RIGA (AFP) - The Latvian government plan to limit what banks in the crisis-hit Baltic state can collect from mortgage-holders may be a heavy blow to Swedish banks.

Prime Minister Valdis Dombrovskis this week began drafting legislation designed to protect cash-strapped homeowners from banks out to repossess properties.

Some economists see the move as a step towards devaluation.

"It has nothing to do with devaluation. The only purpose it serves is to protect borrowers who have only one mortgage," said Liga Krapane, denying speculation the government would use the plan to pave the way for a devaluation of Latvia's lat currency, now pegged to the euro.

Krapane said it would take about a month to draft legislation intended to prohibit banks from evicting families from their only home or apartment and from going after other assets in cases of default on individual mortgages.

The government is considering whether the law could apply retroactively to existing loans, she said.

The plan would deal a heavy blow to Swedish banks, such as Swedbank, SEB and Nordea, that are already suffering huge losses in Latvia where the economy is expected to shrink by 18 percent this year.

The Swedish banking sector fell on the Stockholm stock exchange in Wednesday after the Latvian news. Also the Swedish krona felt the pressure.

Latvia's central bank on Wednesday slammed the government plan, fearing negative impact on lending in an already severe economic enviornment.

"Such a measure should have been adopted earlier, for purposes of slowing down lending, or it should be postponed: this is the most inappropriate moment possible," the bank said in a statement.

Speculation that Latvia will be forced to devalue its currency intensified as its economic woes grew, with the government and central bank repeatedly denying plans for any such move.

Fears that Latvians who borrowed in euros to buy property valued in lats would be hit hard by any devaluation of the lat have mitigated strongly against any move to do so.

Property prices that peaked on the back of a credit bubble that burst as the global recession struck have now fallen by as much as 70 percent.

Some economists argue that once those households are protected from repossession, Latvia would have more scope for devaluation.

If the government's plan were implemented "foreign banks would suffer losses, but the Latvian public would be saved," Danske Bank economist Par Magnusson told AFP Wednesday. "This is a dream package for the Latvians."

Morten Hansen, an economist at Riga's Stockholm School of Economics, discounted the planned legislation as a step toward devaluation.

"It's a way for the Latvian side to become a more customer-friendly and less bank-friendly system," he told AFP.

After several years of double-digit growth, the ex-Soviet Baltic state of 2.3 million people that joined the EU in 2004 is now suffering one of the deepest recessions in the 27-nation bloc.