Italy scales back defence spending hike in new budget plan

By Giuseppe Fonte and Gavin Jones

ROME, Oct 2 (Reuters) - Italy will issue new multi-year economic forecasts on Friday, hiking this year's growth estimate and, in a last-minute decision, scaling back previous plans to raise defence spending in order to keep a lid on the massive public debt, sources said.

The figures will form the basis for the government's 2027 budget later this month which Prime Minister Giorgia Meloni is putting together against a difficult backdrop for the euro zone's third-largest economy.

It will be Meloni's final budget before a national election due next year.

Surging energy prices are driving up Italians' cost of living, government borrowing costs are climbing, and the public debt is expected to overtake Greece's this year as the highest in the 21-nation currency bloc.

GROWTH HOLDING UP, FOR NOW

Nonetheless, Italy's chronically sluggish economy held up better than expected over the first half of the year, and Meloni has indicated that the government will hike this year's growth estimate to close to 1% from a 0.6% projection made in April.

Next year growth will slow, and likely be little changed from the current estimate of 0.6%, the sources familiar with the matter said.

The 2026 budget deficit will be estimated at 2.9% of gross domestic product or slightly lower, from 3.1% last year, also broadly confirming the current 2.9% target and falling below the EU's 3% ceiling for the first time since 2019.

However, from 2027 the deficit is expected to rise again as Italy intends to take advantage of a so-called "national escape clause" (NEC) from the EU's budget rules.

This facility has been offered to all EU countries to help them raise their defence spending and tackle soaring energy costs triggered by the war in Iran, but Italy will make less use of it than previously planned, the sources said.

Rome's current 2027 deficit-to-GDP target is 2.8%.

The government said in August it wanted to tap the NEC to secure an extra-deficit worth 1.5% of GDP, or around €36 billion through ​2028, a plan which it is now scaling back by reducing the defence component.

EASING BACK ON DEFENCE PUSH

Italy will make full use of the extra deficit granted to soften energy costs, amounting to 0.6% of GDP, the sources said, but it aims to reduce the extra spending initially indicated for defence to 0.6% of GDP from a previously planned 0.9%.

In cash terms, the extra spending will amount to around €14 billion each year in 2027 and 2028.

Hiking military spending ​is unpopular in Italy and divides the ruling parties. At the same time, the government is wary of hiking spending too much as its public debt is targeted to peak in 2026 for a third straight year at almost 139% of GDP, with Italy overtaking Greece as the euro zone's most indebted nation.

Economy Minister Giancarlo Giorgetti is in talks with the European Commission to ensure the extra deficit does not prevent Italy from exiting an EU budget disciplinary procedure in mid-2027, the sources said.

Meanwhile, in a constantly evolving situation, Meloni this week sent a letter to the EU urging it to grant "additional flexibility" in budget rules ‌to help governments counter an energy-driven spike in inflation.

Italian inflation jumped to 4.1% in September from 3.2% the month before.

Meloni has urged the EU to allow member states to fund aid measures through extra revenues stemming from the so-called "fiscal drag", by which inflation and nominal pay growth raise the proportion of taxes paid on income.

(Reporting by Giuseppe Fonte and Gavin Jones)