* Reserves down $16 billion since oil blockade
* State subsidies a legacy of Gaddafi years
* Emergency budget helping paper over cracks
By Ulf Laessing
TRIPOLI, March 31 Libya is burning through central bank reserves and scrapping infrastructure projects to overcome its worst budget crisis in decades after the seizure of oil installations by armed groups has reduced the government's income almost to zero.
Oil exports - Libya's lifeline - fell to less than 100,000 barrels a day last week after militiamen shut down two large oilfields, compounding closures of ports in the east by rebel groups campaigning for regional autonomy.
Exports had exceeded one million bpd before armed militias, who helped oust Muammar Gaddafi in the 2011 civil war, started seizing oil facilities last summer to grab a slice of the country's oil wealth.
The budget crisis threatens to accelerate Libya's slide into instability as Tripoli's fragile government struggles to impose its authority on a country where brigades of heavily armed ex-rebels challenge its efforts to introduce democracy.
Any immediate collapse of the state - at least in the next few months - looks unlikely. Libya accumulated more than $130 billion in foreign reserves during times of high oil prices.
But $16 billion have been spent since last summer, killing off plans to overhaul dilapidated roads, schools and hospitals.
"The situation is very, very bad," said Abdelsalam Ansiya, a former lawmaker who was until recently the head of the Libyan parliament's budget committee.
Parliament has failed to approve a budget for 2014 as there is no money to spend - oil and gas exports make up 95 percent of income. Loss of government control of some land border crossings has hit customs duties, one of the only other non-oil sources of income. Few people pay taxes.
Oil revenues in the first two months of this year were 16 percent or less of the budgeted level, officials say. To keep the state running, the central bank has granted a $2 billion emergency loan. It had already given $800 million to the electricity ministry, which is struggling with power outages.
Diplomats expect the central bank to dip further into its foreign reserves because slashing the $53 billion budget is not an option for a weak government ill-equipped to take tough measures.
Almost 70 percent of the 2013 budget was spent on public sector salaries and on subsidies for anything from wheat and gasoline to airline tickets and militia brigades on the state payroll - a hangover from the Gaddafi era meant to keep Libyans happy and social unrest under control.
To keep paying salaries the government has started tapping a special savings fund worth around 12 billion dinars ($10 billion), which had been meant as nest egg for future generations, Ansiya said.
Libya had last year ran a budget deficit of around 6 billion Libyan dinars, he said.
While the government badly needs to cut spending, the budget is actually set to rise this year. The proposal calls for an increase of 2 billion dinars after the government agreed a 67 percent salary increase for oil workers in a futile attempt to buy their loyalty.
The main budget challenge for the government is Libya's dysfunctional public service, a legacy from Gaddafi, who put most adults on the payroll to discourage opposition.
In Benghazi, 22,000 soldiers were on the payroll but apparently not working, said political analyst Salah Elbakhoush. Islamist militants and other militias roam unchallenged, while car bombs and assassinations happen almost daily.
Libyans are also used to paying only two cents for a loaf of bread or $70 for a one-hour domestic flight, costly subsidies introduced by Gaddafi which the new rulers are afraid to cancel for fear of social unrest.
Central bank officials went on live television to stem rumours of state collapse by stating that Libya's foreign currency reserves would keep the country afloat.
"The economy could manage for two and half years though under great difficulties," Ali Mohammed Salem, deputy central bank governor, told al-Nabaa television last week.
On the same show, usually secretive officials disclosed that reserves had fallen to $116 billion from $132 billion in the summer.
"We need a prudent economic policy to change the fundamentals we suffer from. We know that the salaries are a burden," said Salem, referring to the public wage burden.
Analysts caution that part of the central bank's money is parked abroad in illiquid assets such as convertible bonds while cash dollars would be needed to defend the Libyan dinar.
"The central bank cannot continue funding the budget for the whole year," said former lawmaker Ansiya, adding that dollars were needed to pay for imports.
The OPEC oil nation produces almost no food, forcing it to import basics such as milk, cheese or tomatoes from Europe or Arab countries. Even the national passion, harissa, a hot pepper paste applied liberally on a range of dishes, comes from Tunisia.
Husni Bey, who heads one of the largest private firms selling products ranging from Western consumer goods to investment fund assets, said the central bank needed to devalue the dinar due to a growing trade deficit.
"To balance the budget the Libyan dinar must be devalued to a minimum of 2.0 to the U.S. dollar," he said. The current exchange rate is 1.25 to the dollar.
He said oil revenues could fetch as little as $20 billion this year, down from almost $50 billion in 2013, while annual imports were costing $30 billion.
The import bill is rising as the seizures of oil facilities are also cutting off supplies to local refineries, forcing the oil ministry to boost gasoline imports to $650 million a month - a third higher than usual, according to an oil trader.
The budget crunch coincides with a political crisis blocking the Libya's transition to democracy. Potential investors remain wary and many people wonder whether to leave the country to escape instability and crime.
Libya has just cancelled two major business conferences - one for the oil and gas industry and another on Islamic finance - which had been meant to attract foreign investors.
In the capital Tripoli, restaurants are often deserted, while shops such as fashion retailers, supermarkets and jewellers say they are offering big discounts because customers are staying away.
"Many Libyans, rich and less rich, are taking their children and wives to safer places for fear of the unknown and for fear of crime," said Bey. His firm's sales have fallen by 20 percent in the past three months. (Reporting by Ulf Laessing; Editing by Giles Elgood)