Italy faces financial storm over Berlusconi: economist

Italy's Prime Minister Enrico Letta

ROME - Instability in Italy over Silvio Berlusconi's future could trigger early elections next year and punish the country on the financial markets starting this week, a top US economist warned on Monday.

Nouriel Roubini, who teaches at New York University, said in an interview with La Repubblica daily that Italy, the eurozone's third-biggest economy, was currently in a period of "controlled volatility".

He said that "if the situation worsens, which now seems hardly impossible, the consequences could be very damaging for Italy," and warned that investors could start reacting negatively from this week.

The Milan stock market was down 1.75 per cent in morning trading and the difference or "spread" between the rates on Italian and German 10-year bonds widened to 244 basis points (2.44 percentage points) - a sign of increased concern.

Prime Minister Enrico Letta's government needs to decide by Saturday at the latest how to reform a hugely unpopular property tax that Berlusconi's People of Freedom party wants scrapped altogether. Berlusconi supporters have said they could bring down the government if they do not get their way.

Many observers say the tax debate is a pretext for raising the pressure on political opponents to back off from Berlusconi, who faces expulsion from parliament because of a tax fraud conviction earlier this month.

"Our most probable scenario is elections in early 2014 but we do not exclude even sooner than that. The markets are reasoning in a similar way," Roubini said.

"If there is no solution, the spread will rise to 300 (3.0 percentage points) in a few days and the calm period for the Italian stock market will come to an end," he said.

"Bank stocks will be particularly hard hit and credit costs will continue rising. The sooner the elections, the worst the damage for bonds," he added.