Pressure on Italy to cut back further comes despite fears for slow recovery

AUSTERITY DRIVE:ITALY'S CENTRE-right government is in a corner, under intense pressure from the European Central Bank (ECB) to accelerate its austerity programme even as the necessary spending cuts and tax increases threaten to stifle an already weak recovery in the euro zone's third-largest economy.

Silvio Berlusconi’s cabinet plans to rush through a revised emergency budget decree by next week, working through an August 15th public holiday in a symbolic demonstration of political backbone when most Italians are taking their summer break.

Desperate times call for desperate measures. Finance minister Giulio Tremonti said yesterday the government intended to increase taxes on capital gains from 12.5 per cent to 20 per cent.

The same proposal from opposition politicians five years ago drew scorn from Mr Tremonti, who called such a move “a wealth tax on the money of poor people”.

Mr Tremonti also said he wanted to ease labour market laws and liberalise public services, but gave no further clues to the government’s plans, saying firm proposals would be presented at the next cabinet meeting.

The minister turned down repeated requests to disclose the demands made in a letter sent to Mr Berlusconi last Friday from ECB head Jean-Claude Trichet, and Mario Draghi, governor of the Bank of Italy.

The letter prompted Mr Berlusconi to pledge to balance Italy’s budget by 2013, a year ahead of schedule, in return for ECB purchases of Italian bonds.

Bond purchases began on Monday and the yield on Italy’s benchmark 10-year bond dropped by some 100 basis points, substantially reducing borrowing costs – at least for the time being.

“This is encouraging, but the situation remains critical and calls for sweeping fiscal and economic reform measures,” said Riccardo Barbieri Hermitte, economist at Mizuho International in London. “The precedents of Greece, Ireland and Portugal suggest that ECB intervention alone is insufficient to turn a tidal wave of selling.”

Mr Hermitte was reflecting the view that with debt approaching €1,900 billion – equal to 120 per cent of gross domestic product (GDP) – Italy is “too big to bail”.

While the need to cut debt is well understood – to save not just Italy, but the euro – there is concern that excessive austerity measures could derail Italy’s hesitant recovery, knocking budget forecasts off course. Swathes of industry are still producing well below pre-recession levels and some analysts are warning of a third quarter GDP contraction.

“The data now available tell us that there will be a slowdown of the Italian economy due to a global slowdown,” said Giampaolo Galli, director general of Confindustria, the main business lobby.

After a thin record of reforms over eight years in office, Mr Berlusconi is being dictated to by the ECB and Brussels.

However, weakened by court cases and personal scandals, the billionaire prime minister lacks the political credibility to get the rest of the country on board for the pain of immediate austerity and longer-term liberalisation that would threaten the privileged fiefdoms of the professional classes and big corporations.

Rising social tensions were “inevitable” in Italy if Mr Berlusconi’s coalition further damaged the lower and middle classes “without touching the rich”, said Susanna Camusso, leader of CGIL, the main left-wing trade union federation. – (Copyright The Financial Times Limited 2011)