UPDATE 2-Italy's Tria seeks to avoid VAT hikes without widening deficit

Italy's government will consider measures that would enable it to avoid implementing an unpopular hike in value-added tax (VAT) next year without widening the budget deficit, Economy Minister Giovanni Tria said on Wednesday. Italy, whose public debt is proportionally the highest in the euro zone after that of Greece, is struggling to keep its finances in check while honouring the costly promises made by the populist ruling coalition.

Any sign the coalition is losing control of the public finances would be likely to increase the country's borrowing costs, which Tria said were "still too high". "We will evaluate alternative measures. Everything we do will have to confirm the compatibility of the budget objectives. This is very important," Tria told a parliamentary hearing when asked about the government's plans on VAT.

The government this month raised this year's deficit target to 2.4 percent of gross domestic product from a 2.04 percent goal set in December after a drawn-out tussle with the European Commission, giving it slightly more room for spending. Next year it targets a 2.1 percent deficit, but that factors in some 23 billion euros ($26 billion) of expected revenue from a sales tax hike that coalition leaders have vowed to avoid - without clarifying where else they will get the money from.

Without the VAT hikes, the deficit would widen to 3.4 percent of GDP and breach European Union budget rules, the Bank of Italy said on Tuesday, a warning that sent Italian bond yields higher. Benchmark 10-year Italian government bonds currently trade at a yield of around 2.6 percent, below a peak of 3.8 percent in October but above the sub-2 percent levels last seen before the government was formed last May.

"Government plans, the incisiveness of the reforms, and parliament guidelines on budget policy will be important" to reduce interest rates, Tria told the hearing on the government's 'DEF' multi-year planning document. He appeared to be calling for caution ahead of a parliamentary discussion on the DEF starting on Thursday, where the ruling parties may seek wider deficit goals.

After Tria spoke, the leaders of the ruling League and 5-Star Movement reiterated that they would not allow VAT to rise. Tria also said that the public debt, which is expected to increase this year to 132.6 percent of GDP from 132.2 percent in 2018, is fully sustainable even with slower economic growth.

Italy's economy showed encouraging developments in the first two months of this year, he said, adding that the government's forecast 0.2 percent growth rate implied a slight recovery in the first half, followed by a stronger pick-up. GDP fell 0.1 percent in the third and fourth quarters of last year, putting the euro zone's third largest economy into a technical recession. (Writing by Maria Pia Quaglia, Giuseppe Fonte and Gavin Jones, editing by John Stonestreet and Hugh Lawson)

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