Oct. 15 (Bloomberg) -- Latvia’s government needs to pass next year’s state budget to avoid a “negative reaction” from markets, European Union Monetary Affairs Commissioner Joaquin Almunia said.

“The credibility of the Latvian government and the Latvian authorities will in a short period of time improve,” should they adopt next year’s budget, Almunia said in an interview with Latvian state television, broadcast yesterday. Not passing the budget will create “immediately a negative reaction.”

Latvia’s ruling coalition said this week it will try to find 320 million lati ($673 million) in spending cuts and 180 million lati in tax increases to meet demands the International Monetary Fund, the EU and Sweden attached to a 7.5 billion-euro ($11.2 billion) loan. The lenders criticized the Baltic state in past weeks for a lack of commitment to its loan terms.

The cuts have affected public services, especially on the local-government level, Latvian Prime Minister Valdis Dombrovskis told reporters in Tallinn during a visit to his Estonian counterpart Andrus Ansip yesterday. He cited school and hospital closings as examples of the cuts. The country plans to reduce budget spending by 4 percent of GDP next year.

“We understand how difficult this is,” Almunia said. “We are aware of how difficult this is. We are aware how people suffer from this.”

‘Key Decisions’

The governing coalition aims to make “key” decisions on the budget cuts, which would bring the deficit next year to 7.5 percent of GDP, at a meeting on Oct. 16, Dombrovskis said. The budget may be sent to parliament by Oct. 28.

Latvia, which like neighboring Lithuania and Estonia pegs its currency to the euro in the pre-euro exchange-rate mechanism, is suffering the EU’s second-deepest recession behind Lithuania after a lending boom spurred a property bubble that burst when the credit crisis descended on the region.

The spending cuts by the three countries are exacerbating their recessions as they can’t rely on weakening currencies to boost competitiveness. Estonia has made budget cuts of 9 percent of GDP this year, according to Finance Ministry.

“That type of adjustment cannot be made without limiting the quantity of services available,” Dombrovskis said. “While doing the fiscal adjustment, we are downsizing our government.”

To contact the reporter responsible for this story: Aaron Eglitis in Riga at aeglitis@bloomberg.net.

Last Updated: October 14, 2009 17:00 EDT