UPDATE 3-EU approves funds for Latvia, to pay within weeks

* EU gives green light for 1.2 bln euros for Latvia

* EU Commission says funds disbursed in next few weeks

* Latvian PM welcomes EU decision, not clear on IMF

* Swedbank boosts capital, says committed to Baltics

(Adds background, Swedbank quotes)

By Jan Strupczewski and Balazs Koranyi

BRUSSELS/BUDAPEST, June 26 (Reuters) - Latvia will get a vital 1.2 billion euro ($1.67 billion) tranche of financial aid within weeks, the European Commission said on Friday, providing relief for a country hoping to avoid state bankruptcy and devaluation.

The Latvian crisis has caused fears of a chain reaction devaluation in eastern Europe and further overshadowed several top Swedish banks, which expanded aggressively in the Baltic region in recent years but now face mounting loan losses.

Latvia, facing a near 20 percent economic output drop this year, has made sacrifices to quality for further loans from a 7.5 billion euro aid package agreed with the European Union (EU) and International Monetary Fund (IMF) last year.

It has decided to slash spending by 500 million lats ($998.4 million) this year, including cuts in state wages and pensions. It plans cuts of the same size in each of the next two years.

In a key moment, the European Commission said Latvia had won the green light for the 1.2 billion euro payout at a meeting of junior EU finance ministers and central bankers, the Economic and Financial Committee.

"The Commission ... will now proceed with the finalisation of the revised memorandum of understanding for signature by the Latvian government and (Monetary Affairs) Commissioner (Joaquin) Almunia, as well as the technical preparation of the second loan instalment which will be disbursed in the next weeks," EU Commission spokeswoman Amelia Torres said.

The 7.5 billion euro financial aid package was agreed by Latvia late last year after it slid into recession and had to rescue its second-largest bank, Parex.

The fresh loans had been delayed while Latvia tried to persuade EU and IMF officials it had done enough to cut spending and set it on fiscal course for eventual euro adoption.

In the meantime, the central bank spent hundreds of millions of euros to defend the lat's peg to the euro and avoid a devaluation. A clear political commitment from EU leaders had already calmed the financial market, but the EFC meeting was a key formal stage in getting the funds.

"It's quite significant for us to receive this next tranche," Latvian Prime Minister Valdis Dombrovskis told Reuters during a visit to Budapest.

"We still need to agree on the memorandum of understanding, but of course it's a very positive signal from the EU that our programme is on track," he said.

IMF LESS IMPRESSED?

Though the EU has been keen to show its support for Latvia and its currency peg, the IMF has been less vocal. "The IMF is still examining the programme," Dombrovskis said.

"No, we are not in dispute but ... the major contributor is the European Commission and the IMF is only paying a relatively small share of this programme. We expect the IMF to take its time, evaluate the programme and make its decision."

He said the government was meeting regularly with representatives of the European Commission and the IMF.

"They are still examining the measures and also the programme for the coming years of 2010 and 2011."

Of the total 7.5 billion euros for Latvia, 3.1 billion is coming from the Commission, 1.8 billion from the Nordic countries, 500 million from the European Bank for Reconstruction and Development, Poland, the Czech Republic and Estonia and 400 million from the World Bank.

The International Monetary Fund is providing 1.7 billion euros, but the Commission's decisions have no influence over the disbursement of the IMF money.

The woes in Latvia and the other Baltic states of Estonia and Lithuania have hit shares in top Swedish banks, particularly Swedbank and SEB , due to rising losses from bad loans. The chairman of Swedbank said during a visit to Lithuania that his bank remained committed to the region.

"We are here to stay, we have a long term commitment in Lithuania, and we consider Sweden, Estonia, Latvia and Lithuania our home markets," Carl Eric Stalberg told reporters after meeting the Lithuanian finance minister.

Financial analysts in Sweden also hailed a move by Swedbank to boost its capital via internal transactions.

"These banks want to look as well-capitalised as possible. Swedbank saw an opportunity, so they did it," said another analyst, who declined to be named.

(Reporting by Jan Strupczewski in Brussels and Balazs Koranyi in Budapest, writing by Patrick Lannin, editing by Dale Hudson)