Italian government near collapse after budget talks fail

Reuters

* Cabinet fails to agree new budget measures

* Economy Minister Saccomanni furious

* Coalition close to breakdown over Berlusconi legal woes

* Borrowing costs rise at bond auction

By Francesca Piscioneri and Giuseppe Fonte

ROME, Sept 27 (Reuters) - Italian Prime Minister EnricoLetta failed to secure backing for a vital package of fiscalmeasures on Friday as divisions with centre-right partners inhis fragile coalition took the government to the brink ofcollapse.

Letta flew back from a visit to New York with coalitionunity already in tatters after a threat by centre-rightlawmakers to walk out over Silvio Berlusconi's battle against aconviction for tax fraud.

After two days of mounting tension and with financialmarkets on edge, he met ministers late on Friday in a last-ditchbid to avert a rise in sales tax and secure approval foradditional budget measures needed to bring Italy's deficitwithin European Union limits.

However, with the meeting still in progress, officials madeclear that no deal could be reached.

"The conditions aren't in place at the moment," said oneofficial, who spoke on condition of anonymity.

Letta is now expected to go before parliament next week toseek support to continue in office.

Failure to agree on some 3 billion euros of budget measures,demanded by both Letta's centre-left Democratic Party (PD) andBerlusconi's People of Freedom (PDL), underlined the breakdownbetween the two traditional rivals which were forced together bylast February's deadlocked election.

Economy Minister Fabrizio Saccomanni, who has staked hiscredibility on meeting the EU budget limits and faced constantsniping from the PDL over recent months, was furious at thebreakdown, officials said.

PDL lawmakers said proposals to avert the one percentagepoint rise in sales tax, scheduled to take effect in October,would have been funded by an increase in fuel taxes which wouldhave punished consumers.

With the sales tax hike, passed by the previous governmentled by Mario Monti, due to kick in on Tuesday, prospects for adeal appear remote.

"We can't accept the blame for this," PDL secretary AngelinoAlfano, who is also deputy prime minister, told the cabinet,according to one official. "We can't stay in the government iftaxes are going up and there are no cuts to spending," he said.

MEETING WITH PRESIDENT

Letta's left-right coalition has flirted with collapse eversince Italy's top court convicted former premier Berlusconi oftax fraud last month and sentenced him to four years in prison,commuted to a year of house arrest or community service.

On Wednesday, PDL lawmakers said they would resign en masseif a Senate committee meeting on Oct. 4 votes to beginproceedings to expel their leader from parliament.

On returning to Italy on Friday after courting foreigninvestors in New York, Letta met President Giorgio Napolitanowho, if the government fell, would have to either call newelections or try to oversee the creation of a new coalition.

A spokesman for the president's office said the head ofstate, who has repeatedly said he does not want a return to thepolls, had given Letta his full support to seek the backing ofcabinet and parliament.

If Letta, who has a commanding majority in the lower house,can secure the backing of a few dozen Senators among PDL rebelsor opposition parties including the anti-establishment 5-StarMovement, he could form a new coalition.

The political convulsions in the eurozone's third largesteconomy have increasingly worried investors, although with theEuropean Central Bank guaranteeing stability in the markets,there has been none of the panic seen during previous crises.

At an auction of 10-year bonds on Friday, Italy's borrowingcosts rose to their highest level in three months, while thepremium investors demand to hold Italian debt rather thanAAA-rated German paper widened to 267 basis points from under250 at the start of the week.

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