MOSCOW, RUSSIA - Russia plans to sharply raise duties on used imported cars to protect its domestic producers, the government said in a statement on Friday.

Russia was on course to become Europe's largest car market this year after a decade of an oil-fuelled economic boom but sales figures have dropped sharply in the past two months as the financial crisis forced banks to reduce cheap retail lending.

Tougher credit terms, shrinking incomes and uncertainty over currency stability are pushing people away the market for new foreign cars towards second hand foreign cars or AvtoVAZ's home-produced Lada models.

The government has a long history of protecting AvtoVAZ with prohibitive import duties, which analysts say have discouraged the Soviet manufacturer, located in the town of Togliatti on the Volga, from speedy modernisation.

AvtoVAZ faces increasing competition from foreign car makers, almost all of whom have opened or plan to open plants in Russia in the near future.

The government encouraged expansion plans by companies from Ford to Toyota Motor Corp by imposing a zero import duty on car components.

It also promised to gradually cut import duties on brand new and second hand cars as part of its World Trade Organisation (WTO) accession plans, which have been virtually on hold since Russia's August war with Georgia and the souring of Moscow's relations with the West.

The government statement said the new measures, proposed by the government tariffs commission, have yet to be approved by the cabinet.

Under the new rules, an import duty of 30 percent would be imposed on cars older than one year, and a duty of 2.5-5.7 euro per cubic centimetre of engine capacity for cars older than 5 years.

The current duties are set at 1 euro per cc of engine capacity, not exceeding 2.5 litres, for cars between 3 and 7 years old, 1.6 euros for cars with engine capacity over 2.5 litres and a duty of 2-3 euro for cars older than 7 years, seen as prohibitive.

Some of Russia's Far Eastern regions rely on imports of used cars from Japan and previous government plans to impose prohibitive duties have led to major protests.

(Reporting by Anton Doroshev, writing by Dmitry Zhdannikov; editing by David Cowell)