July 13 (Bloomberg) -- The International Monetary Fund’s reluctance to disburse a loan payment to Latvia while the European Union keeps funds flowing signals intensifying tension between the two institutions, Barclays Capital said.

An IMF mission is starting discussions in the Latvian capital Riga today on a 200 million-euro ($279 million) installment, which it delayed in March, citing insufficient effort by the government to rein in spending.

Latvia is going through the EU’s worst recession and has relied on emergency financing since the government was forced to take over the country’s second-largest lender last year. Lawmakers have cut spending by 500 million lati ($1 billion) to unlock the next payments, prompting the European Commission to pledge a transfer of its 1.2 billion-euro share.

Withholding the funds even after the approval of the spending cuts “signaled that the rift between the IMF and EU has widened,” said Christian Keller, Barclays Capital’s chief economist for emerging Europe, in an e-mailed note dated July 10. “The Latvia program has become a headache for the IMF.”

The IMF mission this week will coincide with a visit by representatives from the EU.

The clashes derive from “ideological differences” according to Keller. The IMF focused on economic questions such as the sustainability of the currency peg, the use of economic stimulus or the idea of fast-track euro adoption, Keller said. The EU’s main concern is political, such as euro-adoption rules and the implementation of convergence programs, he added.

Countries Reluctant?

The rift may revive the debate whether Latvia should scrap its currency peg to the euro, devaluing the lats and would raise questions about whether the IMF can still be considered part of the country’s bailout, Keller said. Prime Minister Valdis Dombrovskis said last week the nation may not need the Washington-based lender’s share of the financing.

The difference in the IMF’s and the EU’s approach may also become evident in other countries, Keller said. A probable need to extend Hungary’s rescue program next year may put the two institutions at loggerheads about how quickly the country will be expected to rein in the budget deficit, he said.

In Bulgaria, Sofia Mayor Boiko Borissov, whose party won elections on July 5, advocates taking a loan from the IMF and the EU to support the nation’s currency peg to the euro. A deepening divide between the EU and the IMF could make the incoming government “reluctant” to seek a loan, Keller said.

To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net

Last Updated: July 13, 2009 05:20 EDT