Premier battles to bring Italian economy into line

Date: 12/09/1996

By Ivo Ilic Gabara

“ITALY is the only one of the six founding member states of the EU that will not join the single currency from the start - and everyone knows it,” says former European Commissioner Ralf Dahrendorf.

“One of the crises that may shake the world in the next few years is the crisis of the European Monetary Union - and it will be triggered by Italy,” asserts another well-known economist, the American Rudiger Dornbush.

Both views were expressed last weekend in Cernobbio, on Lake Como, during an international seminar on the Italian economy.

Against this backdrop, Italian Prime Minister Romano Prodi is drafting his first budget, which he must submit to parliament before the end of this month.

It will be a 'Maastricht or bust' budget - or as close as possible. Prodi has admitted Italy cannot meet at least one of the convergence criteria, that of cutting public deficit to less than 3&percent; of GDP by the end of 1997.

Yet the Prodi government is committed to not allowing the country to stray further from the course charted in Maastricht.

The government trusts that by maintaining budgetary rigour, Italy will enjoy sufficient credibility to join the EMU club in 1999 if, as it hopes, the rules are applied loosely because not enough member states meet the strict qualifying criteria by 1997.

This will prove a tall order. Prodi's task has been made more difficult by the slow-down in the Italian economy in the second quarter of 1996. Government forecasts of a 3&percent; annual growth rate, made only a year ago, have been cut to 1.2&percent; - and are likely to sink further. This will cut tax revenue while bloating unemployment benefit payments and thus threaten the government's public sector borrowing targets.

Prodi's margin for manoeuvre is significantly reduced by his dependence on the support of the far-left Communist Refoundation Party. He has pledged to cut the deficit by 16.7 billion ecu in 1997, but without touching welfare spending or pensions.

Further pressure comes from Umberto Bossi's Northern League whose leaders are encouraging fiscal disobedience as a means of breaking the state institutions, and threaten to hit where it hurts.

At the same time, Prodi is aware that a tame budget would scupper Italy's chances of joining EMU from the outset. Veiled calls for a 'rethink' of the Maastricht criteria have already come from Italian politicians and economists.

Because of all these difficulties in delivering a budget credible to Italy's European partners, Prodi is keen to see the lira back in the Exchange Rate Mechanism as soon as possible, preferably before the end of the year. Its re-entry into the currency grid would send a clear signal that Italy is doing all it can to reach the EMU objective.