Mike Collier in Riga -

As birthday presents go, €500m certainly beats book tokens - which probably explains why Latvian Prime Minister Valdis Dombrovskis was in such a good mood on March 11, at a briefing outlining his achievements during a hectic first year in office. And not even the loss of a member from his five-party coalition government the following week has spoilt his mood.

Minutes earlier, the European Commission had deposited the cash - the latest instalment of a €7.5bn package brokered by the Commission, IMF and World Bank - into Latvia's state coffers, adding another tick to a report card that President Valdis Zatlers had signed off like a headmaster the day before: "If you are a student there is a pass-fail column. He has been promoted to the next grade, so can continue working," Zatlers said.

Though 38-year-old Dombrovskis remains Europe's youngest PM, initial estimates of him as a milksop who would last weeks rather than months when he took office on March 12, 2009 have proven inaccurate. Noticeably more confident than in his first press conferences and sporting a slick dark suit instead of the previous drab grey affair, he has toughened up and repeatedly outmanoeuvred his political rivals, most notably in the case of former PM and arch-intriguer Andris Skele of the People's Party whose attempt to re-enter the political fray following a money-making sabbatical has generated less electricity as a party balloon rubbed against a woolly jumper.

Skele attempted to be the pooper at Dombrovskis' birthday party on March 17 when he finally made good on his numerous threats to pull his own party out of the five-party ruling coalition. But if the intention was to undermine Dombrovskis' authority, Skele's gambit has backfired spectacularly, tying the remaining coalition parties together much closer than before and passing the initiative to two other opposition parties, the business-friendly LPP/LC and the Russian-friendly Harmony Centre who have signalled they are ready to work with the government without joining it.

Some commentators are already saying the People's Party is history. Skele put in a hapless performance in a televised debate with Dombrovskis on the day of his pull-out and a decision by one of five People's Party ministers, Ints Dalderis, to keep his job at the Culture Ministry and quit the party instead shows which way the political winds are blowing. And not even the skittish markets bothered to panic in the wake of the coalition collapse: "The market reaction to Latvian political jitters has been limited and we have not seen any spill-over into other CEE markets," said Danske Bank.

Dombrovskis tells bne that the main problem is not political instability, but to make sure that pre-election fighting won't translate into some kind of macroeconomic or financial instability. "This would be the worst thing that could happen."

Poisoned chalice

The Latvian economy may have contracted by 18% in 2009, but no one blames Dombrovskis for that situation, which he inherited from his predecessors Ivars Godmanis and Aigars Kalvitis. And Dombrovskis has managed to keep the IMF and Commission onside and keep the state liquid. In fact, one of the main dangers now is that the money is flowing in too quickly. "It's somewhat early to say if we will end up using the whole amount of (loan) money," he says. "In any case, we are not raising the debate yet. What we raised is really just the pace of absorption of the money. In a sense we are already falling behind the original schedule but what we see is that probably we'll need to slow the absorption further because we have plenty of resources in the treasury and we do not need to pile up excessive reserves to pay interest on them."

"We are talking about slowing the receipt of funds, we are not questioning the repayment schedule. The aim is to be able to refinance this loan in the financial markets at the end of the loan period."

The agreements signed with the Commission and IMF make the government's fiscal targets clear enough, but with elections approaching in October, Dombrovskis is understandably shy of saying where the axe will fall next in order to meet those targets. "We know that we need to move from 8.5% of GDP deficit this year to 6% next year, so it's 2.5% of GDP that is needed," he says. "We need to see first how macroeconomic developments are to estimate how much of the adjustment will come from growth. In 2011, we expect economic growth and corresponding tax revenue. But also there will be a need for further real fiscal measures: possible expenditure cuts or tax rises."

"Medium term we foresee shifting the tax burden from labour to consumption and property. We had a very heated political debate about this while preparing the 2010 budget. Those decisions will eventually be made by the next parliament," he says.

Balancing the books won't be easy, as the experience of increasing duty on cigarettes has shown. Revenues from cigarette sales have plunged and contraband has flooded the country. Barely a week goes by without a big bust by border guards, begging the question of how many truckloads of Chinese smokes are actually making it into the country. Judging from the number of Jin Ling packets in Riga's bins, lots.

Describing the probability of his still being in office by election time as "certainly more than 50%," Dombrovskis is certain the public understands his programme of austerity measures is necessary to rebuild the economy. "There is a continuing improvement in the polls regarding the assessment of our work. The message is getting through," he says.