(Adds details, background)
By Emily Kaiser and Marius Zaharia
WASHINGTON/BUCHAREST, May 4 (Reuters) - The International Monetary Fund on Monday said it approved a $17.1 billion stand-by loan for Romania to cushion the effects of a sharp drop in capital inflows resulting from the global financial crisis.
Of that, $6.6 billion is available immediately, and the rest in installments subject to quarterly reviews, in particular of Romania's progress in overhauling its creaking public finances, a key requirement of the Fund.
Like many of its eastern European neighbours, Romania, a relatively poor European Union state of 22 million, was hit hard when the global crisis intensified in September following the bankruptcy of Lehman Brothers.
Even countries that had no direct exposure to souring U.S. assets suffered when risk aversion spiked and financing suddenly dried up.
The agreement, part of a 20 billion euro ($26.48 billion) package also including cash from the EU and other financial institutions, follows similar deals by fellow EU states Hungary and Latvia which suffered when private lending slowed sharply.
Its goal is to help Romania ride out recession and safeguard it from a potential financing crisis by giving it short term cash support and encouraging vital public sector reforms to correct deep economic imbalances in the future, the Fund said.
"We are hoping to avoid an outright banking crisis ... an even worse decline in economic output and we are hoping to avoid a payments problem," said Jeffrey Franks, the IMF's mission chief to Romania.
"It's an important programme but there is a preventative component, we are preventing things from being worse than they even are now."
The Fund expects the Romanian economy to contract by 4.1 percent this year, underlining a sharp reversal of fortune for the Black Sea state which recorded annual growth rates of around 9 percent last year, the fastest in the EU.
Over several months, Romania has turned from being an attractive destination for foreign investment to an economy plagued by balooning foreign debt, a gaping current account deficit, bloated government budgets and sour market sentiment.
REFORM CONDITIONS
The IMF said broad fiscal reforms aimed at simplyfing "complex" pension policies and curbing "shocking" growth in public sector wages were vital to ensuring Romania had access to sufficient foreign financing and can weather problems in the future.
Romania had signed a letter of intent for an IMF-led aid package in late April, and agreed to budget gap ceilings ranging from 1.6 percent of gross domestic product at the end of the first quarter to 4.6 percent at the end of 2009.
Under the plan, Bucharest will lower its budget deficits to
meet the EU's 3-percent cap by 2011. The agreement also
includes a deal with key foreign banks that have subsidiaries
in Romania to recapitalise them on a "preventive" basis, the
IMF's Franks said. The banks include Erste Bank
"Under the programme, the central bank has already undertaken a series of stress tests of the main banks," he said. "Any shortfall that is shown under these stress tests to occur in 2009 or 2010 must be covered upfront by recapitalisation of these banks."
Franks also said the Fund "broadly" agreed with the Romanian central bank's policy to smooth out foreign exchange fluctuations via interventions in the currency market.
"There is some room for intervention, it's not an unlimited room for intervention," he said.
The Romanian leu hit record lows against the euro in January at 4.3530 per euro
Still, market observers said they suspected the central bank of having stepped into the market on many occasions in recent months to support the leu. (Writing by Justyna Pawlak)