Leaders are bracing for full-blown recession this year, with Premier Chuan Leekpai's cabinet yesterday approving forecasts the economy will shrink 3.5 per cent. Earlier projections put growth at 0.4 per cent, and the latest forecasts also included worse-than-expected inflation figures. Both new figures were contained in Thailand's third letter of intent to the International Monetary Fund - a document crucial to further co-operation with the institution, and hammered out after several weeks of negotiation. The cabinet approved the document in private, without reservation, reflecting market sentiment that it amounts to a seal of 'good housekeeping' by the Chuan administration. One crucial amendment will allow Thailand to increase government spending and produce a budget deficit of 1.5 per cent, rather than the IMF's controversial earlier stipulation for a surplus of at least 1 per cent. One private sector analyst said: 'That gives the government an extra 100 billion baht [about HK$17.25 billion] at least to spend. 'It's good news, and it shows a new level of trust for Mr Chuan's economic leadership. It also shows the IMF has finally recognised the full extent of Thailand's recession, and can be flexible under the right conditions. 'To try to squeeze Thailand into surplus at this time would have been far too painful,' the analyst said. The baht firmed to 45 to the US dollar, while the stock market dipped, both markets already having taken the document into account, analysts said. But forecasts for inflation are slightly worse than expected, with the document estimating costs will rise an average of 11.6 per cent this year. Earlier estimates put inflation at about 10 per cent. One source of the increase is expected to come from a controversial rise in petrol taxes of one baht per litre - a move approved by cabinet yesterday, along with higher tariffs on luxury goods. Widespread opposition to the move is expected, but Democrat Party officials insist the rise will not hit industry and food production, as diesel will be unaffected. Mr Chuan's predecessor, Chavalit Yongchaiyudh, attempted a similar move in October, but backed away at the last minute. His policy turn-around sparked the departure of his finance minister, Thanong Bidaya, which led to a crisis of confidence and Mr Chavalit's resignation in days.