The European Union urged Latvia on Thursday to cut public spending further, offering little hope the Baltic country would quickly receive funds to ease a crisis threatening to force a currency devaluation.
The lat <EURLVL=> currency recovered some ground after taking a battering in the past week and nerves are still strained over the prospect of a cut in the lat's value that would hammer Swedish banks and reignite concerns over eastern Europe's fate in the global financial crisis.
The lat hit an almost 3-month high against the euro on Thursday, boosted by reports of government buying and speculation that support from international bodies might help fend off a devaluation.
Prime Minister Valdis Dombrovskis said on Wednesday he hoped to announce progress in talks with the International Monetary Fund and EU by the middle of next week.
But Monetary Affairs Commissioner Joaquin Almunia stuck with the line that the next portion of last year's 7.5 billion euro bailout would not come until more has been done to adjust state spending to a 19 percent contraction in the economy.
Riga had not planned to unveil more cuts until a second reading of the budget later this month but the existing amendments to the budget go to parliament on Thursday.
"The new budgetary proposals are a step in the right direction and also appear to contain some welcome reforms," the Commission said in a statement. "But more is needed to contain the increase in the budget deficit."
The government is also under pressure to avoid strict austerity measures from a public hit by an economic contraction that amounted to a staggering 18.6 percent in the first quarter.
"Latvia needs to reduce the deficit in a sustainable way with significant budgetary and structural measures, although I acknowledge that the original fiscal targets in the government's economic program are no longer within reach," Almunia said.
"I also understand there are limits on how much the deficit can be reduced to allow some breathing space for the economy and for the people of Latvia, especially the sections of population most in need," Almunia said.
BANKING NERVES
A failed government debt sale on Wednesday added to the surge in interbank lending costs and comments from Swedish and other officials this week, intensifying speculation that devaluing is the only way to cure its collapsing economy.
Bank-to-bank interest rates in the small Baltic state inched up to a new record of 25 percent on Thursday, but both the lat and Swedish banking stocks showed some more resilience.
By 1152 GMT, the euro <EURLVL=> was quoted at 0.7070/80 lats, well away from the 0.7098 level at which the central bank intervenes to keep the lat within a 1 percent fluctuation band to the euro.
Latvia's leaders have stood firm behind the peg for months, even as the economy shrank by a fifth year-on-year, and on Thursday there was no sign of them backing down, with dealers citing purchases of lats by the Treasury.
"The reason for the rise is that first of all the market is quite tight and the state treasury has also been doing some euro-lat trades," said one trader.
"The Bank of Latvia has chosen a certain policy, defining it and explaining to society and is carrying it out," the central bank said in a statement.
"The Bank of Latvia has explained the negative effect of a devaluation on people, companies and the solvency of the state."
The treasury had no immediate comment.
Later it sold 2.75 million Latvian lats of one-month debt in a direct offer to the market, just a fraction of the 50 million lats ($100.1 million) of longer-duration debt it had planned to sell to investors at Wednesday's failed tender.
One money market trader said lat liquidity might ease in the coming days as banks had borrowed more money from the central bank on Wednesday than the previous day.
