Sweden takes axe to its welfare system to rescue the krona

STOCKHOLM - Sweden announced higher taxes on petrol and tobacco and permanent cuts in its renowned welfare state last night in a last-ditch effort to stave off devaluation and rescue its foundering economy.

Financial markets will judge if the multi-billion-krona budget savings, produced in a pact between the minority centre-right government and the Social Democratic opposition, are enough to protect the krona, or whether the central bank must build its wall of 500 per cent interest rates even higher today.

'We have made perfectly clear our intention to defend the krona, and we will do so in future,' the Prime Minister, Carl Bildt, said.

The emergency package included savings of Skr19bn ( pounds 2bn) and increased taxes worth Skr8.7bn in 1993. The combined savings and new taxes will rise to a total of Skr41bn by 1997.

Pensions, sick-leave payments, child benefit and housing subsidies - pillars of the Swedish welfare system - will all be cut. Spending will also be reduced on defence, police, Third World aid, scholarships and transport.

The additional taxes include one krona on a litre of petrol, higher tax on tobacco and a delay in reducing capital gains and other taxes.

The government and the opposition said the pact was aimed at safeguarding the welfare system, employment and low inflation in Sweden.

'The fixed exchange rate will be supported by a tight financial policy,' the two sides said, adding that they had to attack that part of the budget deficit that was structural and had nothing to do with the current recession.

The two sides declared a moratorium on further privatisation of state-owned shares and companies because of the prevailing weak stock market.

Mr Bildt's government had planned to sell the steel producer SSAB and its large shareholding in the food and drugs group Procordia, among other state- owned properties.

The Social Democratic leader, Ingvar Carlsson, speaking at a joint news conference with Mr Bildt's government, said his party had co-operated because 'this is the most serious economic situation faced by Sweden for many decades'.

The chief economist of Nordbanken, Nils Lundgren, said the pact should reassure markets but cautioned that it could not guarantee the krona's present exchange rate.

'I think the market will be quite satisfied, provided there is no further currency crisis in Europe and there is no worsening of the domestic finance sector crisis,' he said.

Political commentators said the pact between Mr Bildt's conservatives and the Social Democrats, bitter opponents in the past, had opened a new era in Swedish politics. The agreement came after three days of all-party talks on the economic crisis, after the central bank was last week forced to raise marginal interest rates to 500 per cent to stem the outflow of capital.

Sweden is a candidate for membership of the EC.