Italy parliament rejects ESM reform, irking Brussels

By Giuseppe Fonte and Angelo Amante

ROME (Reuters) -Italy's lower house of parliament voted on Thursday against a long-awaited reform of the euro zone bailout fund, throwing into doubt ratification of a European Union treaty that is designed to provide help for failing banks.

The vote confirmed the deep hostility within Prime Minister Giorgia Meloni's ruling coalition to the overhaul of the so-called European Stability Mechanism (ESM), which has been approved by all other euro zone countries bar Italy.

Paschal Donohoe, president of Eurogroup of euro zone finance ministers, said he regretted the outcome and would continue to engage on the issue with the Italian authorities in the coming months.

"The finalisation of the ESM Treaty reform is a key element of our common safety net in the euro area, to the benefit of all euro area member countries," he said in a statement.

The vote will prevent parliament from approving the same reform text in the next six months, Ylenia Lucaselli, from Meloni's nationalist Brothers of Italy party, told reporters.

A source in Meloni's office said the rejection could provide an opportunity for the EU to consider changes to the ESM more in line with the euro zone's needs.

Meloni and Economy Minister Giancarlo Giorgetti were not in the chamber on Thursday for the debate and subsequent vote, which saw approval for the ESM defeated by 184 votes against to 72 in favour, with 44 abstentions.

Brothers of Italy party and Giorgetti's League both voted against, whilst the other main coalition group, Forza Italia, abstained. The opposition 5-Star Movement, headed by former Prime Minister Giuseppe Conte, also opposed the motion.

Deputy Economy Minister Maurizio Leo, from Meloni's party, told reporters parliament was sovereign and the government had to recognise its decision.

DEBT RESTRUCTURING FEARS

The ESM can offer a lifeline to euro zone governments cut off from markets, or recapitalise banks and provide precautionary credit. However, many Italian parties fear the pact could trigger a restructuring of Italy's huge public debt.

The original ESM remains operational, but it cannot support the Single Resolution Fund (SRF), responsible for dealing with ailing banks, without Rome signing up to the deal.

"It remains regrettable that we have not been able to deliver on setting up the SRF backstop, an important milestone towards completing the banking union in the EU," Donohoe said.

Meloni's top aide Giovanbattista Fazzolari said Italy's interests came first.

"Our banking system is among the most solid in Europe and the whole world and we don't need to modify (the ESM treaty) to save other countries' big banks," he told RAI state television.

Meloni has repeatedly criticised the ESM for requiring countries to implement austerity or financial reform programmes in return for its help, saying this would increase the risk of a debt restructuring.

The ESM vote came the day after EU member-states clinched a deal on more lenient fiscal rules. Meloni said the new-look Stability and Growth Pact was better than the old one but she was disappointed it had not excluded strategic investments from countries' deficit and debt calculations.

The Italian government indicated earlier this month that it would not approve the ESM treaty unless there was first an agreement on the stability pact.

"They got it all wrong on the Stability Pact and now to cover up the failure they reject the ESM," said Giuseppe Provenzano, a lawmaker with the centre-left opposition Democratic Party.

(Reporting by Giuseppe Fonte and Angelo Amante; Editing by Jonathan Oatis and Gavin Jones)

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