For the first time ever, the European Commission rejected the draft budget plan for a member of the euro currency zone, formalizing a long-anticipated clash between Italy and the executive arm of the European Union.
In a Tuesday statement, the commission said Italy's draft budget that would feature a deficit equivalent to 2.4-percent of the country's gross domestic product, would create an unsustainable risk for the eurozone. The European Commission had called for a deficit measuring just 0.8 percent of gross domestic product.
The official communique from the commission gave Italy three more weeks to rewrite its budget plan with a smaller deficit or face heavy sanctions.
"The Italian government is openly and consciously working against commitments it made," Valdis Dombrovskis, the European Commission's vice-president for eurozone and financial stability, said in a press conference in Brussels. Dombrovskis said Italy left the commission with "no alternative" but to reject its draft plan.
The commission's move marked the first time it ever told a member of the euro currency zone -- which now includes 19 member states -- to rewrite a budget plan.
But Italian officials have said they have no plans to rewrite the draft. On Monday, Italian Prime Minister Giuseppe Conte told Rome's Foreign Press Association there was "no Plan B" for the 2019 budget. "This is the plan we have come up with," he said, adding the plan would help spark economic growth and would ultimately reduce debt.
Giovanni Tria, minister of finance, echoed Conte in saying Italy planned to stick with the draft budget plan. Among the factors pushing the deficit higher are increased social spending and lower tax rates, particularly for corporations.
Tuesday's developments sent markets reeling.
The MIB-30 blue-chip index on Milan's Italian Stock Exchange fell nearly 1 percent Tuesday even though the formal declaration from the commission came near the end of the trading day.
The yield on the benchmark ten-year government bond briefly rose above 3.6 percent, its highest level in nearly five years. Higher bond yields, which reflect investor nervousness, increase the cost for the government to borrow money, making large deficits less sustainable.
The euro currency fell against the dollar Tuesday, even though the dollar itself lost ground against other key currencies.
Fedele De Novellis, a senior economist with REF Research, told Xinhua markets were not reacting to the specifics of the European Commission's rhetoric about Italy but rather to what he called the "general mood" created by the standoff between Italy's five-month-old populist, anti-establishment government and the commission.
"The drama itself is having an impact on markets," De Novellis said. "Italian officials keep saying 'There is no Plan B' but the markets are worried that the Plan B might actually be that Italy could start moving away from the euro currency."
In Monday's remarks, Conte categorically denied Italy would even consider such a move. But De Novellis said markets remain skeptical.
"Any move from Italy against the euro zone would have a devastating effect," De Novellis said.
Silvia Ardagna, a Goldman Sachs economist who follows Italy and the European Union, agreed in a research note: "This may well get worse before it gets better."
Ardagna said continued market turmoil could convince Italy to back down by making the government realize that its hardline stance and aggressive spending plans are unsustainable.
