By Jan Lopatka
PRAGUE (Reuters) - Czech Vice Prime Minister Karolina Peake quit the junior ruling party on Tuesday, a move that could cost the austerity-minded coalition its parliamentary majority although she pledged to keep supporting government policies.
Prime Minister Petr Necas will hold talks with Peake to safeguard a clear majority in parliament, the CTK news agency reported, given that her move split her Public Affairs party and she plans to set up a new political faction.
A government fall would likely bring early elections and a centre-left cabinet that would raise taxes for top earners and firms to meet fiscal targets while pursuing a more pro-European policy than the mildly eurosceptic Necas.
Prague's centre-right government has pleased investors and rating agencies with steps to cut the budget deficit to the European Union's 3 percent limit in 2013 or even this year, although some analysts say growth will suffer.
With a debate raging in the debt-ridden euro currency zone over whether austerity or growth can lead the way to recovery, the vast majority of economists have applauded Prague for its approach. The Czech Republic remains outside the euro zone.
Peake, in a nod to concerns for the government's fate, said she would continue to back its coalition agreement and was open to cooperating with other deputies from her party.
Peake stopped short of saying she would leave her cabinet post and said she would speak to Necas about her situation on Wednesday at a government meeting. "I am setting up a new political platform and I will gladly offer them (current Public Affairs deputies) to cooperate," she told reporters.
The scandal-ridden Public Affairs party has been torn by infighting that almost brought about the three-party government's collapse earlier this month.
Peake was on the side of those wanting to preserve the coalition, to which the party eventually agreed last week, although internal feuds with her rivals have continued.
She wants to set up a new faction of up to 10 of Public Affairs' 21 deputies that would be enough for the government to preserve a majority even if the rest of Public Affairs' representatives left the cabinet.
Peake said she had no list of deputies that may follow her, although Czech media said two deputies had opted to do so.
Political commentator Jindrich Sidlo said Peake may already have secured enough votes to keep the cabinet afloat. "I think that having made this step, she must have well counted the votes she can bring into the coalition over the required 100."
The two other parties in the government control 93 seats in the 200-seat parliament.
AUSTERITY PAINFUL BUT VITAL - KALOUSEK
Separately, Finance Minister Miroslav Kalousek said one would have to be a "psychopath" to relish downsizing the Czech Republic's public sector, but failure to do so now would lead to Greece-style unrest in only a few years.
Lauded by investors for slashing Prague's public finance deficit, Kalousek has also caused some economists to scratch their heads over his faster-than-planned pace of fiscal tightening, which has hurt an economy already in recession.
Speaking at an economic forum in Prague, he spelled out his reasoning: markets would punish any country that failed to rein in debt and deficits by driving up bond yields to unaffordable levels and kicking off the fiscal death spiral seen in Greece.
He said a package of tax hikes and spending cuts approved last week to trim the deficit to 0.9 percent of gross domestic product by 2015 had put the Czechs ahead of other EU states.
"None of the measures please us. Only a psychopath enjoys coming up with bad news," Kalousek said. "But this is... the news that makes it possible for us to finance Czech debt at below a level of 4 percent, an interest rate for which most of my colleagues (in Europe) envy me today."
Markets have responded. Czech 10-year bonds traded at a yield of 3.474/345 percent on Tuesday, far below the equivalent Italian bond's yield of 5.487/455 percent.
Kalousek said each percentage point more in bond yields would add 7 to 8 billion Czech crowns ($371.40-$424.46 million), or about 0.2 percent of GDP, to annual debt maintenance costs.
He and his ally, Necas, have pushed for three belt-tightening plans since coming into power in 2010, producing a 3.1 percent of GDP deficit last year in a big overshoot of an original 4.6 percent goal, and aiming to meet the EU's 3 percent ceiling this year, or a year ahead of plan.
But the measures have hammered their respective parties' popularity and hurt domestic demand helping trigger a small economic contraction in the second half of last year despite record performance in the country's dominant export sector.
The austerity push has angered voters. Unions have called a nationwide strike for Saturday to protest against the plan, including lower pension hikes and a number of tax rises. ($1 = 18.8475 Czech crowns)
(Additional reporting by Jana Mlcochova and Jan Korselt; Editing by Mark Heinrich)