Latvia prepares to face its "D-day"

By bne IntelliNews October 2, 2009

Mike Collier in Riga -

October didn't begin well for Latvia's economy - but then it's hard to remember a month that did in the recession-wracked Baltic state.

October 1 saw Eurostat data released that showed Latvia's unemployment rate reached 18%, while the rating agency Moody's reaffirmed that, "The fundamental credit outlook for the Baltic banking systems is negative."

On the same day, state auditor Inguna Sudraba - one of the few figures to retain any level of public trust - released a critical report on last year's emergency nationalisation of Parex Bank. The remarkable collapse of Parex, former poster-child of the Baltic economic boom, was the event that revealed to the rest of the world Latvia's perilous economic position and forced the country to seek a €7.5bn emergency bailout from international lenders, which is still being squabbled over. Sudraba said the Parex deal was "rushed" and "allowed a number of errors that significantly affected the 2008 state budget." The LVL674m (€953m) spent on Parex up to the end of 2008 was equivalent to 37% of budgeted state tax revenues for 2009, she pointed out. When it acquired the bank, the government had little idea of its assets and liabilities, having ordered an audit only after the deal was a fait accompli.

Tellingly, large chunks of Sudraba's full report remain censored, sparking speculation that they contain damning evidence of dodgy dealing among the then-government of Ivars Godmanis, many members of which remain in the current government of Prime Minister Valdis Dombrovskis. The Latvian central bank was quick to react to the report, issuing a statement fretting about the impact it might have on the markets and potential future buyers of Parex, whilst hastily adding that publishing the report was actually correct.

Having kittens

Anyone whose appetite for gloom was so far unsated on October 1 could wander across Riga's Stone Bridge in the rain to hear more at the annual conference of the Latvian central bank, where Andris Ozolins, head of DnB Nord in Latvia, told delegates that banking sector losses would likely exceed LVK1bn (€1.4bn) in 2009. "We were called a Baltic tiger, but we now look like a kitten," Ozolins said in a game attempt to make the stony-faced bankers smile.

None did, perhaps because they knew the real D-day for the Latvian economy is yet to come - on October 23 to be precise, when Finance Minister Einars Repse is due to deliver his 2010 budget to parliament for approval. Whether he gets that approval or not could determine Latvia's economic future for years to come, and it is by no means certain he'll carry the day.

Repse and PM Dombrovskis from the New Era party are fighting a running battle with the People's Party, the largest of the five parties in the ruling coalition. The People's Party is acting as awkwardly as possible in its attempts to make people forget it was largely responsible for the position in which Latvia finds itself. It has wrecked efforts to introduce a new real estate tax, has played fast and loose with deals signed with the IMF and EU, and even "accidentally" released market-sensitive information about future paper issues during a parliamentary debate. Dombrovskis is doing his best to deal with the People's Party's "games" without admitting the obvious: that he is being lined up as a scapegoat. "What do they want to achieve? That's not very clear and something they have stated very clearly, but certainly they are changing their positons on several issues where they had a clear position," he told bne.

People's Party eminence gris and former PM, Andris Skele, has become a cheerleader for devaluation of the national currency, the lat. But the central bank governor, Ilmars Rimsevics, has always been against such a move and his rhetoric in recent weeks has become tougher, describing as "quacks" advocates of devaluation. "Some say Latvia has an alternative - to devalue the lat. From devaluation there would not be more money. Inflation would rise, import prices would rise. Price growth would diminish consumption. Devaluation would not help, but it would increase our payment problems," he told the central bank conference. "Devaluation would lower our ability to attract investment. It would not solve the basic problem of sustainability and a balance between expenditure and revenue."

Nevertheless, the pro-devaluation camp appears to be gathering strength, if only because hard-pressed Latvians are getting sick of bad news. The idea that a quick fix is available instead of years of painful reform is a tempting one. One of the most perceptive Baltic-watchers, Neil Shearing of Capital Economics, thinks devaluation may be on its way. "We think the real exchange rate still needs to fall by something like 25%, and that this is now most likely to occur via a devaluation of the currency peg," he said. "At present the peg is being propped up by a huge IMF-led bailout package. But with little public or political appetite for the further cuts in government spending being demanded by the Fund, the programme's future is in doubt. We think it is more likely than not that Latvia will devalue its currency over the course of the next year."

Should Finance Minister Repse fail to win approval for a budget containing LVL500m worth of cuts, the consequences for Latvia will be dire. Both the EU and IMF are losing patience with the Latvian government's inability to stick to its agreements.

Elena Flores is overseeing the European Commission's support to Latvia and is clearly frustrated. "Sometimes I'm surprised the way political developments go in this situation," she told bne. "In the current crisis, one would expect a stronger sense of having to come together irrespective of different parties having different views... We are not the police of the EU member states, but when we come back in November we expect to see the conditions of the agreement have been fulfilled. If the answer is 'no', the rest of the loan that is available will not be able to come."

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