Italy still struggling to reach EMU finish line

Date: 28/11/1996

By Tim Jones

WHEN the lira re-entered the Exchange Rate Mechanism last weekend, the Italian government thought it was putting one of the last touches to its European single currency application form.

The currency's return to the ERM fold after four years in the wilderness was Prime Minister Romano Prodi's dearest wish, as a step towards ensuring that his country - a founding member of the European Communities - will also be in the first tier of monetary union entrants.

That the negotiations were tough was not surprising, given the industrial interests involved in the two main protagonist member states - Italy and France - which forced both governments to look over their shoulders towards their car manufacturers.

Tough-talking French protectionist Jacques Calvet, chairman of PSA Peugeot Citroën, had called for the lira to return to the ERM with a central rate against the deutschemark of 950-970, while Fiat's Gianni Agnelli was not prepared to accept anything under 1,000. Rome's opening request for a central rate above 1,000 per mark was eventually whittled down to 990.

The Bank of Italy will be happy with such a high rate since, even if it proves unsustainable given the country's history of inflation, the lira has room to fall by 15&percent; before the central bank will be forced to defend it.

The new regime was put to the test on day one when examining magistrates announced they were seeking Prodi's indictment for alleged corruption when he was chairman of state-owned company IRI.

Returning to the ERM means that no formal hurdles now stand between Italy and monetary union. All Prodi has to do is satisfy the other criteria by continuing to douse inflation and, above all, getting the budget deficit down to the magic figure of 3&percent; of gross domestic product.

But by this yardstick, Italy's chances of winning a ticket to monetary union from January 1999 remain slim and would almost certainly depend on a generous reading of the Maastricht Treaty's budgetary targets.

Since this year's deficit is worth 6.6&percent; of GDP, even budgetary austerity on the scale now proposed by Prodi will only reduce it to 5&percent; of GDP next year, according to Giorgio Raedelli at Lehman Brothers investment bank.

“The burden of proof is on those who say the government can get down to 3&percent; in 1997,” he said. “That is a cut in the deficit of nearly 4&percent; of GDP in a large, open economy which will already be on its knees.”

The effects of tax increases and spending cuts are expected to slow Italian growth significantly next year, making it politically impossible for the government to impose further austerity, particularly since its dependence on the support of the Refounded Communist Party makes welfare spending virtually untouchable.