ERM Realignment: Devalued lira gives EC a breathing space: Italy told 'good times are over'

A HUGE SIGH of relief will be breathed by the Italian government and monetary circles if last night's realignment within the European monetary system succeeds today in calming the tempest which has been battering the lira.

The realignment follows two weeks of high tension in which the Bank of Italy increased the discount rate by 1.75 to 15 per cent and bled its resources to keep the lira within its limits against the deutschmark, and in which nothing - not even demands by the Prime Minister, Giuliano Amato, for special powers to steer the economy - seemed to restore confidence in the Italian currency.

The sobering experience can only have brought home at last to even the most carefree Italians that their economy is in serious trouble. It has given industrialists, politicians and commentators the opportunity to warn that the years of irresponsibility by the government parties, in which public spending was allowed to soar far beyond the country's means and the state deficit to run out of control, had to end.

Mr Amato warned Italians on television last night that the respite afforded by the realignment would only help Italy if the government's calls for massive spending cuts were adhered to 'even more severely' than before. His main targets are pensions and health spending - respectively the most generous and the most wasteful in Europe - the cumbersome and inefficient civil service; regional administration, and tax evasion, a national pastime.

The fate of his demand for special powers to take urgent fiscal and other measures if the situation on the international money markets should endanger the economy remains uncertain. The political parties, including those that support his government, are unwilling for parliament to relinquish control, and President Oscar Luigi Scalfaro has indicated he will not sign anything unconstitutional. Undeterred, Mr Amato has repeated his demand, arguing that the Bank of Italy can react to a situation immediately by changing interest rates while the government is forced to go through long parliamentary procedures.

It was not immediately clear whether Italian interest rates would now go down. It had initially been assumed that they would stay high until after the French referendum on Maastricht next weekend, which in itself would decide the future course of the lira. A 'no', the thinking went, would be the disastrous end of monetary union and the straitjacket which would force the Italians to take the unpalatable measures necessary to keep in line. A 'yes' would be welcome but concerted action by other European central banks to prop up the lira would doubtless end.

With this in mind, Italy's industrialists in particular have been demanding drastic measures within the next two weeks, to convince the markets that the government is really going to cut the deficit and reform the economy. Otherwise the choice for industry, said one, 'is between a slow death and a quick one'. In comments on television after the announcement, Mr Amato indicated that he feared the relaxation of pressure on the lira might be seen as a sign that Italy could be less serious about cutting costs. 'We must reinforce these measures,' he said.

The Prime Minister sought to reassure the public that the realignment would make little difference to them individually. It would not lead to greater inflation, he said, because the root of Italian inflation lay in internal problems and not in its relationships with other countries.