Is The Lira Becoming The Peso Of Europe?

The economies of Italy and Mexico don't have much in common. Italy, after all, is an export powerhouse and a full partner in the Group of Seven, representing the world's most powerful economies. But when the Milan stock exchange caved in and the Italian lira plummeted almost 6% against the dollar and the German mark on Mar. 17, Italians and other Europeans began to wonder whether a Mexican-style meltdown might be possible in Europe. A collapse of the lira would rock Europe's trading system and ratchet up pressure on other currencies, including Spain's peseta and the French franc.

Although the lira stabilized afterward, the brief panic was a reminder that Italy's embattled Prime Minister Lamberto Dini has only the slimmest room to maneuver in his efforts to bring Rome's public finances in line. Dini did win parliamentary approval in mid-March of $20 billion in tax hikes to plug a hole in this year's budget. But only votes from the far-left Communist Refoundation party put the technocratic leader over the top. Now, Dini faces the even trickier task of getting Parliament to sign off on paring down Italy's no-longer-affordable pension system.

But the real problem spooking investors is political. They fear that Italy is headed for a political collapse that will sabotage any budget-cutting. Dini, a stopgap Premier committed to resigning in the next few months, is weak and likely to get weaker. He is coming under increasing attack from the center-right Freedom Alliance coalition headed by media tycoon and former Prime Minister Silvio Berlusconi. This group wants national elections as early as June--assuming that, as the polls show, Berlusconi would be swept back to power. "A majority of the country is with us," says Giuliano Ferrara, a Berlusconi aide.

In Dini's corner for now is the center-left coalition of former Communists, the Northern League/Lombard League, and many former Christian Democrats. They want to put elections off until at least the fall to give Dini a chance to pull off pension reform and a tough 1996 budget. This group also hopes that national sentiment will once again turn against Berlusconi, whose populist rhetoric is sounding increasingly hollow.

So Berlusconi and his allies are likely to do all they can to bring the government down now. That is why investors are fleeing. They worry that Italy is going to be plunged into a fierce election campaign that would prevent the government from doing any serious work on pensions or the budget. Germany's mighty Bundesbank is said to have plans to prop up the lira, but it doesn't want to move until the political picture clears.

FROM BOOM TO BUST? It has become a cliche to say that political turmoil does not matter in Italy. Fiat, the argument goes, will continue to export its cars, Pirelli tires, and Giorgio Armani suits, no matter what the rascals in Rome do. Indeed, Fiat, the biggest private employer in Italy, announced in late March that it was going to hire an additional 3,000 workers.

But the boom may quickly go bust if Italy doesn't muster the political will to prevent itself from being caught in a vicious cycle of devaluations, inflation, and interest-rate hikes. Already, the strongest inflationary pressures in years are building up, owing to increased prices of raw materials from oil to steel. Fiat had to raise prices on its new models in January. And labor is expecting big wage increases this summer to compensate for an inflation rate that has more than doubled, to nearly 6%. If Italy's fractious politicians don't work out a modus vivendi soon, the comparisons with Latin America might turn out to be right.

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