* EU executive asks Italy to explain deteriorating public finances
* Rome has time until Friday to replay
* Move could lead to start of EU disciplinary action next week
* Dispute worsened after Salvini gains in EU vote
The European Commission wrote on Wednesday to the Italian government asking it to explain a deterioration in the country's public finances, a move that sets the stage for a possible legal clash with the eurosceptic coalition in Rome.
The letter, signed by economic commissioners Valdis Dombrovskis and Pierre Moscovici, was sent the day after Italy's far-right Deputy Prime Minister Matteo Salvini called EU fiscal rules obsolete and urged the European Central Bank to guarantee the debt of euro zone states.
Applying the rules that Salvini wants to change, the EU executive asked Italy to explain why its huge debt went up last year instead of falling, as required.
The procedural move was exceptionally delayed until after last week's EU elections, where Salvini's League emerged as a big winner, although eurosceptic forces remain a minority in the new European Parliament.
If Rome does not provide by Friday sufficient explanation for its growing debt or accepts that it must limit its spending plans this year, the Commission is likely to formally launch disciplinary steps next week, EU officials said.
Salvini's League is the junior partner in the Italian administration led by the anti-establishment 5-Star Movement, but after the League won a third of Italian votes in Sunday's EU poll, the government seems bound to adopt his hardline stance.
On Tuesday, Prime Minister Giuseppe Conte, who was selected by the 5-Star Movement, backed Salvini's calls for a new role for the ECB in guaranteeing large public debts -- a position that is anathema to Germany and most other euro zone countries.
Salvini insists that Italy should cut taxes to boost growth, rather than abide by fiscal rules that could hamper activity.
INEVITABLE WARNING
The EU's letter is a legal obligation under EU law and is sent when countries do not abide by agreed fiscal targets, which require them to keep the headline deficit below 3% of gross domestic product and to cut debt if it is above 60% of output.
Similar letters were sent on Wednesday to France, Belgium and Cyprus. Each country will be assessed individually, with different conclusions on the following steps.
Italy's situation appears the most complicated.
Its national debt rose from 131.4% of GDP in 2017 to 132.2% in 2018 and will go up to 133.7% this year and to 135.2% in 2020, according to Commission forecasts.
To make matters worse, the country's structural deficit, which under EU law should shrink by 0.6% of GDP a year until it is in balance, has instead been rising every year since 2015.
Italy narrowly escaped EU disciplinary action last year for its 2017 fiscal outturn and was exceptionally allowed to keep its 2018 structural deficit unchanged instead of reducing it.
But new figures released in April showed the country's structural gap had worsened last year and will continue deteriorating in 2019 as the government pursues free-spending policies which have so far had little impact on growth.
Although the numbers seem damning for Italy, EU rules give the Commission a broad margin of discretion when it issues its assessment on June 5.
In its conclusions, Brussels will take into consideration ‘relevant factors’ that Italy deems may have contributed to the deterioration.
If they are considered insufficient, the Commission will start disciplinary action that could end in a fine of 0.2 percent of Italy's GDP -- around 3.5 billion euros ($3.9 billion)-- if Rome repeatedly ignores EU calls to put its finances on a sustainable track. But this would take a long time and is politically unlikely.
European Union finance ministers would have to formalise the opening of the procedure in a meeting on July 8-9, if the Commission recommends it.
European Central Bank Vice President Luis de Guindos warned on Wednesday that Italy risked higher borrowing costs that would damage the economy and outweigh any benefits from higher spending if it did not respect EU budget rules.
