Italy’s Berlusconi Reneges on Austerity Pact

Italy revokes €5 billion in planned austerity measures in order to appease regional political parties.

The Italian cabinet reneged on a promise to implement €5 billion worth of austerity measures this week in a move that is likely to trigger further market contention and meet the disapproval of other European Union member states.

Prime Minister Silvio Berlusconi agreed to cancel a proposed wealth tax as well as cuts in local government funding under pressure from members of his own coalition in the Lega Nord party, a separatist movement that is powerful in the industrious north of Italy.

When Italy’s creditworthiness was called into question this month, Rome hastily announced additional austerity measures in order to eliminate its budget shortfall altogether a year ahead of schedule, in 2013. In exchange, the European Central Bank in Frankfurt purchased Italian sovereign bonds in an attempt to reduce the country’s borrowing costs and prevent another European debt crisis.

The Berlusconi government had previously planned up to €48 billion in spending reductions with most cuts postponed until after the parliamentary elections of 2013. It promised to accelerate some of those plans and cut billions more between now and election year but that aim seems in jeopardy.

Europe’s central bank president Jean-Claude Trichet urged Italy on Saturday to agree to a deficit reduction package soon. “It is essential that the target that was announced to diminish the deficit will be fully confirmed and implemented,” he stressed.

The ECB spent €41.6 billion buying Italian and Spanish debt last month. Italy’s foreign minister said that his government would urge the bank to continue the bond purchase operation — something Trichet and his fiscal hawks are wary of.

The Italian treasury will be put to further test this September when €60 billion in redemptions come due.

Italy’s national debt amounts to more than 120 percent of its economy and is one of the largest among developed nations. Only Greece and Japan are more heavily indebted.

The third largest economy in the eurozone, Italy is far less competitive than Germany and other countries in the north. Cronyism, corruption and rigid labor laws constitute major impediments to growth. The judiciary is more political than is the case in most of the rest of Europe, forcing companies to often settle out of court while the prevalence of bribery and organized crime perpetuates a traditional imbalance between the industrialized north and the largely agricultural south of the country. Especially in the south, a high amount of economic activity is confined to the informal sector.

Due to its sheer size, its conservative banking industry and high level of personal savings, Italy should be able to stave off the specter of default but if there is a crisis of confidence, the country’s seemingly unstable political constellation can only deepen and prolong it.

The ruling party is beleaguered by corruption and scandals and may have to cope with a leadership vacuum if Berlusconi fails to stand for reelection two years from now. The leftist opposition, formally united in a single party since 2007, is easily scattered and generally opposed to spending reductions altogether.