EU seeks clarification on Italy's breach of debt-cutting goals

By Steve Scherer ROME (Reuters) - The European Commission has asked Italy to explain why its draft budget for next year will breach debt-reduction goals it promised the European Union, a step that may lead to demands from Brussels for changes to the spending package. Italy's 2015 budget proposal showed a "significant deviation" from its previous plan for achieving a balanced budget in structural terms, or adjusted for the effects of the business cycle, according to a letter from incoming Jobs and Growth Commissioner Jyrki Katainen released on Thursday. Italian Prime Minister Matteo Renzi took a risk with Brussels last week when he set out 18 billion euros (14.20 billion British pounds) in tax cuts in next year's draft budget and pushed back a target date for achieving a structural balanced budget by a year to 2017. In the letter to Economy Minister Pier Carlo Padoan and published on the ministry's web site, Katainen also said he wanted "to know how Italy could ensure full compliance with its budgetary policy obligations" in next year's budget. Renzi defended his tax-cutting efforts and downplayed drama over budget cuts worth a few "decimal points" of gross domestic product when he arrived at a meeting of EU leaders in Brussels on Thursday. Italy can easily cut an additional 2 billion euros from its deficit next year if needed, he said. Renzi is campaigning, with the support of France and other struggling states, to shift the focus of European budget policy away from austerity as he seeks to rekindle Italian growth with tax cuts after three years of stagnation. France has also submitted a draft budget that breaks its pledge to bring its deficit within EU limits in 2015. The problematic budget is the second time in two years France has failed to keep a budgetary promise. Outgoing commission President Jose Manuel Barroso would not confirm the commission had sent similar letters to France and three other member states, adding that the commission "was not in favour" of Italy making its missive public. However Renzi, a formidable political communicator who relishes taking on opponents, dismissed his concerns. "The era of secret letters from this building is over," he said as he entered the EU council headquarters ahead of the summit. "It's time for total transparency." The issue of Europe's economic policy mix will come up when the 18-nation euro zone leaders meet over lunch on Friday in Brussels, but Germany, the region's biggest economy, has so far held fast against deficit spending as an expedient to growth. DEBT CRISIS Italy, the euro zone's third-largest economy, teetered near default in 2011 as Greece, the only country in the region with a bigger debt as a percentage of output than Italy's, received an international bailout. The debt crisis prompted the EU to adopt more stringent budget rules, some of which are being applied for the first time this year. If the commission is not satisfied with Italy's response, it can demand budget changes by the end of the month. In recent days, a number of EU sources have said that Italy's budget plans risked rejection, although the issue has been complicated by the impending handover to a new European Commission on Nov. 1. Barroso told reporters that he believes the "very difficult economic situation" justifies allowing "the maximum amount of flexibility" in applying the budget rules, "and I'm sure the incoming commission will feel the same way". In the letter, Katainen, who is a member of both the old and new commission, said he is seeking "a constructive dialogue with Italy with the view to come to a final assessment", and requested a response to his queries as soon as Friday. In its latest economic bulletin, published on Thursday, the Bank of Italy said that Italy's move to slow its debt reduction was "justified" by the poor growth outlook. It predicted the country would slide into recession in the third quarter for the third time in six years. (Additional reporting by Adrian Croft and Francesco Guarascio in Brussels and James Mackenzie in Rome; Editing by Larry King)