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European Business Italian parliament approves controversial new spending targets despite EU pressure

Italy’s parliament approved on Thursday deficit-raising spending targets, defying markets and Italy’s eurozone partners who had been pressing for changes.

The parliamentary vote clears the proposals to be forwarded to the European Commission for review. But the document already has been criticized as unrealistic by the parliament’s own budget office and the Bank of Italy.

The new spending targets are set to raise Italy’s deficit to 2.4 per cent of GDP next year. In a slight softening, Italy’s leaders pledged to lower the deficit in the subsequent two years.

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But that has done little to assuage concern over the boost in spending to meet a raft of campaign promises made by the two populist parties that formed the governing coalition, and the impact it will have on Italy’s high public debt.

Also on Thursday, five senior sources told Reuters that the European Central Bank won’t come to Italy’s rescue if its governments or bank sector run out of cash unless the country secures a bailout from the European Union.

Italy has seen its borrowing costs surge on financial markets since its new government unveiled plans to increase its budget deficit, defying EU rules and reawakening concerns about its huge pile of public debt.

The sources, attending an economic summit in Indonesia, said Italy could still avoid a debt crisis if its government changed course but should not count on the central bank to tame investors or prop up its banks.

This is because EU rules do not allow the ECB to help a country unless this has already agreed on a rescue “program” – political jargon for a bailout in exchange for belt-tightening and painful economic reforms, an option the Italian government has firmly rejected.

Any attempt to circumvent those rules would damage the ECB’s credibility beyond repair and undermine acceptance of the monetary union in creditor countries, such as Germany, the sources said.

“It’s a test-case to show Europe and its mechanisms work,” said one of the sources on the sidelines of the International Monetary Fund’s annual meetings in the Indonesian resort town of Nusa Dua.

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The sources warned that Italian banks, with 375-billion euros (US$435-billion) of domestic government debt on their balance sheet, were the possible flashpoint.

This is because they relied on those government bonds as collateral to secure cash at the ECB, including some 250-billion euros worth of long-term loans.

If Italy, like Greece, were to lose its investment-grade rating, the bonds that the banks used would become ineligible for regular ECB lending, as well as for the ECB’s bond-buying stimulus program.

Banks that don’t have alternative collateral of good quality would then need to apply for a lifeline known as Emergency Liquidity Assistance, supplied by the Bank of Italy.

“There are some banks that are actually in pretty good shape so it wouldn’t be all of them (requesting ELA),” another source said.

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