Jan. 22 (Bloomberg) -- Prime Minister Romano Prodi's government, Italy's 61st since World War II, is on the verge of collapse after a key ally unexpectedly abandoned his coalition, leaving the premier without a majority in parliament.

Prodi will speak about the political crisis in the Chamber of Deputies, the lower house of the legislature, at 11:30 a.m. The prime minister will resign if lawmakers in both houses don't vote to back his government, allies said as they left an emergency meeting with Prodi last night in Rome. That confidence vote will take place tomorrow, news agency Ansa reported.

``Prodi will go the chamber to institutionalize the crisis and we will see what the crisis is when there is a vote,'' said Roberto Manzione, a senator with Prodi's coalition.

Should Prodi offer his resignation, President Giorgio Napolitano will decide the fate of the government. The president can ask Prodi to try to form a new administration, call early elections or seek bipartisan support for an interim government to modify the election law.

Napolitano indicated last year that he wants changes to voting rules before permitting an election. The current system awards parliamentary seats to even very small parties, requiring the creation of fractious, multiparty coalitions.

Shaky Majority

The Prodi government has been teetering on the brink since it won the closest elections in modern Italian history in April 2006 that left him with a razor-thin majority in the Senate. He was constantly forced to resort to confidence votes, staking the survival of his government on the outcome, to get his bickering allies in line. He passed the 2008 budget last month with the 31st confidence vote of his 21-month old administration.

The constant divisions within his government contributed to sapping his popular support even after he delivered a second year of economic growth, reduced the budget deficit to under the European Union limit for the first time since 2002 and oversaw a drop in the unemployment rate to a 15-year low. A Dec. 23 survey by polling company Ispo Ltd. showed only 29.6 percent of Italians had confidence in Prodi, down from 44.5 percent a year earlier.

Former Prime Minister Silvio Berlusconi, who leads Forza Italia, the party that won the most support in the last elections, immediately called for early elections, saying a vote should be held in the coming months, Ansa reported.

Minister Resigns

The latest crisis erupted last week when Justice Minister Clemente Mastellaresigned after he and his wife were named as suspects in a corruption probe. He said his Udeur party, a Catholic party that controls three seats in the Senate, where Prodi holds just a one-seat majority, would continue to back the premier. Last night, he reversed that decision, saying that the government was finished and he would not back Prodi in further confidence votes.

``We are leaving the coalition,'' Mastella said at a press conference in Rome. ``We will not give our support to this government or this governing coalition. We're in a government crisis.''

The political turmoil is affecting Italian financial markets. Alitalia SpA plunged as much as 8.6 percent in Milan trading today on concern that the collapse of the government could derail the planned sale of the unprofitable airline to Air France-KLM Group. Shares were down 2.9 percent to 68 cents at 9:25 a.m. in Milan.

Risk Premium

The political tension has prompted investors to demand higher yields for investing in Italian debt. The spread, or difference in yields, between Italy's benchmark 10-year bond and comparable German debt is the most in the European Union, and has widened 3 basis points to 39 basis points since June 17, when Mastella announced his resignation. A basis point is 0.01 percentage point.

``In the past few days we've been seeing a widening of the spread based on the situation of uncertainty in the economy as investors seek more stable securities,'' Giuseppe Maraffino, a bond strategist at UniCredit Global Research in Milan, said in an interview on Bloomberg Television today. ``The situation of political uncertainty in Italy surely doesn't help and could increase the trend.''

The key to resolving the situation will be working out changes to the election law that might permit a vote to be held that would produce a more stable successor to Prodi, who has already said he won't run again.

Election Law

Parliament has been working throughout this legislature to revamp the election law, which both government and opposition agree contributes to the unstable administrations that have plagued Italy since its return to democracy after World War II. The law sets low support thresholds to gain seats in parliament, leading to broad coalitions made up of parties that often have conflicting agendas. Prodi's current government ranges from Communist and green parties to libertarian and Catholic parties.

Proposals to modify the law would create a system to favor larger parties or coalitions over smaller ones. There would also likely be ``majority premiums'' -- extra seats -- for the party or coalition that wins the biggest bloc in parliament. That would help give the winners a more stable working majority in the legislature, even if they gained a narrow victory. Currently such a premium exists in the Chamber of Deputies and not the Senate, leading to Prodi's downfall.

Italy last had an interim government after Berlusconi's first administration collapsed in January 1995 when one of his allies abandoned his coalition. That interim government was led by Lamberto Dini, whose administration lasted 16 months and managed to carry out an overhaul of pension rules before elections were held. Dini is now a senator and has voted with Prodi, while criticizing many of the allies in the coalition.

Prodi was elected for the first time in 1996 after Dini's term in office. His government lasted 17 months, before a Communist ally defected.

To contact the reporters on this story: Andrew Davis in Brussels at abdavis@bloomberg.net; Steve Scherer in Rome at scherer@bloomberg.net.

Last Updated: January 22, 2008 04:31 EST