Ireland to shrink "rainy day fund" by half to boost investment

* 500 mln euros per year to fund, down from 1 bln euros

* But fin min maintains limits on 2018 budget

* Says country on target to balance budget in 2018 (Adds minister maintains 500 million euro limit for new budget measures; bullet points)

By Conor Humphries

DUBLIN, July 12 (Reuters) - Ireland (Other OTC: IRLD - news) is to cut the amount of money put into a "rainy day fund" to 500 million euros per year from 1 billion euros to allow for more capital investment, Finance Minister Paschal Donohoe said on Wednesday.

But he decided against increasing the amount of funds available for spending rises and tax cuts in the 2018 budget, maintaining a relatively modest ceiling of 500 million euros worth of new measures to be announced in October.

Donohoe's predecessor Michael Noonan last year pledged to save 1 billion euros a year in the new contingency fund once Ireland's budget is balanced in 2019 to protect the country against future economic shocks.

But Donohoe said he planned to cut that to 500 million euros and would use the other 500 million for more capital investment, which he said has become a bigger priority.

"I believe the appropriate way of doing that is to put in 500 million euros a year across those years to manage the kind of shocks that may develop externally and at home," Donohoe said.

"But what we are doing differently is we are saying we are going to put a further 500 million into increased capital investment in the country."

Priorities for spending will include housing, public transport and meeting Ireland's climate change targets, with capital expenditure to peak at 7.8 billion euros in 2021 from 4.2 billion in 2016, he said.

The measures will not threaten adherence to EU fiscal rules, Donohoe said, adding that Ireland is on target to balance its budget in structural terms next year.

Donohoe was appointed last month by Ireland's new prime minister Leo Varadkar, who has set increased capital investment as a key priority.

With Ireland's economy and population growing faster than anywhere else in the European Union, Varadkar has said he wants far greater investment in infrastructure.

Capital (Other OTC: CGHC - news) spending ground to a near-halt during the financial crisis and remains among the lowest in the bloc.

Donohoe told Reuters in an interview last month that Ireland's demographics were so different to the European norm that if it did not generate the capacity to invest, it would impair the ability of the economy to grow. That would pose "really stark social challenges", he said.

Ireland is on target to hit its forecast of economic growth of 4.3 percent this year and 3.7 percent in 2018, Donohoe said. (Reporting by Conor Humphries; Editing by Catherine Evans)