Latvia's PM steers through deep cuts to avert meltdown

LATVIA'S GOVERNMENT says it has saved the country from bankruptcy by agreeing deep budget cuts, amid warnings that economic meltdown in the Baltic state could send shockwaves through eastern Europe and Scandinavia.

Latvian prime minister Valdis Dombrovskis said the ruling coalition had resolved to slash more than €700 million from next years spending, in a move to secure urgent payment of the next €1.2 billion tranche of an emergency international loan.

The measures agreed by the five-party alliance include a 20 per cent cut in state salaries, a 10 per cent cut in post-retirement pensions, and a huge 70 per cent reduction in pensions for older people who still work.

Parental allowances will also be cut by 10 per cent, but the government decided against replacing a 23 per cent flat income tax with a progressive rate system.

“It was a difficult decision and it will not be popular but it had to be done,” Mr Dombrovskis said after a cabinet meeting that lasted 12 hours and was often stormy. “Our decision is sending a signal to the EU that we are serious.”

A parliamentary vote on the swingeing budget cuts could be brought forward to next week, as Latvia struggles to keep its currency pegged to the euro during the deepest recession in the EU, which could see its formerly booming economy shrink by 20 per cent this year.

“With yesterday’s decisions, the state has really been saved from bankruptcy,” Mr Dombrovskis said of the outcome of marathon talks which on Thursday night.

Mr Dombrovskis – who came to power in March after street protests over the economic crisis helped oust the last government – said that he had received a “positive” response from the EU about the budget cuts, and believed that Latvia had “avoided the worst-case scenario”.

He had warned that Latvia’s coffers could be empty within weeks unless it secured the next portion of a €7.5 billion bailout agreed last year with the EU and International Monetary Fund, which was conditional on the country drastically reducing its budget deficit.

After several years of rapid growth largely fuelled by cheap loans, skyrocketing property prices and consumer spending, Latvia suffered a severe shock when credit dried up and export markets shrank last year.

The central bank in Riga has spent heavily to maintain the lat currency’s peg to the euro, amid fears that devaluing the lat would torpedo investor confidence and cause many Latvians to default on loans that are denominated in foreign currencies, leading to a possible banking crisis.

Such a scenario would put heavy pressure on currency pegs in neighbouring Estonia and Lithuania, and on Scandinavian banks that are heavily exposed to the Baltic region.