By Giselda Vagnoni
ROME (Reuters) - Italy's ruling parties want to spur economic growth by setting next year's budget deficit target at more than two percent of annual output, a level that clashes with European Union commitments and may boost the country's mammoth debt.
Earlier this month, Economy Minister Giovanni Tria reassured the European Commission he would stick to goals that would improve public finances, including cutting Italy's structural deficit, which is adjusted for economic cycles and one-off spending or income, and lowering debt.
But Tria, an academic and member of neither ruling party, is locked in a tug-of-war with the anti-establishment 5-Star Movement and the right-wing League, who want major spending on their flagship campaign promises amid flagging growth.
"I think we can even breach the 2 percent level on condition we do it not to fund demagogic measures but to put the country on a growth path," Cabinet Undersecretary Giancarlo Giorgetti, a prominent member of the League, said in a television interview on Wednesday night.
To improve the structural deficit even slightly, Italy's headline deficit probably needs to stay between 1.5 and 1.7 percent of gross domestic product (GDP), EU officials and economists have estimated.
Italy's public debt, at about 132 percent of GDP, is the highest in the EU after Greece.
Tria wants to keep the 2019 budget deficit at 1.6 percent of GDP, according to a government source, while sources from the 5-Star and League have told Reuters they want it as high as 2.5 percent and not below 2 percent.
Tria stuck with his prudent line on Thursday, telling parliament he would "ensure a gradual implementation of our economic policies, which are compatible with the need to guarantee the equilibrium of our structural budget".
Prime Minister Giuseppe Conte, another former academic who is close to 5-Star but is not a member of either party, told reporters at an EU meeting in Austria that the budget "must send a message we are keeping public accounts in order."
Neither Conte nor Tria gave a figure for next year's deficit target.
Tria has to set growth, deficit and debt targets for next year's budget by Sept. 27. A slowing economy is making the government's task harder.
The economy ministry sees growth at 1.2 percent this year, compared to an April forecast of 1.5 percent, and at 0.9 percent next year, calculated on the basis of current legislation, compared with 1.4 percent previously, sources close to the matter told Reuters on Thursday.
Italy, like all other euro zone countries, will have to submit its draft budget for next year by mid-October. The Commission could reject it if it decides it is out of line with rules, a power the EU executive has so far never used.
But markets have been unnerved by the debate, with Italian bond yields widening and falling according to the tone of daily comments from the ruling parties, which took power in June.
Yields have trended down in recent weeks due to confidence that Tria will keep a lid on the deficit, but they jumped on Thursday after 5-Star leader Luigi Di Maio seemed to hint his party may even quit the government over the budget.
"If we don't find the resources (to fund promised measures) it's better to go home. It's useless to just chug along," Di Maio said in a radio interview.
"I'm fully aware what it means to increase the deficit and what can happen in the markets, and that's why we won't hike the deficit to give bonuses but to fund a credible plan for the growth of the country," Di Maio said.
(Reporting by Giselda Vagnoni, Additional reporting by Luca Trogni in Milan and Giuseppe Fonte and Gavin Jones in Rome, Editing by Steve Scherer, Gareth Jones, William Maclean)