Italy’s Political Economy: Between Fiscal Constraints and Reform Imperatives

Expert Comment — Europe Programme

5 February 2026

Italy has long been Europe’s most enigmatic major economy — a country with immense potential constrained by structural weaknesses, political instability and the highest public debt in the eurozone after Greece. In 2026, Italy faces a familiar set of challenges but in a new and more difficult context. The European Central Bank’s monetary tightening, the end of the NextGenerationEU funding bonanza and the fragmentation of the country’s political landscape all point to a period of heightened economic and political risk.

Italy’s public debt, at approximately 140 per cent of GDP, is the highest in the eurozone after Greece and the third highest in the developed world after Japan and Greece. The sustainability of this debt depends critically on the interest rate the government pays relative to its nominal GDP growth rate. During the era of ultra-low interest rates (2014-2022), the arithmetic was favourable: the government could borrow at near-zero rates while the economy grew at 2-3 per cent in nominal terms, causing the debt-to-GDP ratio to decline gradually. The ECB’s tightening cycle has reversed this dynamic. With interest rates at 3-4 per cent and growth below 1 per cent, the debt ratio is once again rising.

Italy is not a Greece-style crisis waiting to happen — its debt is held domestically, its banks are stronger and it has the ECB as a backstop. But the room for policy error has narrowed dramatically, and the combination of high debt, low growth and political instability is a dangerous one.

Italy is the largest beneficiary of the NextGenerationEU recovery fund, receiving approximately €200 billion in grants and loans. The funds have been directed toward infrastructure, digitalisation and green investments, and the early evidence suggests they have made a meaningful contribution to economic activity. But the programme is scheduled to wind down by 2026, and the question of what replaces it — both in terms of European fiscal transfers and domestic investment — remains unanswered.