Italy approves deficit-hiking budget, awaits EU's verdict

By Giuseppe Fonte and Angelo Amante

ROME (Reuters) - The Italian cabinet on Monday signed off on an expansionary 2019 budget, boosting welfare spending, cutting the retirement age and hiking the deficit to set up a showdown with authorities in Brussels over compliance with EU rules.

The government of the right-wing League and the anti-establishment 5-Star Movement had already issued the financial framework for the budget, raising the target for next year's deficit to 2.4 percent of gross domestic product.

That is comfortably below the EU's 3 percent ceiling, but up sharply from a targeted 1.8 percent this year, unnerving financial markets and contravening EU regulations that call on Italy and similarly highly indebted countries to narrow the deficit steadily towards zero.

So far, the reaction from Brussels has been irate, with EU commissioners threatening to reject the package before formally receiving it, and triggering a war of words with Rome.

The Commission will now assess the fiscal framework - a separate document from the budget law - over two weeks, and could dismiss it and ask Rome to draw up a new one. The EU executive has never taken this step since it was given beefed-up powers in 2013.

The League and 5-Star say they will not backtrack, arguing that their big-spending budget is needed to boost growth and tackle rising poverty in the euro zone's third largest but most sluggish economy.

"This budget keeps the government's promises while keeping public accounts in order," Prime Minister Giuseppe Conte told reporters after the cabinet meeting, flanked by his top ministers.

Its key measures include a basic income for the poor, a partial amnesty for citizens who settle tax disputes with the authorities, and tax cuts for the self-employed.

The Commission says the budget will push up Italy's public debt which stood at 131 percent of GDP last year, the highest in the euro zone after Greece's. It rejects Rome's argument that the package can lower debt by expanding the economy.

FEARS "UNFOUNDED"

Economy Minister Giovanni Tria said he was confident he could explain to the Commission that Italy needed to raise spending to offset a slowing economy, and described the 2.4 percent deficit target as "normal."

Italy's fiscal plans have pushed up the yield on Italian government bonds, raising borrowing costs for state coffers and creating fears of contagion for the broader euro zone, but Tria brushed off concerns.

"The idea that this budget can blow up Europe is totally unfounded," he said.

The 70-year old economics professor, unaffiliated to either ruling party, had pushed for a lower deficit target but was overruled by party chiefs, triggering reports that he planned to resign after the budget is approved by parliament. He denied this on Monday.

Five-Star leader and Deputy Prime Minister Luigi Di Maio said the basic income, his party's flagship policy which will cost some 10 billion euros (£8.8 billion) next year, will kick off before the end of March.

To help fund spending measures, the budget makes life harder for Italy's struggling banks, reducing the proportion of interest payments they can deduct from their taxable income.

While attracting international criticism, the budget is popular with Italians. A survey by pollster Demopolis on Friday showed 52 percent backed the plan, compared with 38 percent who gave it the thumbs down.

The spread between the yield on Italy's benchmark 10-year bonds and their German equivalent stood at just over 3 percent on Monday, broadly stable compared with the end of last week.

($1 = 0.8636 euros)

(writing by Gavin Jones; Editing by Richard Balmforth and John Stonestreet)