By Melissa Kite, Deputy Political Editor
Last Updated: 11:31PM GMT 15 Nov 2008
Mr Letwin has been drafted in by David Cameron to draw up a key plank of the Tory fightback on the economy as concerns over Mr Osborne's performance intensify, The Sunday Telegraph has learned.
The plans, to be announced in the next 10 days ahead of the Alistair Darling's pre-budget report, are likely to focus on cutting Whitehall bureaucracy and other spending which does not boost the economy. Infrastructure projects such as school building will remain untouched.
Mr Letwin, chairman of the Conservative research department, is devising cuts to get public spending beneath Labour figures, senior sources said.
It is the latest action plan from the Tory leadership in the face of growing demands from within the party for a sharper economic rescue package to rival Labour's.
The decision of Labour MPs to advocate tax cuts, and heavy hints from Gordon Brown that he will unveil a substantial package of cuts in the pre-budget report, have plunged the Conservatives into a major rethink.
The fact that Mr Letwin, Mr Osborne's predecessor as shadow chancellor, has been charged with drawing up the spending cuts will fuel the impression that Mr Osborne is being sidelined as the party's ratings on the economy falter.
After weeks of damaging headlines, Mr Osborne courted further controversy this weekend by warning that Mr Brown's borrowing strategy could lead to a "collapse of sterling". Such comments breach the protocol that senior politicians do not comment on the strength of sterling in case they precipitate a crisis.
Yesterday Lord Kalms, a former Conservative treasurer and founder of the Dixons retail empire, called for Mr Osborne to be replaced with David Davis, the former shadow home secretary. He told The Daily Telegraph: "I am informing everyone who will listen that change needs to happen."
The comments are damaging for Mr Osborne, who has fought hard in recent days to rescue his reputation which was battered by the Deripaska affair. He moved to silence his critics, who claim that he has been outmanoeuvred by Mr Brown, with the announcement of a £2.6 billion tax break plan for companies last week, but it met with a mixed response.
Desperate to regain the initiative, Mr Osborne was mindful that a turning point for the party last year, when it was flagging, was his announcement at the party conference of cuts in inheritance tax.
He devised a tax cut, which was briefed to this newspaper last weekend as "ingenious", and announced it in full the following Tuesday. The party offered a £2,500 National Insurance break for companies for every new worker taken on who has been unemployed for more than three months. David Cameron said the £2.5 billion scheme would pay for itself by reducing unemployment benefit.
The CBI responded by saying it would help some small businesses keep people in work, but the British Chambers of Commerce said firms were not in a position to start recruiting. Mr Brown dismissed it as "unfunded".
The Tories also point out that Mr Brown's decision to fund tax cuts through borrowing and to "spend his way out of recession" will only lead to more debt and higher taxes in the future. Tony McNulty, the employment minister, admitted last week that taxes might have to go up once the economy emerges from the downturn.
The Prime Minister kept up the pressure this weekend by using the G20 financial summit in Washington to call for co-ordinated tax cuts across the world's major economies to help reduce the effect of the downturn.
Labour produced a dossier titled "Osborne's judgement under scrutiny" in which it accused the shadow chancellor of "schoolboy errors".
Tory insiders, however, insist that Mr Osborne is safe, and that that Mr Cameron will never break the political "axis" he has formed with his Notting Hill friend.
A senior insider admitted that Mr Osborne's job had been diluted to take him out of the firing line: "It has been decided that he should do less of the general politics."
It has been reported that Mr Osborne is suspending his work as election coordinator until next March to allow him to concentrate on completely rewriting his economic plans. A series of u-turns, first revealed by this newspaper months ago and denied at the time, have now been confirmed by Tory officials, including ditching green taxes. Mr Osborne is also searching for a way out of his policy of "sharing the proceeds of growth between tax cuts and public spending", since there now isn't any growth. Depending on what Mr Letwin decides, he may need to water down his commitment to match Labour's spending plans.
But rumours of Mr Osborne being replaced with William Hague, Mr Davis, or even Ken Clarke are "very wide of the mark", insiders say.
Mr Hague is understood to have told colleagues that he does not want the job. Another senior MP had a different theory for why Mr Osborne is safe: "George is not going to move because David won't move him. There is an element of lightning conductor in George."
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