By Roberto Landucci
ROME (Reuters) - Italy's center right must push through justice reform or withdraw from the coalition government, Silvio Berlusconi told his People of Freedom (PDL) party on Friday after his conviction for tax fraud was upheld by the supreme court.
Just three months after center-left Prime Minister Enrico Letta took office at the head of an uneasy alliance with Berlusconi's PDL, the euro zone's third largest economy faces deep uncertainty that may further hinder efforts at reform.
Struggling to contain deep divisions over tax and economic policy, the coalition's lifespan may depend on when Berlusconi's party considers it most politically expedient to try to force an election.
"If there is no reform of the justice system, we are ready for new elections," Berlusconi told PDL lawmakers at a party meeting on Friday, according to a source who attended and who spoke on condition of anonymity. The media mogul and his supporters maintain the justice system is biased against him.
Five PDL government ministers told the party leadership they were willing to resign if needed, Senator Lucio Malan told reporters after the meeting, saying: "They entrusted their mandates to Berlusconi...We agreed to decide what to do in the coming days."
Yet how imminent a threat such talk may pose remains uncertain, with the 76-year-old billionaire apparently cautious about rushing into action before he is ready.
"Berlusconi said not to take any hasty decisions and to think of the interests of the country," PDL Infrastructure Minister Maurizio Lupi told reporters.
Officials at the meeting also said that senior party members may ask President Giorgio Napolitano to pardon Berlusconi - an idea the president rejected last month.
Letta repeated on Friday that Italy must have a stable government, saying the last thing it needs is to be worn down by partisan battles.
Berlusconi faces the threat of a year under house arrest or in community service as well as losing his seat in parliament over the first definitive sentence he has received in dozens of trials during his two decades in politics.
While he is unlikely to spend any time in jail due to his age, the verdict was an unprecedented blow and a Senate vote on expelling him from parliament could come in September.
He has declared he will continue his political activities under the "Forza Italia" (Go Italy!) name of his first party, with speculation growing that his daughter Marina may succeed him as party leader.
REFORM PROSPECTS DIM
The upheaval means the already dim prospects of significant reforms to revive Italy's stagnant economy and cut its massive debt have receded further.
Agreement over thorny issues such as privatizations due in the autumn, or the much-disputed IMU property tax which Berlusconi wants to scrap but which would blow a hole in already strained public finances, will be difficult.
"It depends on the PDL," Deputy Economy Minister Stefano Fassina, from Letta's center-left Democratic Party (PD), told Reuters.
"It's not something which can be settled in the next few hours but over the next few weeks, we'll have to settle the IMU issue and on an issue like this, it can't just be about Berlusconi's personal interests," he said.
Problems just as serious could also come from Fassina's own fractious camp, with many in the center-left unhappy at the prospect of remaining in alliance with a convicted tax evader.
To add to the problems facing Letta, Matteo Renzi, the ambitious young mayor of Florence, is widely expected to mount a bid to lead the party.
Letta said the situation was "politically very delicate" and called on all sides to show responsibility in the interests of the country. But he acknowledged there were limits to what was acceptable.
"I don't consider that continuing at any cost is necessarily in the interests of the country," he said.
For all the drama surrounding the sentence, financial markets have shrugged off the ruling at least for now, encouraged by the European Central Bank's guarantee to backstop countries that run into difficulty on the bond markets.
The main barometer of investor sentiment, the spread between Italian 10-year bond yields and their safer German equivalents, actually fell on Friday to 261 basis points from 270 the previous day.
Italy's blue-chip share index closed only slightly lower, although shares in Berlusconi's Mediaset media empire ended 2 percent lower.
But the calm could change if prolonged political instability fuelled doubts about Italy's badly strained public finances and created the kind of pressure that brought down Berlusconi's last government as the euro zone crisis peaked two years ago.
With Italy's stagnant economy showing the first faint signs of improvement after two years of recession, it can ill afford months of debilitating stalemate.
Claudio Aspesi, an analyst at research firm Bernstein, said markets anticipated little action during the August summer holidays but tensions would intensify once activity picked up after the break.
"In September this could reignite concerns on the government's survival and the repercussions for the economy," he said.
(Additional reporting Danilo Masoni, Francesca Landini, Francesco Canepa and Antonella Cinelli; Writing by James Mackenzie, Silvia Aloisi and Naomi O'Leary; Editing by Barry Moody and Michael Roddy)