IMF agreement on budget critical for Latvia-Fitch

NEW YORK, June 4 (Reuters) - Fitch Ratings said on Thursday an agreement between Latvia and the IMF on a new budget deficit target will be important for maintaining the lats exchange rate peg to the euro amid market pressure over a potential devaluation.

Fitch said the agreement, which leads to a disbursement of the next tranche of International Monetary Fund and European Union financing, will be critical to calm fears and mounting public speculation over a devaluation of the lat currency EURLVL=.

The Latvian government's revision this week that it expects gross domestic product in 2009 to contract 18 percent compared with 12 percent underlines the severity of the economic challenges facing the country, Fitch said in a statement.

"As a result, the government has revised its 2009 general government budget deficit forecast to 9.2 percent of GDP from 7 percent, even assuming further budget cuts submitted to parliament on 1 June are passed and implemented."

The IMF had agreed a revision in the budget deficit to 7 percent from an original 5 percent target and is in discussion with the Latvian authorities over its latest proposals.

IMF agreement over the budget plans is required to secure the disbursement of the next tranches of IMF and EU funding totaling 1.4 billion euros, which are part of a 7.5 billion euros bail out programme agreed in December. For details, see [ID:L41029355].

"A breakdown in the relationship with the IMF and EU would leave Latvia facing a substantial budget and external financing gap, and Fitch believes that such a scenario would be likely to precipitate a devaluation of the Lat," Fitch said.

Fitch cut Latvia's ratings to BB-plus from BBB-minus early April.

(Reporting by Manuela Badawy; Editing by Kenneth Barry)