UPDATE 2-Latvia second EU member to seek IMF aid in crisis

(Adds Estonia, Lithuania, analysts, background)

By Jorgen Johansson and Patrick Lannin

RIGA, Nov 20 (Reuters) - Latvia sought economic rescue from the International Monetary Fund and European Union on Thursday, becoming the second EU state to seek a lifeline after sliding into recession and having to take over its second-largest bank.

It followed weeks of speculation from analysts that Latvia and its Baltic neighbours, heavily exposed to foreign borrowing, could seek IMF help to stave off economic ruin, following Hungary and Ukraine in October and Serbia this month.

The country's capitulation gives credibility to fears that others in the EU's former communist eastern wing will be forced to reach out for aid as a global downturn takes hold.

"We have decided to start official talks with the European Commission and the IMF about funding to stabilise the economy," Prime Minister Ivars Godmanis told reporters.

Latvia says its stability is helped by having a banking sector dominated by Nordic banks Swedbank (SWEDa.ST), SEB (SEBa.ST) and Nordea (NDA.ST).

But what was Europe's fastest growing economy shrank 4 percent in the third quarter and state finances have worsened as the credit crunch hit home at a time when economists when the Baltic economies were already heading for a hard landing.

The crunch has put a clamp on the funds that Latvia needs to counterbalance its large current account gap, and the government this week denied rumours it was planning to devalue the lat currency from its target band against the euro to help.

Finance Minister Atis Slakteris said in a statement that the sums needed from the IMF and EU would become clear during the course of talks.

He said the country needed to ease the impact of the global financial crisis on Latvia, to boost the economy and to ensure the stability of its financial system.

"It is planned that the first results of the talks could be known in the next week," Slakteris said.

Neighbours Lithuania and Estonia said that they saw no need for funds.

"We are coping on our own ...," Lithuanian Finance Minister Rimantas Sadzius told Reuters.

The lat was unaffected by the news, said one trader. It was quoted at 0.7087/99 euros, still at the 0.7098 euros weak end of its 1 percent band. The central bank has spent more than 600 million euros in the last seven weeks to support the currency.

AFTER BOOM CAME BUST

"It was clear that help from the EU and IMF would be needed," said Latvijas Krajbanka economist Olga Ertuganova, pointing to the slide in GDP and falling budget revenues.

Danske Bank analyst Lars Christensen said the move was positive. "I don't think there is anything problematic about it. I think it is a right decision, it should have been done some time ago, but it is good they are doing it now," he said.

Latvia has been plagued by economic imbalances, with its economy first soaring on a flood of easy credit as the Nordic banks fought for market share and then plummetting almost as rapidly when the banks cut lending due to fears of overheating.

The central bank says its budget deficit could now soar to 4 percent of gross domestic product (GDP) next year as the slowdown hits tax revenues, and government covers the cost of dealing with the crisis and its take over of Parex Bank.

Latvia has already injected 200 million lats ($353.2 million) into Parex and is standing guarantor for more than 700 million euros of syndicated credits due next year. If these credits canot be refinanced, the state will have to repay them.

The country has also been running a huge current account deficit, which, though it has narrowed a lot, stood at 12.6 percent of gross domestic product in the third quarter.

The central bank has said the deficit, caused by a surge of imports, is financed by long-term loans from the Nordic banks which have come to dominate the banking market.

If successful, Latvia would be the second EU country to get outside help after Hungary's tapped the IMF, Brussels and the World Bank for $25.1 billion. (Reporting by Jorgen Johansson, writing by Patrick Lannin, editing by Patrick Graham)