Prime Minister Giorgia Meloni’s government is aiming to bring Italy’s deficit below 3% within the next two years to reassure Brussels officials scrutinising its huge debts, according to people familiar with the matter.

Officials are targeting a shortfall of 2.9% in 2026 that would ensure the country arrives just under the ceiling required by European Union (EU) fiscal rules, said the people, who cited draft calculations for the upcoming budget. They declined to be identified because the matter is confidential. The Finance Ministry declined to comment because any numbers aren’t final.

It’s not clear how Meloni’s coalition would achieve such an outcome, which could require aggressive cuts to public spending or reneging on giveaways promised to voters. Talks within the alliance on the sacrifices needed are likely to intensify in the next week or so.

Italy has faced heightened scrutiny of its public finances ever since the EU’s decision in June to scold the country for its excessive shortfall and enact a special monitoring regime. While other nations including France are in the same boat, Meloni’s challenge is complicated by a mammoth pile of borrowings.

Finance Minister Giancarlo Giorgetti has until Sept 20 to deliver a fiscal plan to Brussels that puts Italy on track to comply with the bloc’s 3% deficit limit, and his ministry has said it will deliver the plan by mid-September.

Reaching 2.9% would entail a more aggressive path for the public finances than the Treasury’s outlook in April, when officials published projections for Italian borrowings and deficits in coming years that didn’t take into account any fiscal measures they might adopt. 

“For the deficit to shrink to 3%, the government will need to get lucky or get real about the scope for tax breaks. With higher debt servicing costs also squeezing budgets, the choices that lie ahead are tough ones,” said Bloomberg Economics senior economist Simona delle Chiaie.

Aside from the 2026 target, the draft calculations do resemble the prior trajectory for the deficit, though only within rough ranges. This year’s shortfall, for example, could be as high as 4.5%, the tallies show. 

The government is trying to cap a mammoth pile of borrowings. Debt is seen at almost 138% of economic output this year, reaching a peak at 139.8% in 2026.

Tax revenues have been higher, giving the government a bit more cash, but a rising trajectory for public spending isn’t helping. On an annualised basis, central government expenses rose 2.3% in July from the previous month. Revenues, by contrast, increased by only 1.3%.

Meloni has been hampered in her efforts to fix the public finances by the legacy of a pandemic-era home-improvement tax incentive called superbonus. That left Italy’s deficit far wider than initially estimated last year, at 7.2% of output. 

The actual path for the public finances will ultimately depend on the fiscal policy choices Meloni makes, and the strength of the economy. 

The government sees growth of 1% this year, boosted by a recovery in services, and investments from the EU’s massive pandemic Recovery Fund, of which Italy is one of the main beneficiaries.

Still, the coalition has made some expensive promises to voters, including tax cuts on wages worth about €10 billion that have narrowed her options to tame the public finances. 

Total needs for the coming year’s budget add up to about €25 billion, only half of which are readily available, according to people familiar with the matter. 

The rest of the money will have to come from cost cuts at ministries and measures such as delaying retirement for some categories of workers who were allowed early exit from the workforce, the people said. 

Even that may spark tensions within the coalition, with League Leader and Deputy Premier Matteo Salvini unwilling to deprive his voters of any campaign pledges, whether on pensions or tax cuts. 

He recently vowed to spend the full promised €10 billion on renewing a reduction in the tax wedge, or the difference between costs paid by the employer and the net pay given to employees.

For now, markets remain unbothered, with the spread between Italy and Germany’s 10-year bonds - a measure of risk in the region - not too far off the two-year low reached in March.

  - Bloomberg