By Giuseppe Fonte and Gavin Jones
ROME (Reuters) - The head of Italy's central bank on Tuesday warned the new anti-establishment government to be cautious with public finances to avoid upsetting financial markets and increasing public debt.
Bank of Italy Governor Ignazio Visco told a gathering of bankers in Rome that Italy's reform effort had petered out and that, if a new financial crisis should hit, it was now "much more vulnerable than we were 10 years ago".
The governing coalition of the 5-Star Movement and the right-wing League plans sweeping tax cuts and higher welfare spending, but Visco said nervousness on financial markets and Italy's huge public debt argued for a cautious approach.
"Prudence and far-sightedness are needed to avoid (market) tensions and to avoid leaving Italians with a higher debt and lower income in the future," he said.
Italy's public debt, at around 132 percent of national output, is the highest in the euro zone after Greece's.
Visco backed a plan to pool together Italy's small mutual banks - which the government has suggested it may suspend - saying the changes will make it easier for them to raise capital and avoid possible crises.
He also called for the completion of a reform passed by the previous government forcing the larger, so-called "popolari" or co-operative banks, to become joint stock companies.
Consolidation of the banking sector "remains the most efficient tool to address inefficiencies and guarantee access to capital", he said.
MOST SLUGGISH
Visco said the reduction of bad loans at Italy's banks was proceeding well, with the value of soured credit sold through a state guarantee scheme adopted in 2016 amounting to 32 billion euros, and expected to rise "significantly" in coming months.
Italy has been the most sluggish economy in the euro zone since the launch of monetary union in 1999. The coalition that took office last month says it will work to change Europe's fiscal rules to allow it to spend more on public investments, cut taxes and provide income support for the poor.
"There is certainly a need for public investments, to be chosen and implemented with maximum efficiency, just as there is a need for a broad and balanced tax reform," Visco said in his first remarks since the government came to power.
However, he added that such measures needed to be "administered with care" to avoid an increase in debt, and said "it would be risky to rely only on them in an effort to get out of the low-growth trap Italy has been in for so long".
Economy Minister Giovanni Tria, an academic who is not a member of either ruling party, has promised the government's program will be implemented gradually, while keeping public accounts in order and reducing the debt burden.
However, speaking at the same conference as Visco, he said boosting growth was "no less important" than meeting public finance targets, and promised to fight against any euro zone reforms that penalized Italy.
He said that "the time is ripe for a sharing of risks" to strengthen the euro zone's banking system, and that it was a "mistake" to subordinate the need for risk-sharing below risk-reduction - a reference to the approach favored by Germany.