Latvia's date with the euro slips further

By bne IntelliNews October 30, 2007

Mike Collier in Riga -

Latvia's embattled government claimed on October 24 that it's finally getting the economy under control after passing its 2008 budget proposals. Yet 24 hours later, the head of the central bank was providing more bad news by pushing back the target to adopt the euro. The most likely date now looks to be 2013, and even that may be optimistic given soaring inflation and a yawning current account deficit.

"A lot of people assumed that once we joined the EU, monetary union would come almost as a given," Ilmars Rimsevics told an audience of the Baltic's financial movers and shakers on October 26.

"Latvia and some other countries will miss the first window of opportunity," he admitted, adding that no one could have foreseen the factors that are taking the country away from the road towards the euro.

By Rimsevics' reckoning, those factors include massive inflows of foreign investment, unlimited EU funds, remittances sent home by Latvian workers abroad and consumer credit characterised until recently by ready money with few questions asked. "We know how we got into this situation and we know how to get out," Rimsevics said, adding that there was "no doubt" that inflation would fall early in 2008.

Official government policy is targeting a 2012 introduction of the euro. Rimsevics believes that date is possible, but would require a big commitment and was quick to add that 2013 might also be a possibility, describing euro adoption as "a reward for combating inflation" - currently 11.4% and rising.

Tensions

Despite Rimsevics' show of support for the government, there are clearly still tensions between the central bank and the government. The budget adopted the bank's bare minimum recommendation of establishing a surplus of 1% for 2007 and 2% for 2008, and opposition figures argue that even these figures have been extensively massaged.

With nominations for the next stint as central banker closing on October 26, it was noticeable that the People's Party of Prime Minister Aigars Kalvitis waited until just before the deadline (and just after he had delivered his speech) to give their official backing to Rimsevics' continued tenure.

Nor may it have been coincidental that Rimsevics made a point of describing the support of the Slovenian government for its own central bank in recent years as "incredible." Slovenia became the first Central and Eastern European state to adopt the euro on January 2007.

At the helm of a government that's currently lacking a foreign minister, economics minister and regional development minister (other ministers are covering, with the prime minister himself taking the economy portfolio), Kalvitis simply has too much on his plate to think about ousting Rimsevics, who is regarded in financial circles as a safe pair of hands. He has been instrumental in building up significant reserves at the Bank of Latvia (enough to cover every lat in circulation) and has consistently played down periodic devaluation panics.

Other economy-watchers generally agree with Rimsevics' assessment, though doubts are starting to creep in about when inflation will actually start falling. "The size of the current account deficit and the shortages in the labour market are bigger problems than inflation," SEB Unibanka chief economist Andris Vilks told bne. "I expect to see inflation peak sometime in the next three to six months. By September 2008 it will still be around 7.5-8%."

His counterpart at Hansabanka, Martins Kazaks, says the 2013 target "seems okay," but won't happen by itself. "There are still loads of things for the government to do to drive down inflation. It is good that they aim for a surplus, but more comprehensive reforms must be implemented such as increasing efficiency of the public sector, which means shedding labour," Kazaks says.

But Kazaks lines up with Vilks in suggesting that Rimsevics' inflation diagnosis is too optimistic. "Average CPI inflation in 2008 will be at about 9-10% due to very high inflation early in the year and then falling gradually."


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