DURING an informal lunch with the Foreign Press in Rome last month, Italian Prime Minister Mr Romano Prodi was quizzed on alleged German reservations about Italy's inclusion in the European Monetary Union (EMU) start up.

The affable Mr Prodi, himself an economics professor and former head of Italy's huge state holding company, IRI, smiled benignly and said: "Look, you don't have to tell me that German public opinion doesn't want the lira in EMU. I know that, only too well. In fact, one of the reasons why I want to bring forward the 1998 Finance Bill to mid August is partly to offer further proof to German public opinion that we continue to be serious about getting Italy's economy into line with the Maastricht criteria".

Mr Prodi and his experienced Finance Minister, the former Bank of Italy governor and ex Prime Minister, Mr Carlo Azeglio Ciampi, know only too well that there are a lot of important people out there, including bankers and independent economists, who remain sceptical about Italy's ability to turn its back on years of wasteful public spending and sustain the long march up the steep and thorny path of fiscal rectitude.

In the four years following the lira's withdrawal from the European Union's Exchange Rate Mechanism (ERM) in September 1992, the Italian currency went on a Funderlandstyle big dipper ride that resulted in an effective devaluation of nearly 50 per cent. The Financial Times calculates that between September 1992 and April 1995 (the lowest moment), the lira fell 36 per cent on a "trade weighted basis". This statistic is of no small concern to Italy's two biggest trading partners, France and Germany, which both suffered from competitively priced Italian exports.

However, with the arrival of Professor Prodi at the helm, the listing Italian ship has apparently begun to right itself. The promises to "take Italy into Europe" and to put the lira back into the ERM formed a major plank in the campaign platform on which Mr Prodi led his centre left Olive Tree coalition to victory in the April general election last year.

At the time, such talk sounded well intentioned but unrealistic. The 1995 Italian deficit GDP ratio was 7.4 per cent, while the Maastricht criterion is 3 per cent. The 1995 State Debt GDP ration was 126 per cent, while Maastricht requires 60 per cent.

By the autumn, however, Mr Prodi and his government appeared to be giving it their best shot. A stormy bi lateral meeting with Spanish Prime Minister Mr lose Aznar in Valencia in September had finally convinced Mr Prodi that EMU would by now rather than later and he returned to Rome to seriously toughen his 1997 "austerity" Budget.

In the end, Mr Prodi forced a tough £25 billion pound package of spending cuts and tax hikes (including a one off "Eurotax" worth £4.8 billion) through parliament while in November the lira rejoined the ERM at a central parity figure of 990 to the Deutschmark, a figure that was probably more to the liking of France and Germany than of Italy.

With annual inflation now running at 2.6 per cent, the Bank of Italy last month cut its official discount rate to 6.75 per cent, the third such cut in the last seven months and one which brought Italian interest rates down to their lowest level for 21 years. (At 6.75 per cent, however, they remain among the highest in the EU).

Further good news for 1996 concerned a forecast growth figure of 0.8 per cent, while the government is confidently predicting a 2.0 per cent growth figure for 1997 (most independent economists would say this is optimistic). Best of all, last week the EU's statistics office, Eurostat, predicted that by the end of 1997 Italy's deficit GDP ratio would meet the 3 per cent Maastricht target.

The problem about this Italian "good news" is that it is all too late for some observers who argue that, while it is clear that Prime Minister Prodi is doing a good job, it is not certain whether he will be able to sustain the momentum.

In a recent interview, Bundesbank President Mr Hans Tietmeyer spelled it out loud and clear: "Today it is not just a question of reaching a ratio in which the deficit equals 3 per cent of GDP but also of sustainability, of those nations which have a sustainability culture. The question of sustainability is the crucial one". Mr Tietmeyer did not specifically name Italy but the reference was fairly obvious. His colleague, Mr Ulrich Cartellieri, a board member of Deutsche Bank AG, was less circumspect when speaking at the World Economic Forum in Davos, Switzerland last week, saying: "If Italy and certain other European countries are in, a time bomb is ticking within EMU. The fiscal success that the government in Rome has enjoyed recently cannot be maintained in the long run". "Sustainability" again, it seems.

Put simply, many bankers and economists argue that if Italy was included in the first wave of EMU countries, then Europe's new currency, the euro, would get off to a shaky start. In particular, the perceived unreliability of the lira could mean that the euro would be weak, leading to rising inflation and rising interest rates in Europe and prompting financial instability in world currency markets as well as a probable political row on the dollar euro exchange rate.

All of these reservations about Italy became even more public last week with the Financial Times' revelation that some sort of plot had been hatched by senior EU monetary officials to delay Italy's entry into EMU until the year 2000 or 2001 rather than at the January 1st, 1999, start up.

The newspaper alleged that this deal was a "face saving compromise" whereby Italy's initial exclusion would help guarantee a strong and stable euro while its inclusion before the introduction of euro notes on January 1st, 2002, would make Italy feel "more or less in".

Mr Prodi termed the report less of a compromise and more of an insult. He still hopes that his so far impressive track record, allied to a midyear deficit trimming mini budget worth £5.7 billion pounds and an anticipated 1998 Finance Bill will convince the sceptics.

For the time being, though, the jury on Italy is out. While bankers and economists have their reservations, politicians and diplomats argue that it is politically impossible to leave the world's fifth largest economy and a founder member of the European Union (remember the EU founding charter is called the Treaty of Rome) out of EMU.

Not only would the resultant Europe look dangerously divided but the immediate impact of exclusion on both Mr Prodi's political future (he has staked his colours to the EMU mast) and Italian public opinion would be devastating. Whether Europe likes it or not, Italy has to be allowed play with the big boys.