THOUSANDS of retired public sector workers face having their pensions reduced after a massive overpayments blunder.

Huge numbers of ex-military personnel and NHS staff are said to be caught up in the chaos, which is thought to date back years.

The Government has already made clear it will not seek to "claw back" the cash immediately.

However, Chancellor Alistair Darling said the individuals would be forced to accept lower payments in future - sparking fears that many could be left struggling to make ends meet.

The problem could be made worse because recent heavy falls on the stock market and sharp reductions in interest rates have cut pensioners' income from savings.

The situation only emerged last night, after Lib Dem Treasury spokesman Vince Cable received a tip-off and challenged Mr Darling in the Commons.

He said a firm called Xafinity Paymaster were believed to have overpaid public sector pensions to former servicemen and health service staff "for decades".

Dr Cable revealed that he raised the matter with Cabinet Secretary Sir Gus O'Donnell "several days ago", who confirmed the difficulty and asked for time to contact pensioners and tell them what had happened.

Dr Cable asked the Chancellor: "How many people are we talking about, how much money is involved, what are the steps that are going to be taken to retrieve the overpayments - which I understand in some cases is going back decades and are potentially enormous?

"I hope none of us can face the possibility of large numbers of ex-servicemen suddenly being faced with bailiffs turning up and asking them to repay overpayments."

Mr Darling responded that repayments were "not going to happen".

But he added: "It will be necessary to adjust what's paid for the future. It does need to be put right from next year."

Xafinity is believed to distribute 5% of public sector pensions, but it is not yet clear how much has been overpaid or what geographical areas are involved.

The Cabinet Office is due to put out a written ministerial statement giving details of the issue later today.

Meanwhile, Britain is likely to suffer more from the economic downturn than any other major country, Mr Darling warned.

The Chancellor cited London's status as a major financial services centre as a reason why the country could be worse affected than others, when asked by MP Adam Afriyie in the Commons why the European Commission and the IMF were predicting the UK would be the hardest hit in the developed world.

He said: "We were bound to be affected more substantially in relation to the loss of revenues we are now experiencing because of the lack of profitability in the financial services sector.

"London is the major financial services sector of the world. Of course we are likely to be more severely affected as a result of the profitability being reduced and I've made that point on many occasions.

"We're also affected by the downturn in the housing market because of the reduced revenues in relation to stamp duty."