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Will Rome's Red Ink Drain Italy?

Business Outlook: EUROPE


Italy's current-account surplus, modest inflation, and low wage increases should be the ingredients for a rising currency. Instead, the lira has been plummeting, hitting a postwar low against the German mark in mid-February (chart).

The catalyst in the lira's drop is Italy's fiscal fiasco. New Prime Minister Lamberto Dini took office intending to reform Italy's bloated pension system and to offer an interim "minibudget" that would trim 20 trillion lire ($12.5 billion) from Rome's deficit. But the budget was dead on arrival in Parliament, as opposition mounted to hints of higher energy and value-added taxes. Now, Italy faces a 1995 deficit of some 160 trillion lire, 10% of its gross domestic product.

To prop up the lira, the Bank of Italy lifted interest rates by three-quarters of a point on Feb. 20, but a deficit deal still will have to be forged. The timing is crucial because in March, Rome must issue new and refinanced debt totaling 119 trillion lire. More important, Italy's lira and deficit problems could feed on each other. A worsening deficit means a weaker lira, which lifts import prices and inflation. Already, early reports on urban consumer prices showed a 0.8% rise in February, twice the January increase.

In turn, the Bank of Italy may have to lift rates again. And since interest payments on the public debt account for all of the government's deficit, rising rates will widen the fiscal gap.

So far, the chief beneficiary of the shrinking lira has been exports. An 11.9% jump in exports over the year ended in the third quarter led the 3.7% gain in Italy's real GDP. And the export momentum continued at yearend. Industrial orders in November were up 25.3% from a year ago, while output was up 6.1% in the year ended in December.

Domestic demand, up only 1.8% in the third quarter, is struggling, however, because of high unemployment and stagnant real wages. Now, higher interest rates and more taxes suggest that Italy's recovery may lose some pep in 1995, even as its Continental neighbors pick up steam.BY JAMES C. COOPER & KATHLEEN MADIGAN

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