Italy defends budget as EU warns of "unprecedented" rules breach

By Francesco Guarascio

BRUSSELS (Reuters) - Italy's Prime Minister defended its free-spending budget on Thursday, brushing off criticism from Brussels as the European Commission stepped up pressure over a draft it labelled an unprecedented breach of EU fiscal rules.

Giuseppe Conte also faced discontent over the 2019 fiscal plan at home, calling a meeting of the government for Saturday to stave off an emerging internal rift over conditions of a partial tax amnesty.

The draft, signed off by Italy's cabinet on Monday, will hike the deficit at a time when EU regulations say it should be falling, boost welfare spending and cut the retirement age.

In the first formal step of a procedure that could lead to Brussels rejecting the budget and to fines against Italy, the Commission sent Rome a warning letter on Thursday.

The document said the budget appeared to be in "particularly serious non-compliance" with EU rules as its deviation from targets was "unprecedented", and gave Rome until Oct. 22 to respond.

EU officials stressed they were seeking Italy's reply and changes to the draft budget before taking any further measures. "We have time," economic commissioner Pierre Moscovici told a news conference in Rome after he handed the letter to Italy's Finance Minister Giovanni Tria.

Conte said Italy was ready to reply to the commission's concerns but he was not worried by the letter. He did not think Italy's deviation from targets was large, and expected the Commission to send similar letters to Spain, France and Portugal.

"Italy's is a case apart," an EU official told Reuters, adding that letters to other governments will only warn against possible budget risks.

Conte called the budget "beautiful", having said on Wednesday on arriving for a two-day EU summit that he saw no room for changing tack on it.

If it is not amended, the Commission could reject the draft by Oct. 29 in what would be an unprecedented move that could further rattle financial markets..

The gap between Italian and German 10-year bond yield spreads hit its widest level in 5-1/2 years after news of the Commission letter broke.

COALITION SPAT

Other EU leaders also warned Italy about the budget, some in public and others behind closed doors, as Conte laid out the plans - an unusual move at an EU summit..

Before the meeting, Austrian Chancellor Sebastian Kurz said fiscal rules should be respected by all.

Dutch Prime Minister Mark Rutte said on Twitter he had expressed his concerns to Conte on Thursday, and that the Commission had the Netherlands' full support in making sure EU fiscal rules were respected.

In what could be a further source of concern at home, Deputy Prime Minister Luigi Di Maio, leader of the 5-Star party, said on Wednesday a legislative text on a partial tax amnesty had been "manipulated" before its final approval, raising doubts about the stability of Italy's coalition government and about the budget's revenues.

The anti-establishment 5-Star has always opposed amnesties - a frequently used policy in Italy where people or companies can avoid being pursued for tax dodging by paying a fee. Its coalition partner, the far-right League, favours amnesties, which bring money into the treasury and are popular with voters.

Di Maio said on Thursday the dispute needed to be sorted out because it was upsetting financial markets.

Asked by reporters about the coalition rift, Conte - who is not from any political party - replied: "There is no division".

But later in the day, he told a news conference he had called a government meeting for Saturday to overcome political differences over the text.

(Reporting by Francesco Guarascio; additional reporting by Gavin Jones in Rome and Jan Strupczewski in Brussels; Editing by John Stonestreet)