The Italian job: how Rome plans to work around NATO spending hike

Italy has committed to NATO's new 5% GDP defense spending target by 2035, a substantial increase from its current 1.5%, despite facing significant public debt at 135% of GDP. To meet this ambitious goal without further straining finances, the Meloni government plans to reclassify civilian infrastructure projects, such as ports, railways, and roads, as 'dual-use' defense expenditures, building on prior accounting adjustments. This strategy, which also involves delaying major outlays until after the 2027 election and leveraging future EU fiscal flexibility, positions Italy as a test case for other NATO nations grappling with similar fiscal pressures while aiming to fulfill their defense pledges.

Analysis

Italy's commitment to NATO's 5% GDP defense spending target by 2035 presents a significant fiscal challenge, given its public debt stands at 135% of GDP. To navigate this, the government is pursuing a strategy of creative accounting rather than immediate, large-scale military procurement. The plan involves reclassifying substantial, pre-existing civilian infrastructure investments—including ports, railways, and roads totaling a potential 483 billion euros—as 'dual-use' expenditures to count towards the NATO target. This approach, which builds on previous accounting changes used to meet the 2% goal, is designed to minimize the impact on strained public finances and defer major outlays until after the 2027 general election, a move necessitated by domestic political opposition to defense hikes. By successfully lobbying NATO to delay the target to 2035 and remove minimum annual spending increases, Italy has bought time. The country's ability to get this broad interpretation of defense spending accepted by NATO and the EU will serve as a critical test case for other indebted member states facing similar pressures.

Key Decisions for Investors

• Investors should monitor Italian and European infrastructure, construction, and engineering sectors, as they are positioned to be the primary beneficiaries of this spending initiative, rather than traditional aerospace and defense contractors.
• Holders of Italian sovereign debt and equities should closely track communications from NATO and the European Commission regarding the acceptability of Italy's 'dual-use' accounting, as a rejection could precipitate fiscal tightening and heighten sovereign risk.
• Given the spending is heavily back-loaded to post-2027 and subject to future political dynamics, the full impact should be modeled over a long-term horizon, with caution against pricing in the entire commitment in the near term.