Chirac consigns Italy to the second division

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Jacques Chirac yesterday said what many people had long thought - Italy is heading for the second division in Europe. The country's hopes of qualifying for the first round of European monetary union were severely rebuffed as the French President explicitly stated that the country is too far behind to meet the Maastricht convergence criteria on time.

The French President singled out Italy as a country that might have to wait beyond the launch date of 1 January 1999 to be allowed to join a single European currency. He also made special reference to the Italian lira as a currency whose devaluation could threaten the export markets of the "core" Europe once monetary union was in place.

"More time may be needed for those who are behind, like Italy," Mr Chirac said in what appeared to be a deliberate attempt to humiliate ahead of a Franco-Italian summit meeting in Naples, scheduled for the end of the week.

His comments whipped up a storm of protest in Rome, including reports that the bilateral summit was about to be scrap- ped. The French ambassador, Jean-Bernard Merimee, was summoned to the Prime Minister's office, and eventually Mr Chirac retracted his remarks, saying instead that he "ardently hoped" Italy would make the single currency on time. But by that stage the damage was already done.

By casting doubt on Italy's European future, Mr Chirac effectively cut the ground from under the Italian government's feet in its efforts to sell the budget - an unprecedented 62.5 trillion lire package of spending cuts and swingeing tax increases - as one last big push for a place in Europe.

The financial package has already caused friction between opposing ends of Mr Prodi's broad centre-left coalition, and political analysts believe any serious assault on its credibility would almost certainly cause a government collapse, with incalculable consequences for Italy's future stability. The financial markets remained cautious yesterday, but the lira and Italian bonds lost much of the ground they had gained in the last few days.

Mr Prodi did his best to remain upbeat, evoking "tensions created by the strength of Italy's export capacity": "We always think of Italy being afraid of competition from France and Germany. In fact, France and Germany are also very afraid of competition from Italy."

A more considered look at the events of the past few days, however, suggests the fear is all on Italy's side, and that a number of European countries intend to make sure that a country burdened with singularly unhealthy public finances does not join the single currency until it is ready.

When Mr Prodi's government took office in May, it had no intention of trying to meet the Maastricht criteria by 1997, but planned to satisfy most of them by 1998 - believing at that stage either that the introduction of a single currency would be postponed or that the criteria would be eased.

That policy remained in place until mid-September, when two key developments forced the Prodi government to change its mind. First, the successful launch of tight-budget packages in France and Germany suggested the euro would in fact be launched on schedule. Second, Mr Prodi made a crucial visit to Spain for talks with his counterpart Jose Maria Aznar.

According to diplomatic sources, Mr Prodi asked Mr Aznar to join him in petitioning the big European players for a sort of reprieve whereby their two countries would be judged on their economic performance in 1998, not 1997 as was previously agreed. Mr Aznar refused to go along with this plan, telling Mr Prodi that Spain had every intention of meeting the targets.

Suddenly, Italy seemed to have been left out in the cold, and Mr Prodi rushed back to Rome with a new plan. The first budget was ditched and a new one prepared in 24 hours. The new deal passed muster with the cabinet, and Mr Prodi euphorically announced that the package would get Italy into Europe.

That euphoria has proved near-impossible to maintain. Italy currently meets none of the Maastricht criteria, and even under the latest plan it can only hope to get close to the target considered most important - a 3 per cent deficit-to-GDP ratio, from around 6.5 per cent now.

The plan can only succeed if the political will exists to admit Italy into the single currency, warts and all. Mr Chirac and Mr Aznar have made clear that they don't like the idea, and the dip-lomatic community is fairly sure that Germany doesn't like it either.

"Italy doesn't meet any of the Maastricht criteria and this budget may not even meet its targets. Because of its high public debt and reliance on short-term debt financing, Italy is still a rather different economy from the core European countries," said Ros Lifton of HSBC Markets in London. "President Chirac's remarks may have been politically inappropriate, but he was largely stating the obvious."