Pressure on new Premier Romano Prodi to pass a mini-budget increased on Wednesday after Bank of Italy Governor Mario Draghi told the government it had to slash the budget deficit by 2% of GDP over the next 18 months.
In a speech delivered at the central bank's annual general meeting, Draghi said the deficit risked exceeding 4% again this year in breach of the European Union's ceiling of 3%.
He said that for the government to meet its EU-agreed target of a 2.8% deficit by 2007, it needed to introduce corrective measures totalling 2% of GDP or some 28 billion euros. Italy's budget deficit has breached the 3% limit for the past three years, rising to 4.1% in 2005 - the highest level since 1996.
It is seen as hitting some 5% of GDP this year unless budget adjustments are made. The previous government led by Silvio Berlusconi, which predicted a deficit of 3.8% this year, promised the European Commission that it would be slashed to 2.8% by the end of 2007.
Brussels has ruled out an extension on that deadline.
European Commission chief José Manuel Barroso said in interviews published by the Italian press on Wednesday that "to ensure the rapid reduction of the public debt and preserve the overall credibility of the monetary union system, the Italian government must end the excessive deficit situation in 2007".
Italy's debt mountain - the third biggest in the world - began rising last year for the first time in a decade and is forecast by the European Commission to hit 107.4% of GDP this year. Barroso, who met with Prodi in Brussels on Monday, said that Italy could meet its commitments providing it firmly stuck to the measures contained in the rigorous 2006 budget.
But European Economic and Monetary Affairs Commissioner Joaquin Almunia said in another interview published by Il
Sole 24 Ore that the 2006 budget would probably have to be supplemented by "new measures" this year and by a tough 2007 budget.
"Given that everyone agrees that time has been wasted and that the current situation could be worse than expected, it would be best to adopt additional measures," the commissioner told the Milan financial daily. According to press reports, the Prodi government is considering a 7-billion-euro mini-budget which would include a small increase in VAT and cuts in government ministry costs.
Draghi said in his address that the government had to curb public spending and make local governments more accountable if they overspend. "Structural measures involving all the main spending categories and all levels of government are imperative," the Bank of Italy chief said, noting that primary spending had increased in real terms by 2.5% a year over the past decade.
He warned that the government would have to find "extra resources" if it intended reducing fiscal pressure or relaunching public investments. He underscored the sharp decline in the primary surplus, that is, state revenue not including net interest payments on the public debt.
The primary surplus has plummeted from 6.6% of GDP in 1997 to 0.4% this year, Draghi said.
Draghi also stressed the need for a "substantial rise" in the retirement age, which is set to pass from 57 to 60 as from 2008 under reforms introduced by the previous government. The governor said that pension spending accounted for 15.4% of GDP and that almost a quarter of that went to people aged under 65.
On the growth front, Draghi said Italy was on course for a 1.5% increase in GDP this year thanks to a recovery in export levels and investments. He said that this was still weak compared to other European economies, underscoring that "a return to growth is an absolute priority".
In other comments, Draghi referred to his predecessor Antonio Fazio, who resigned last December after months of criticism over a banking takeover scandal. The former Treasury director general said that "the verdict is still open on his (Fazio's) conduct" and that Fazio had "spent his entire professional life at the service of this institution".
"We are awaiting the outcome of the judicial process. While the institutional integrity of the monitoring structure of the Bank of Italy was saved, the bank was nonetheless damaged (by this affair)," Draghi admitted. Fazio is currently under investigation for insider trading and abuse of office. He is suspected of acting above the law in his efforts to help Banca Popolare Italiana (BPI) and its former chairman Gianpiero Fiorani beat a Dutch bank for control of Italian lender
Antonveneta.
Last September, ABN Amro prevailed in its bid after Italian judicial probes blocked the BPI operation.
Fiorani is under investigation for alleged embezzlement, price-fixing, insider trading and hindering the work of market regulators as he tried to engineer the failed takeover of Antonveneta - a bank whose market value (about $9.8 billion) was more than three times that of BPI.
Draghi has vowed to restore the Bank of Italy's credibility and rebuild faith in the transparency of Italy's banking system.
