RIGA - Speculation that Latvia may be forced to devalue its currency intensified after it emerged the Latvian Central Bank spent 165.83 million lats (235.95 million euros) defending the exchange rate peg, which has been in place since the country gained independence from the Soviet Union in 1991.
The latest buy up is the largest since the International Monetary Fund (IMF) and other international lenders approved a 1.7 billion euro bailout package in December 2008.
Latvian banks have bought about 643 million lats this year, removing them from circulation and creating a shortage of lats on the local market.
Latvia's currency is pegged to the euro, as part of its accession path to the euro zone, with a 1 percent fluctuation band around a central rate.
The lat has been at the weak end of its band for weeks, with interbank interest rates spiking to a record breaking 19.6 percent on June 5.
There are concerns devaluation could destabilize the entire region and threaten other pegged currencies including those in neighboring Estonia and Lithuania.
However, analysts remain convinced Latvia will be forced to abandon the peg or at least reset it at a lower rate against the euro, a move that could devalue the currency by as much as 30 percent.
"The level of intervention is frankly staggering and time is clearly running out for the Latvian authorities," Timothy Ash, head of emerging-market economics at Royal Bank of Scotland Plc in London, told Bloomberg.
HEADSTRONG
The Latvian government has repeatedly ruled out the possibility of devaluation 's a stance backed by the European Union, which said the peg is vital for economic and political stability in the region.
Economic and Monetary Affairs Commissioner Joaquin Almunia told the media on June 6 that widespread reforms to Latvia's health, education and budget systems were key to economic recovery.
However, many analysts see devaluation as the quickest way to deal with the country's foreign debts and return to growth.
On June 9 the Latvian government agreed to slice a massive 500 million lats from its budget in a bid to secure the next 1.4 billion euro tranche of aid from international lenders.
Under radical budget cuts, the government plans to slash public sector salaries by 120 million lats.
The IMF previously withheld a scheduled loan payment after the government failed to hold its budget deficit at 5 percent as was agreed under the terms of the loan.
Latvia's government is continuing to negotiate a wider deficit with the European Commission and the IMF to ensure the next payment of its loan. Failing that, Latvia faces bankruptcy, Prime Minister Valdis Dombrovskis has warned.
Latvia's economy is expected to contract by almost a fifth this year due to the global crisis, and rumors of currency devaluation has European financial markets rattled.
There remain widespread fears devaluation could spark a banking sector collapse.
Swedish banks are the biggest players in the region, with Swedbank and SEB's combined loan portfolio in the Baltics topping more than 23.85 billion lats.
Loan losses are soaring at the banks, with speculation that Latvia may devalue its currency driving down their share prices and the Swedish krona.
