I have read in many internet forums about cases of people obtaining the citizenship in Italy, they are mostly in spanish but if you read spanish I can post the links for you to read their stories.
I do know a friend of a friend who did obtain the citizenship in Italy and took the time to email me all the details. She arrived in Italy as a tourist and started the procedure during 2002 at the Comune of Verona ( the person obtaining the citizenship in Italy is from South America and she emailed me regarding the process, now I believe it is even easier than that time).
She first collected all the paperwork the way the consulate wants it for citizenship only that she apostilled and translated EVERYTHING.
She reached Italy and before the 8th day went to Questura to get her PdiS for tourism (she had to buy francobollos for 10 euros, her passport, 6 passport pictures and present a health insurance to cover her for the following months, and some proof of residence -friend's house, hotel, anywhere they can locate you for the following days).
After she got the PdiS for tourism, she went to the Comune with her folder with all her paperwork for citizenship, the comune employee reviews it (fast) and then gives you a paper -to present at the questura- saying that they have to give you a PdiS per attesta di Cittadinanza.
So, after you get this paper from the Comune you go to the questure to upgrade your PdiS and you additionally need to show them that your health insurance covers you in Italy for 6 months (has to be all prepaid, you could get it for from 200 to 400 euros there) and that it covers for maternity. The 6 months coverage is because this is the time the cittadinanza takes (in theory).
Once you have the PdiS per Cittadinanza in the passport, you bring (but do not leave) again your folder with the vital records, you obtain a Codice fiscale and you go the Comune to prove your residency in Italy (either a rent in your name or a letter of somebody who rents or own a property in the area under that comune saying that you are living with him/her).
If the comune (like Verona) knows what you are talking about (and you do not have to show them the circolare K.28 and defend your right of getting a PdiS per Cittadinanza within 10 days of your arrival in Italy), youu could reach this point a week or two after arriving in Italy and will be able to work. But, if you have to fight them the law, then it may take you a month more. When I said you could work after 2 months, it is because usually you are not staying where you will like to live, you are staying where you know somebody or where rent is cheap.
The proof of residency takes about a month (in theory a maximum of 60 days but it happens within 2-3 weeks if they find you during the first visit). The police checks that you live where you say you were living, if they do not find you they leave a paper and you have to go within 24 hours with the paper to the police. If you cannot make it within 24 hours you go later and they send again somebody to check you live there.
After the police verifies your residency and once you have a paper saying that yes, you actually reside where you say you do, then you go to the comune with this paper and your vital records, only that this time you leave everything there. The Comune at this point will contact the consulates of the countries where your ancestors were born to check that nobody lost the right to Italian citizenship and also to enquire if a signatures doesn't seem valid, they do all this via fax and they get their replies via fax (later on via mail, but they use the fax to speed up the process, but still this part takes at least 6 months). Then they send the paper work to the comune where your ancestor was born, and once they transcribe your vital records and your ancestors they inform the comune where you reside, and they will inform you that your citizenship is officially recognized.
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Links (P di Soggiorno per acquisto della cittadinanza)
http://www.giustizia.it/cassazione/leggi/dpr394_99.html#notart11 (art 11 "c")
Link K.28
http://www.anusca.it/Flash/Circolare_28.htm (Thanks Scotto)
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