UPDATE 4-Latvia to cut pensions, salaries to avert crisis

Thu Jun 11, 2009 5:28pm EDT

* Latvian government says agreed ways to cut budget

* Pensions, state salaries, parent allowances to fall

* No tax rises

* Moody's sees devaluation avoided, pressure to continue (Recasts with government decision, adds quotes)

By Jorgen Johansson and Patrick Lannin

RIGA, June 11 (Reuters) - Latvia's government is to reduce old age pensions and state sector salaries but not raise taxes, it said on Thursday as it tries to win more loans and avert crisis and possible currency devaluation.

The five-party coalition government agreed with social partners such as unions and employers on ways to find savings of 500 million lats ($1.01 billion) to win further loans from the International Monetary Fund and European Union, which are seen as the only way to survive a deep economic slump.

"It was a difficult decision and it will not be popular but it had to be done," Prime Minister Valdis Dombrovskis told reporters after a marathon and sometimes chaotic government session of almost 12 hours.

"Our decision is sending a signal to the EU that we are serious," he added.

Against expectations, the government decided against introducing a progressive income tax for the first time to replace the current flat tax of 23 percent.

The moves will include a cut in old age pensions of 10 percent, a whopping 70 percent cut in the pensions of those who still work, and a 20 percent cut in state sector salaries.

The tax-free minimum on income will also be cut and allowances for parents reduced by 10 percent.

The steps, which Dombrovskis has said he expects parliament to back on June 17, are aimed at winning a further 1.2 billion euros of funds from a 7.5 billion euro IMF and EU rescue package.

The economic crisis has led to speculation Latvia will have to devalue and end the peg of its lat currency to the euro.

Ratings agency Moody's expected a devaluation to be avoided given Latvian and EU commitments, but said risks remained.

"Moody's also stresses that the possibility of a devaluation cannot be ignored, as the economic and social pressure in Latvia will continue to be elevated for some time," it said. [ID:nLB777098]

The lat currency stayed firm, but dealers said the money market was in a state of coma after central interventions to support the lat drained it of liquidity.

The government's planned cuts have sparked strong reactions.

The police union in a statement called cuts facing the Interior Ministry "the collapse of the entire security system."

It said thousands of police faced the sack just as social tensions could rise and the work of security forces increase.

Despite such rhetoric and the fact Latvia in January had its worst post-Soviet riot, there have been few signs of a repeat.

Dombrovskis got some support as the chairman of the largest party in the five-party ruling coalition said it would back the cuts despite misgivings about how they were drawn up.

Fears of devaluation have receded, but nervousness remains and the government had to deny a financial market rumour the prime minister was quitting.

The Latvian lat flirted with the top of its trading band against the euro, which could lead to the central bank intervening to sell lats and help unlock trade.

The euro was quoted in late trade at 0.6970/80 lats EURLVL= ,its highest value since May 2008.

The central bank buys euros and sell lats at the 0.6958 level, and buys lats and sells euros when it gets to 0.7098.

It has spent 907 million euros ($1.3 billion) this year to support the lat and shake off market fears. (Reporting by Laura MacInnis and Patrick Lannin; Editing by Ruth Pitchford/Victoria Main/Leslie Adler)

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