By Naomi O'Leary

ROME (Reuters) - The governor of Italy's Lazio region resigned on Monday over a corruption scandal that could increase political instability in debt-plagued Italy before elections due next year.

Italy's regions, which largely control significant areas of spending including health, are under scrutiny as the government of Prime Minister Mario Monti tries to enforce spending cuts to ease one of the major debt crises afflicting the euro zone.

Allegations of embezzlement of party funds largely involve members of Silvio Berlusconi's People of Freedom (PDL) party and risk tarnishing both the group and the former prime minister, who has hinted he may seek re-election in the spring.

PDL member Renata Polverini gave in to massive pressure to resign on Monday after allegations that members of her regional government had embezzled and misused party funds. Polverini said that she had done nothing wrong.

"It's the first time since 1970 that a governor who has done nothing wrong has resigned. But I do it with my head held high," Polverini said.

The scandal erupted earlier this month when the regional chief of the PDL, Franco Fiorito, was placed under investigation on suspicion of sending party funds into his own accounts overseas. In Italy, most party funds are provided by the state.

The case, which is reminiscent of the scandals that wracked the former Berlusconi government, has sparked public outrage in an Italy weary of public spending cuts and high unemployment.

Fiorito has offered to give back 400,000 euros ($516,600)after documents seized by investigators and leaked to Italian media showed that party funds paid for a Sardinian holiday, a BMW car and shopping at luxury fashion brand Gucci.

The documents also indicated that 750,000 euros were sent to his own accounts in Italy and overseas and that more than a million were put down as "non specified" expenses.

BAD BEHAVIOUR

The portly Fiorito, who has since resigned, fought his portrayal as the villain in the story by telling investigators that fellow party members had behaved worse than he did, which helped turn the spotlight onto Polverini.

"I have never had a credit card, neither have my co-workers, and no one has made payments with a Lazio Region credit card. Neither have they made cash withdrawals," Polverini said as she resigned, blaming opposition politicians for making baseless allegations.

Before her resignation Polverini began a belated austerity campaign, putting up posters around the Lazio region - which includes Rome - and announcing that she had saved 26 million euro via cost-cutting measures.

Aside from expenses, members of the Lazio regional assembly earn around 13,000 euros a month, more than ten times the average salary in Italy, in return for which they sat for 52 days in 2011 and passed 13 bills this year.

The case compounds political uncertainty ahead of elections, due in spring next year. A similar corruption scandal forced the resignation in April of the head of the Northern League, a coalition partner of the previous Berlusconi government.

Apart from Lazio, members of the Campania and Lombardy regional governments are under investigation for alleged misuse of public funds. ($1 = 0.7743 euros) (Editing by Mark Heinrich)