Italy stands by main pillars of budget as EU deadline nears

By Giuseppe Fonte and Anne Kauranen

ROME/HELSINKI (Reuters) - Italy stood by the main pillars of its 2019 budget on Friday, as a deadline neared for it to change what Brussels called overly optimistic economic assumptions or face penalties for breaking EU fiscal rules.

Deputy Prime Minister Luigi Di Maio and Economy Minister Giovanni Tria said they were committed to respecting a maximum budget deficit of 2.4 percent of economic output next year.

But the European Commission, which has given Rome until Tuesday to present a new budget, has forecast a deficit of 2.9 percent and a structural fiscal gap - excluding one-offs and business cycle swings - rising to 3.0 percent.

Under EU requirements, Italy should cut its structural deficit next year to 1.2 percent and continue reducing it every year until it reaches a balanced budget.

Tria said the government was "busy drafting an answer to the European Commission with regards to the most contentious points of the budget".

But Rome would confirm its "main pillars", as an economic slowdown had made fiscal expansion even more necessary, he told a parliamentary hearing.

The government says it will introduce an income support programme next year to tackle growing poverty, and reduce the retirement age in an effort to free up the labour market and generate more job opportunities for the young.

It is also promising tax cuts and offering a partial amnesty for citizens who settle tax disputes with the authorities.

The Commission rejected Italy's 2019 fiscal plan last month, saying it flouted a previous commitment to lower the deficit and that it did not guarantee a reduction in the country's debt, the second highest in the euro zone as a proportion of GDP.

ITALIAN BONDS

In Helsinki, Valdis Dombrovskis, the Commission Vice President responsible for the euro, on Friday reaffirmed the EU executive was considering starting an excessive deficit procedure if Italy did not change the budget.

He said Brussels believed Rome's fiscal calculations were "overly optimistic".

"Basically the assumption is that if they ... increase public spending, it will stimulate the economy and thus will help to reduce the budget deficit. We see that this is actually not materialising," he said.

The standoff between Rome and Brussels has spooked financial markets and, after Tria spoke, 10-year Italian bond yields climbed to 3.46 percent, their highest in over a week.

That pushed the closely-watched gap over safer German Bund yields back above 300 basis points.

Italy's central bank warned that the rise in borrowing costs over recent months risked impacting the economy and cancelling out the expansionary effects of the budget.

"I hope for a solution that combines both Italy's respect for the rules it must abide with as a member of the monetary union... and the government and parliament pursuing their political goals," Luigi Federico Signorini, the Bank of Italy's deputy director general, told a parliamentary committee.

Di Maio, whose anti-establishment 5-Star Movement governs in a coalition with the far-right League, said he believed market pressure would ease when investors realised the government was committed to holding the deficit inside its 2.4 percent target.

But he gave no indication that the government was willing to change the 2019 budget draft.

Asked if Italy would pay any fines the EU might levy, Di Maio told reporters in Rome "pacts must be honoured", but that he did not expect any charges to be levied and was confident an agreement with Brussels would be reached.

(Reporting by Gavin Jones and Giuseppe Fonte in Rome and Anne Kauranen in Helsinki; writing by John Stonestreet)