UPDATE 4-Italian president hopes to solve political crisis without new vote

Reuters

(Corrects name of Italian prime minister in paragraph 4)

* Letta to address parliament Wednesday on crisis

* Berlusconi calls for election

* Signs of dissent in Berlusconi's party

* Labour minister sees some volatility in markets

By Alessandra Galloni and James Mackenzie

ROME, Sept 29 (Reuters) - Italy's president began talks onSunday to pull the country out of a new political crisis,attempting to undercut a move by former Prime Minister SilvioBerlusconi to bring down the government and force new electionsseven months after the last vote.

For the third time since 2011, Italian President GiorgioNapolitano is trying to steer the country out of political chaosthat has proven a major threat, not only to the euro zone'sthird-largest economy, but to the region's efforts to halt itsfour-year debt crisis.

The latest turmoil was set off on Saturday when the fiveCabinet ministers who are from Berlusconi's party suddenlystepped down, leaving the government only formally in place.

The resignations were set off by clashes at a Friday Cabinetmeeting over an imminent sales tax hike. Tensions have beenrunning high in Prime Minister Enrico Letta's uneasy coalitionof left and right parties ever since last month, whenBerlusconi, who is a member of Parliament, was convicted of taxfraud. Lawmakers must vote on whether to oust him.

Letta will go before parliament on Wednesday and hold aconfidence vote to verify what is left of his parliamentarybacking. He has a commanding majority in the lower house, and ifhe can gain support from a few dozen senators among dissentingBerlusconi followers or opposition parties, he could form a newgovernment. But if he doesn't find support - and Napolitano doesnot try to form a transition government - then Italy would finditself quickly back at the polls.

In a television interview on Sunday evening, Letta said hesensed that there might be rebels within Berlusconi's People ofFreedom Party. "I hope that there is a part of the PDL which isnot in accord with Berlusconi," he told RAI television.

REBELS

Over the weekend cracks appeared within Berlusconi's PDL.While Berlusconi said he wanted to go straight to elections,other centre-right politicians voiced more caution and saidSaturday's resignations were an extreme act. One longtimeBerlusconi loyalist, Fabrizio Cicchitto, expressed rare dissentover the way Berlusconi had withdrawn his ministers withoutparty consultation.

Napolitano has reiterated that he would only dissolveparliament as a last resort.

The political jockeying that will ensue will inevitably takeRome's attention off the important structural reforms that Italyneeds to adopt in order to cure its economic ills and become astronger player within the European Union. Italy is emergingfrom the worst recession since World War Two.

Two years ago, Italy risked taking the euro zone's debtcrisis to a boiling point, when its borrowing costs soaredbecause of a lack of confidence that the then-Berlusconigovernment could bring down the country's 2 trillion euro debt.Berlusconi's resignation in 2011 ushered in a technocratgovernment led by former European Commissioner Mario Monti, whopushed through some key economic changes, notably a pensionsreform.

But political chaos gripped Italy again this year when noclear winner emerged from February elections and a quarter ofthe popular vote went to the anti-establishment Five-StarMovement. To end the stalemate, Letta's unusual coalitiongovernment was formed at Napolitano's behest.

Since 2011, the European Union has adopted several policiesaimed at preventing a repeat of the debt crisis. Notably, apledge made in September 2012 by the European Central Bank thatit would step in to avoid another flare-up has eased investorconcerns about the solidity of the euro zone.

However political instability has cost Italy dearly. Thecountry's borrowing costs hit a three-month high at an auctionof 10-year bonds on Friday, while the premium investors demandto hold Italian debt rather than German paper widened to about267 basis points from under 250 at the start of the week.

In an interview on Sunday, Labour Minister Enrico Giovanninisaid he expected financial markets to be rattled on Monday bythe latest political developments. Giovannini said thevolatility need not last if there is a quick resolution to thecrisis.

"If instability were to persist and affect the euro zone,then international authorities could put much stronger pressureon" Rome, Giovannini said.

ELECTIONS

Berlusconi's shock move on Saturday came after thegovernment's failure to avert a hike in the sales tax at aCabinet meeting the day before.

Letta dismissed the motivation as a "huge lie," saying thatBerlusconi, who celebrated his 77th birthday on Sunday, wasacting out of fury at his expected expulsion from parliamentfollowing the tax fraud conviction.

The big risk of early elections is that - because of thecurrent dysfunctional electoral law - it is likely that a votewould lead to a stalemate similar to the one that followedFebruary's vote.

Letta said on Sunday that his government had already draftedproposals to change the law.

"We cannot vote with this current electoral law. We have tochange it," he said.

(Writing by Alessandra Galloni; Editing by Stacey Joyce)

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