Page last updated at 11:28 GMT, Monday, 8 June 2009 12:28 UK

Fears grow on Latvian currency

German Chancellor Angela Merkel (R) greets Latvian Prime Minister Valdis Dombrovskis during an official welcoming ceremony at the chancellery in Berlin April 29, 2009
Latvia's prime minister has tried to reassure investors

Fears remain over the Latvian currency after the central bank said it has spent almost 1bn euros ($1.4bn; £876m) this year supporting the lat.

If Latvia was forced to devalue the lat, it could trigger a wave of revaluations in Eastern Europe and hurt European banks invested in Latvia.

The central bank sold 237m euros of the currency last week, taking its total this year to 907m euros.

The lat is under pressure after a bond auction failed.

Latvia is hoping to raise money from the European Union and the International Monetary Fund, after securing a 7.5bn euro bail-out from them in December.

The government is weighing up more spending cuts to lower its budget deficit and qualify for the next instalment of the bail-out. A delegation from the IMF is going through the Latvian budget this week.

Latvia's Finance Minister Einars Repse said on Monday that the government would propose up to $700m in additional spending cuts.

Knock-on effects

Latvia's economy contracted at an annual pace of 18% in the first three months of the year.

The lat is fixed within a trading band that allows it to rise or fall by 1% against the euro. As currencies elsewhere have fallen, Latvia's fixed currency regime has made its exports uncompetitive.

The Latvian central bank spent about 1bn euros last year to prop up the currency, after it finally bailed out its second-biggest bank.

A devaluation would have serious consequences for Estonia and Lithuania, Latvia's two biggest trading partners.

That in turn would hit Sweden, whose banks have heavy exposure in the Baltic region. Swedbank, the biggest lender in the region, is seen as particularly vulnerable.

The Swedish krona has dropped 1.6% against the euro so far this month and is approaching a six-week low.

Valdis Dombrovskis, the Latvian prime minister, said last week it was a situation "that will go over and when we have agreement with international lenders the market will also calm down".

"We have just to put this talk (about a devaluation) to one side," Mr Dombrovskis told Latvian television. "We're just getting ourselves all worked up and creating emotion. The central bank and government have clearly said there will be no devaluation."

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