By Alessandra Galloni and James Mackenzie
ROME (Reuters) - Italy's president began talks on Sunday to pull the country out of a new political crisis, attempting to undercut a move by former Prime Minister Silvio Berlusconi to bring down the government and force new elections seven months after the last vote.
For the third time since 2011, Italian President Giorgio Napolitano is trying to steer the country out of political chaos that has proven a major threat, not only to the euro zone's third-largest economy, but to the region's efforts to halt its four-year debt crisis.
The latest turmoil was set off on Saturday when the five Cabinet ministers who are from Berlusconi's party suddenly stepped down, leaving the government only formally in place.
The resignations were set off by clashes at a Friday Cabinet meeting over an imminent sales tax hike. Tensions have been running high in Prime Minister Enrico Letta's uneasy coalition of left and right parties ever since last month, when Berlusconi, who is a member of Parliament, was convicted of tax fraud. Lawmakers must vote on whether to oust him.
Letta will go before parliament on Wednesday and hold a confidence vote to verify what is left of his parliamentary backing. He has a commanding majority in the lower house, and if he can gain support from a few dozen senators among dissenting Berlusconi followers or opposition parties, he could form a new government. But if he doesn't find support - and Napolitano does not try to form a transition government - then Italy would find itself quickly back at the polls.
In a television interview on Sunday evening, Letta said he sensed that there might be rebels within Berlusconi's People of Freedom Party. "I hope that there is a part of the PDL which is not in accord with Berlusconi," he told RAI television.
Over the weekend cracks appeared within Berlusconi's PDL. While Berlusconi said he wanted to go straight to elections, other center-right politicians voiced more caution and said Saturday's resignations were an extreme act. One longtime Berlusconi loyalist, Fabrizio Cicchitto, expressed rare dissent over the way Berlusconi had withdrawn his ministers without party consultation.
Napolitano has reiterated that he would only dissolve parliament as a last resort.
The political jockeying that will ensue will inevitably take Rome's attention off the important structural reforms that Italy needs to adopt in order to cure its economic ills and become a stronger player within the European Union. Italy is emerging from the worst recession since World War Two.
Two years ago, Italy risked taking the euro zone's debt crisis to a boiling point, when its borrowing costs soared because of a lack of confidence that the then-Berlusconi government could bring down the country's 2 trillion euro debt. Berlusconi's resignation in 2011 ushered in a technocrat government led by former European Commissioner Mario Monti, who pushed through some key economic changes, notably a pensions reform.
But political chaos gripped Italy again this year when no clear winner emerged from February elections and a quarter of the popular vote went to the anti-establishment Five-Star Movement. To end the stalemate, Letta's unusual coalition government was formed at Napolitano's behest.
Since 2011, the European Union has adopted several policies aimed at preventing a repeat of the debt crisis. Notably, a pledge made in September 2012 by the European Central Bank that it would step in to avoid another flare-up has eased investor concerns about the solidity of the euro zone.
However political instability has cost Italy dearly. The country's borrowing costs hit a three-month high at an auction of 10-year bonds on Friday, while the premium investors demand to hold Italian debt rather than German paper widened to about 267 basis points from under 250 at the start of the week.
In an interview on Sunday, Labour Minister Enrico Giovannini said he expected financial markets to be rattled on Monday by the latest political developments. Giovannini said the volatility need not last if there is a quick resolution to the crisis.
"If instability were to persist and affect the euro zone, then international authorities could put much stronger pressure on" Rome, Giovannini said.
Berlusconi's shock move on Saturday came after the government's failure to avert a hike in the sales tax at a Cabinet meeting the day before.
Letta dismissed the motivation as a "huge lie," saying that Berlusconi, who celebrated his 77th birthday on Sunday, was acting out of fury at his expected expulsion from parliament following the tax fraud conviction.
The big risk of early elections is that - because of the current dysfunctional electoral law - it is likely that a vote would lead to a stalemate similar to the one that followed February's vote.
Letta said on Sunday that his government had already drafted proposals to change the law.
"We cannot vote with this current electoral law. We have to change it," he said.
(This story corrects name of Italian prime minister in paragraph 4)
(Writing by Alessandra Galloni; Editing by Stacey Joyce)