Prodi fears attacks will undermine Italian economy

ROME, Oct 22 (Reuters) Prime Minister Romano Prodi defended his financing plans today, brushing off a debt downgrade and slide in polls while expressing concern a dispute over his budget could hurt Italy's ''psychological recovery''.

The centre-left leader said his 2007 budget plan, which has been watered down by his leftist coalition allies and criticised by rating agencies, business and the opposition, included ''loads of money to reduce the cost of labour and foment growth''.

But, as with his government's reforms to open up the service sector to more competition, Prodi told La Repubblica newspaper that the benefits had been eclipsed by ''the political game''.

''This is serious because Italy needs a psychological recovery at least as much as it needs structural reforms,'' said the former president of the European Commission.

Two ratings agencies downgraded Italian government debt this week citing the apparent inability of Prodi's government to cut spending and bring the budget deficit in line with the European Union's ceiling of 3 percent of gross domestic product.

The agencies echoed economists' criticisms that the budget does not include structural reductions in spending, relying too much on hopes of increasing fiscal revenue.

Prodi rules with a majority of only one seat in the Senate, leaving him vulnerable to demands of leftist coalition allies who, together with unions and local authorities, have forced the government to water down a 15 billion euro deficit-cutting plan.

The government now threatens a confidence vote on the fiscal reforms in the budget, possibly this week, and Prodi said that one way or another ''the budget's ability to heal the country's finances will not be affected''.

Structural economic reforms would merit ''their own laws and a debate in parliament'' separate from the budget, he said.

He blames the downgrade on overspending by his predecessor, the conservative leader Silvio Berlusconi, and asked ''why they didn't do it earlier, when the disaster was in full flow''.

With his popularity sliding in polls six months into the job, Prodi said he ''would like to see what government could gain popularity on the eve of heavy budget cuts like this''.

Recent polls have shown that even centre-left voters are not massively convinced by the budget, though they do approve of the income tax reforms which favour low-income workers and put more of a tax burden on the better-off.

This, plus a higher tax burden for small business, has mobilised middle-class resistance which is being whipped up by Berlusconi. He called Prodi a ''big liar'' at a rally yesterday meant to kick off a major offensive against tax reforms.

Media tycoon Berlusconi, Italy's richest man, has predicted the 2007 budget will be Prodi's downfall. The opposition is also relishing reports of serious infighting in Prodi's coalition.

But Prodi told the paper he was convinced of the ''serious, determined and earnest support'' of his allies and that the ''smell of conspiracy really emanates from the centre-right''.

Reuters DKA GC1701