The draft Economic and Financial document (DEF), which has been obtained by Reuters, raises the budget deficit forecasts for 2012-2014 and slashes this year's economic growth outlook.
Italy's budget deficit is already one of the lowest in the euro zone as a proportion of output and many economists say its chronically weak growth is more of a concern than fiscal slippage.
Under former Prime Minister Silvio Berlusconi Italy promised its European partners last summer that it would balance its budget in 2013, bringing forward the previous 2014 target to try to reassure markets as Italian bond yields surged.
Now Monti's technocrat government is poised to revert to the old 2014 target as the economy contracts sharply, weighed down by a series of austerity measures approved to accelerate deficit reduction.
Monti was hailed as a savior when he replaced Berlusconi in November as Italy appeared to be heading towards a Greek-style debt crisis, but his popularity is declining and his reforms are drawing rising criticism and resistance.
A similar move by Madrid earlier this year to weaken its deficit target sent yields on Spanish debt sharply higher. However, Spain's deficit is much larger than Italy's and is considered to be a bigger problem.
Monti still enjoys enormous credibility internationally and the revised deficit targets are unlikely to disturb markets that are now more concerned about the danger of excessive austerity, said Nicholas Spiro from Spiro Sovereign Strategy.
"Berlusconi could have promised a balanced budget this year and people would have just laughed, while Monti can promise it in three years and he is still credible," Spiro said. "I don't believe that a decision to be less aggressive on the fiscal front is a concern for a country like Italy."
The draft DEF raises the 2012 deficit target marginally to 1.7 percent of gross domestic product from 1.6 percent, while the 2013 goal is raised to 0.5 percent from 0.1 percent.
The nearly balanced budget, with a 0.1 percent deficit, is now targeted in 2014.
The economy is forecast to contract 1.2 percent this year, according to the document, compared with a 0.4 percent decline in GDP projected by Monti's government in December.
IMF MORE DOWNBEAT
Earlier on Tuesday the International Monetary Fund forecast that Rome would not balance its budget before 2017.
It said in its Fiscal Monitor report that the deficit would fall this year to just 2.4 percent of output and would stand at 1.5 percent in 2013, a full percentage point above the revised forecast in the draft DEF.
The IMF is also more downbeat than Monti on the economy, forecasting a steep contraction of 1.9 percent this year.
Despite its forecasts, the IMF urged Monti not to adopt additional corrective measures due to the weak economy.
The delay in the balanced budget goal contained in the DEF suggests that Monti is following this advice.
IMF Chief Economist Olivier Blanchard told reporters the government was pursuing the right policies to improve market sentiment and improve Italy's economic prospects.
Since taking office in November the former European Commissioner has passed a reform of the pension system, partially deregulated some professional services and proposed a reform of the labor market which is still before parliament.
The IMF said Italy would miss its deficit targets as a result of the economic recession and that the budget, if adjusted for the weak economic cycle, would already post a surplus in 2013.
In a subtle shift of language recently Monti has increasingly referred to the so-called "structural" deficit - adjusted for the business cycle - when talking about Italy's balanced budget target.
The deputy governor of the Bank of Italy, Fabrizio Saccomanni, said on Tuesday it would be "an excellent result" if Italy achieved a deficit below 1 percent of GDP in 2013.
The draft DEF forecasts that the public debt will rise this year to 123.4 percent of GDP from 120.1 percent in 2011, and fall in 2013 to 121.6 percent.
(Writing by Gavin Jones; editing by David Stamp)
Reuters