg's October survey of economists is for quarterly growth of 0.2 percent, while the Bank of Italy estimates just 0.1 percent.
Over the longer term, projections are more for sluggish expansion, rather than outright recession. Bloomberg consensus for 2019 is 1.1 percent, while Goldman Sachs is more downbeat at 0.1 percent.
To contact the reporter on this story: Fergal O'Brien in Zurich at fobrien@bloomberg.net
To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Kevin Costelloe
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