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Latvia: Internal political fights and IMF pressure
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”, reports businessneweurope.eu.
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."

Swedish newspaper „Svenska Dagbladet“ reported, that Swedish finance minister Anders Borg confidentially met with the heads of biggest banks and warned them,

according to newspaper, about “coming finance crisis in Latvia”. Such scenario would be very unwelcoming to Swedish banks SEB, Nordea and Swedbank.
A. Borg said, that it is expected that Latvia will approve the budget level as agreed with IMF and EU, otherwise country is in risk that these institutions will turn away and financial problems will only deepen. Latvia is in obligation to pursue very strict fiscal policy. And the budget of 2010 should be compatible with that.
EU offered Latvia to decrease its budgetary expenses by LVL 500 billion, so budget deficit decreases from 10% in 2009 to 8.5% next year. Budget plan should be approved at the end of October.
The Economist discussed whether IMF and EU would leave Latvia without financing. It was doubtful because with the default it would take down with itself also other countries in the region.
About the coming crisis A. Borg warned already in September, when next year budget was produced. It said that “Since it is difficult to evaluate, whether Latvia will be solvent, and when it will recover, it is impossible to totally reject a risk of significant default”.

Latvia: Lat stability
Lat devaluation risk increased again when country’s government initiated actions to protect households having credits, says Financial Times.

Government intends to define that banks can settle their claims against private households having mortgage credits only for pledged real estate, meaning that credit value and asset value will be related. Taking into account that during last 2 years real estate values went down by more than 50% and some of the households could take an advantage of stop paying loans, banks appear to be in a very unfavorable situation now, since. Swedish banks, having dominating position would have to take biggest part of the losses. Banks’ balances are quite strong to cope with these losses, nevertheless equity indicators would decrease banks’ capability to issue credits and influence Swedish market as well.

“From Government point of view, the biggest advantage will be the fact, that devaluation would not make big problems. The biggest barrier until now was the fact that majority of credits were denominated in euro, but mortgages evaluated in lats, therefore devaluation would significantly increase credit value if comparing with the pledge value”, says Danske Bank.

Jyske bank does not predict lat devaluation, but say it will be inevitable, if government would not take necessary budgetary expenses corrections.

Prime minister Valdis Dombrovskis asked to prepare urgently amendments to Civilprocess and other normative acts, overseeing the limits for banks to claim against private borrowers, if the loan was taken for the only housing. The claim is to be settled only against the pledged property, and there would be no responsibility for the warranties.

The head of Latvia central bank again said that devaluation is a myth and would not give any positive results, only the rise in inflation, higher financing costs, more expensive imports and lowering purchasing power and other.

“Devaluation only would make situation worse and there would be more difficulties to solve fiscal and finance sector problems. Growing government debt is presumably the factor which upsets foreign investors and they are willing to wait. In a case of devaluation, external debt would increase by the devaluation percentage and it would increase its maintenance costs. Furthermore, it would not help to solve Latvia’s fiscal problems – matching expenses with long term income”, he said.

Euro price in lats came very close to Latvia central bank intervention limit when government unsuccessfully tried to sell its securities last week. LVL/EUR rate came up to 0.7088, but the official fixed rate at which LVL is pegged to euro is LVL 0.702804 for 1 euro. Exchange rate is allowed to fluctuate only +/-1 % from a fixed rate. Latvia central bank intervenes the market and buyout lats when the rate LVL/EUR rate comes to 0.7098. Last time intervention was necessary in June 2009 when talks about lats stability came up.

Baltics: Unemployment in Baltics 
Official registered unemloyment level in Latvia in the begining of March was 9.5% - 1.2 percentage point higher than a month ago. According to Employment Agency data, there were 103.7 ths. latvians searching for a job.
Government expects, that uneployment rate should be kept within 13% level before the year end, even though some unofficial sources speak about real 25% and higher unemployment rate.
In the end of February, Lithuania reported official unemployment rate 8.2% - there were 176.4 ths. people looking for a job.
Estonia’s jobless rate was 7.1%, up by 1.1 percentage point since January end. Officiallly there were 46.4 ths. of free workforce, 177% more than a year ago. 

Eastern Europe is the region hardest hit by the global credit crisis and recession, largely due to its relatively large exposure to foreign currency borrowing. During the summer, the economic cycle has nevertheless bottomed out in Eastern Europe as well. But the recovery will be shaky and uneven, predicts SEB in its October 2009 issue of Eastern European Outlook.

The main reasons for the shaky recovery are public sector budget consolidation and the fact that credit tightening will ease only slowly.
Exports will gradually strengthen. Domestic demand will remain weak in the coming year, however. Households will be squeezed by a weak wage and salary trend and by rising unemployment, while corporate capital spending will be hampered by large idle production capacity and cautious lending practices.
“Our conclusion is that the recovery in Eastern Europe will be highly dependent on a continued upturn in the world economy, especially in the euro zone, which is a major export market for Eastern Europe,” says Mikael Johansson at SEB Economic Research.

Poland is the only EU country to start its recovery without having fallen into recession and SEB expects a continued gradual strengthening of polish growth in 2010-2011. Russia will recuperate at only a moderate pace from its historic GDP decline in the first half of 2009, despite being buoyed by higher commodity prices. The Ukrainian economy will return to only weak positive growth in 2010. Of the three Baltic countries, Estonia is best positioned for recovery, with GDP growth ending up around zero in 2010 and rising the year after. In Latvia and Lithuania, GDP will continue to shrink next year, though only moderately. These countries will resume positive growth on an annual average basis only in 2011.

In many countries of the region, certain key economic imbalances such as large current account deficits and high wage-driven inflation have been wiped out. Remaining as challenges are necessary budget corrections after very large 2009 deficits in many countries, higher than in the euro zone. Thanks to continued international bail-out loans, SEB expects hard-pressed Latvia and Ukraine to avoid suspension of payments.

In the Baltics, depressive economic forces will remain in place next year. Painful austerity policies will continue, including further pay cuts to restore lost competitiveness. Political tensions have increased, especially in Latvia and Estonia. There is a risk that exchange rate worries will re-emerge in the run-up to the Latvian parliament’s vote on the 2010 budget. It is also still an open question whether Estonia will meet the vital budget deficit criterion for the desired euro zone accession in 2011.
“Our main scenario is that the Baltic countries’ fixed exchange rates against the euro will survive and that the international loan program will remain on track. The coalition government in Latvia will probably work out a new austerity proposal for 2010 that the EU, the IMF and the Nordic countries will accept,” Johansson says.

 

 

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