Prodi's fall would be least of Italy's economic worries

ROME (Reuters) - Italy's growth prospects are weakening fast and, though Romano Prodi might tell you otherwise, they have little or nothing to do with the prime minister's desperate battle to keep his government afloat.

Prodi, whose survival depends on a vote of confidence in the Senate late on Thursday which he is expected to lose, told parliament before the vote that Italy could ill afford to lose him as the global economy threatens to slow sharply.

However, with his precarious multi-party coalition the 68 year-old leader has done little to improve the potential of the euro zone's third largest economy, which has been underperforming its peers for well over a decade.

"This government has been more concentrated on surviving than passing reforms, so it would be hard to see the fall of Prodi as a blow to the economy," Tito Boeri, economics professor at Milan's Bocconi University, told Reuters.

For Italian firms and consumers, inured to years of instability and weak government, high oil prices, a strong euro and the prospect of recession in the United States are more worrying than the fall of yet another government.

Employers' confederation chief Luca di Montezemolo last month called Italy a "do it yourself country" which "hasn't been governed since it joined the euro".

Italian industrial output has fallen for three straight months, consumer and business confidence are at record lows and economists are cutting their growth forecasts almost by the week. The economy is now seen expanding only around 1 percent this year, maintaining Italy's role as a euro zone laggard.

This is not really Prodi's fault, or at least not much.

"Italy's growth prospects depend overwhelmingly on the international cycle," said Unicredit MIB economist Marco Valli.

"It has been underperforming the rest of the euro zone for years by roughly the same amount, regardless of which government has been in power, and that is likely to continue."

LONG-STANDING PROBLEMS

That doesn't mean economic management is irrelevant, but it would need a determined, cohesive government to tackle long standing problems like poor infrastructure, an under-qualified workforce, stagnant productivity and a low employment rate.

Prodi's 9-party, Catholic to communist coalition has never fitted the bill as it has bickered its way from crisis to crisis during its 20 months in power, keeping Prodi in constant negotiations to preserve his wafer thin majority in the Senate.

Its main reforms have been some modest service sector deregulation which analysts said would only help growth as the first step in a long-term project, but which soon petered out.

Bank of America analyst Holger Schmieding said markets were watching Italy's crisis but were unlikely to react to it much.

"Markets weren't expecting much in terms of economic reforms out of Italy anyway so the alternatives are not very scary compared with what has been happening," he said.

"Markets don't like uncertainty, but I wouldn't advise any client to change his asset allocation on Italy until it's clear what comes next."

DEFICIT RISK

Analysts said Prodi's demise carried risks but was not necessarily bad news, and were sanguine about the widely aired possibility of a brief, interim government charged with reforming Italy's complicated and ineffective electoral system.

"What follows Prodi could be better, but unless we change the electoral system we risk a divisive election campaign which could easily produce another equally fragile, divided government," Boeri said.

The risks regard public finances. Even here Prodi gets far from top marks but, thanks to his efforts to curb tax evasion, he has done better than his predecessor Silvio Berlusconi.

Despite some tensions with Brussels over the pace of fiscal consolidation, the budget deficit last year fell below the European Union's 3 percent of GDP ceiling for the first time since 2002 and public debt returned to a downward trend.

"Prodi has failed to get a grip on spending and the 2008 budget will actually raise the deficit compared with the underlying trend, but what he has done is get more Italians to pay their taxes," said Boeri.

"It would be worrying if whoever takes over shows less commitment in that regard."