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Italy puts big squeeze on budget deficit

After three days of frantic negotiations and political horse-trading, the Italian government last night announced the most austere budget package in the country's post-war history in a last-ditch attempt to qualify for European monetary union on time, writes Andrew Gumbel.

Romano Prodi, the Prime Minister, emerged from eight hours of cabinet discussion to announce a cut of 63 trillion lire in the 1997 budget, almost double the 32.5 trillion that his predecessor, Lamberto Dini shaved off this year's at considerable political and social cost. The goal is to bring Italy's budget deficit down to 3 per cent of GDP by the end of next year, as stipulated by the Maastricht treaty - a target which until recently few had considered possible until 1999 at the earliest.

Roughly 38 trillion is due to come from a combination of cuts in expenditure and tax rises, another 13 trillion from a one-off "Europe tax" and a further 12 trillion from unspecified treasury operations. It was far from clear, however, how this highly ambitious plan would go down either in parliament or the country at large.

To put his budget together, Mr Prodi has needed the support of a broad swathe of parties from the liberal centre led by Mr Dini to the far-left Rifondazione Comunista, which is not part of the government but whose votes are crucial to give the government a majority in the Chamber of Deputies. On Thursday, the leader of Rifondazione Comunista, Fausto Bertinotti, won a commitment that the new budget would not touch state pensions or increase charges for health care.

That deal caused considerable dismay on the right wing of the government coalition. Diego Masi, the parliamentary floor leader of Mr Dini's party Rinnovo Italiano, said the package was over-reliant on tax increases and tendered his resignation.

Opinion polls show that the one-off Europe tax, in particular, is unpopular with the electorate since Italy already has one of the highest tax thresholds in the EU. Mr Prodi has promised this will be the last austerity budget, but the continuing belt-tightening plays into the hands of fringe political groups including the separatist Northern League, which has made considerable mileage out of the resentment northern voters feel at having to bail out the less affluent south.