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Latvia’s government will today defend slashing the budget by 10 percent after surviving local and European Parliament elections, allowing lawmakers to focus on meeting the terms of an international bailout.

The cuts “are very serious button tightening,” said Lars Christensen, head of emerging markets at Danske Bank in Copenhagen. “The prospect for getting International Monetary Fund money looks better today than it did on Friday.”

The ruling coalition of Prime Minister Valdis Dombrovskis, 37, plans to reduce spending by 500 million lati ($983 million) in a bid to comply with the terms of a 7.5 billion euro ($10.4 billion) loan from the IMF and European Commission. The government hopes to pass the budget cuts on June 17.

“Now that the local elections are out of the way, there is a good chance that we will see quick progress on agreeing a modified budget deficit for this year and passing spending cuts,” said Aidan Manktelow, an analyst at the Economist Intelligence Unit.

Latvia’s economy contracted 18 percent in the first quarter, marking the deepest recession in the European Union and impeding government efforts to rein in the deficit. The IMF and the Commission withheld a 200 million-euro payment in March after lawmakers failed to commit to spending cuts on concern voters would reject them in local elections. Dombrovskis has said the nation will go bankrupt if bailout money dries up.

‘Long Way’

“There will still be an awfully long way to go to stabilize the economy,” Manktelow said. “A further round of budget cuts is likely to be needed later in 2009, not to mention 2010.”

The Swedish krona snapped two days of declines against the euro today and traded at 10.897 at 8:26 a.m. in Stockholm, from 10.9159 yesterday. The lats strengthened 0.71 percent today to 0.7005 lati per euro as of 9:18 a.m. today, after strengthening 0.53 percent yesterday. The lats trades 1 percent around a midpoint against the euro in a quasi-currency board system that backs lati in circulation with foreign currency.

Central bank purchases of lati have paved the way for the currency to appreciate because traders who bet on a decline now face pressure to find lati to close contracts, according to Parex Banka AS.

Reserve Rise?

The central bank has bought about 644 million lati ($1.26 billion) of lati this year to keep the currency in its trading band against the euro. The lats strengthened 0.6 percent against the euro yesterday, the biggest gain since June 2006 saving account payday loan.

“The central bank may even increase its foreign reserves” this week, since they may be the only source for lati, said Kaspars Jansons, head of treasury at Parex.

The country pegs its currency, the lats, to the euro, obliging it to use wage and price cuts to sustain exports. The IMF and the Commission originally stipulated Latvia must keep the deficit within 5 percent of gross domestic product. The government is waiting for approval for a 7 percent gap, while the coalition last week proposed a 9.2 percent deficit in a first parliamentary reading.

European Union officials are in “permanent contact” with Latvian authorities, EU Monetary Affairs Commissioner Joaquin Almunia said yesterday. “We are helping the Latvian economy through our balance-of-payments facility, but the next installment depends on the agreement that I very much hope will take place.”

Quell Speculation

Policy makers have struggled to quell speculation the country may be forced to devalue the lats, sparking a decline in Sweden’s krona because the Nordic nation’s banks are the biggest in the Baltic states of Latvia, Lithuania and Estonia.

Latvia’s economic fate may determine the pace of recovery in the largest Nordic economy. It is “obvious” that Latvia’s crisis will have an effect on Sweden’s economic development, Finance Minister Anders Borg said on June 5.

Swedbank AB, the largest bank in the Baltics, and SEB AB, the second-largest, have together lent more than 366 billion kronor ($46.6 billion) in Estonia, Latvia and Lithuania.

Sweden’s government can handle a possible bank collapse, or nationalization, sparked by the economic collapse in the Baltic states, Borg said on June 4.

“There is clear concern over contagion risks within the region,” Ashley Davies, a currency strategist at UBS AG in Singapore, wrote in a research report yesterday. “The krona will remain under pressure due to their banks’ loan exposures to the Baltic region.”

Latvians gave six of eight seats in the European Parliament to parties mostly out of power during the economic boom between 2005 and 2007, when the economy expanded about 10 percent a year. In the Riga municipal elections, voters choose three parties that were largely in opposition during the boom years, and one party that was in government during the period.

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