A Political Duel With The Budget As Victim

With inflation heating up, Italy's task of cutting its budget deficit is becoming increasingly urgent. But a new round of political uncertainty is threatening to undermine the government's efforts.

On May 31, Prime Minister Lamberto Dini submitted a tough three-year plan to cut the deficit. However, former Prime Minister Silvio Berlusconi's June 12 victory in a referendum, allowing him to keep all three of his television stations, shifts the political landscape. Recouping some lost clout, Berlusconi has called for early elections this fall, which would cripple Dini's efforts to pass his budget, given his already-slim parliamentary majority. The lira plunged after the vote, forcing the Bank mf Italy (BOI) to intervene. Investors believe Dini, a former central-bank director general, is more committed to deficit cutting than Berlusconi.

Dini's 1996 budget is ambitious. It raises 32.5 trillion lire ($19 billion), split between spending cuts and tax hikes. The plan fattens the projected 1996 surplus in the primary budget--all items excluding interest--from 47.5 trillion to 80 trillion lire. Interest on Italy's huge national debt would total 189.4 trillion lire. That yields a 1996 deficit of 109.4 trillion lire, down from 130 trillion in 1995. Dini proposes to cut the deficit from 7.4% of gross domestic product in 1995 to 3% by 1998.

But Dini's blueprint is overly optimistic. Economic growth projections--3% through 1998--seem too upbeat, and expected inflation--3.5% for 1996, falling to 2.5% by 1998--appears too low. With inflation jumping to 5.5% in May, from 3.6% last summer, and with further hikes in interest rates likely, 1996 interest payments look too low.

The BOI lifted official rates by three-quarters of a point on May 26, to 9%, and BOI Governor Antonio Fazio has set informal inflation targets: If inflation exceeds 5.2% for 1995, or 4% for 1996, the BOI "will not hesitate" to tighten further. But lasting gains on inflation depend on fiscal reform, and that requires the Dini government to stay on until 1996.

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