Is It Hot In Latvia In August?

Well the big news this morning is that the IMF mission to Latvia has finally reached agreement with the Latvian government on a new policy package that will give the country access to about $278 million in new financing. Details of the deal are scant at the moment, since the Letter of Intent will not be published until the IMF board approves the agreement, but it seems the terms of the IMF deal are (on the face of it) tough: additional budget cuts worth a reported 500 million lats ($1.02 billion) for 2010, a progressive income tax with the possibility of an increase in VAT if the cuts do not reduce the budget deficit to the stipulated level.

Really, this agreement changes very little in my opinion. As Capital Economics’ Neil Shearing points out, many people are assuming that with the rapid Current Account adjustment in many CEE countries, the threat to external financial stability has largely gone away. But as Neil argues, while theoretically, it should be enough for the countries just to move back to balance, practical experience from Argentina etc suggests that as recovery arrives the CA tends to move from large deficit to large surplus. And this of course means exports growing at a much faster rate than imports. This is the only practical way to pay down the debt.

And as Afoe’s own Claus Vistesen puts it:

This is all about the composition of the external balance and what kind of extensions foreign creditors give. Now, the benefit of the peg is of course that you can begin to accumulate foreign assets at reasonable valuation to your liabilities. HOWEVER, the only way to reasonably begin this process is of course to actually begin accumulating those assets and in order to so so, you need productive investment targeted at foreign operations and this is very difficult unless the “internal devaluation” has run its course. Essentially, domestic investment to serve foreign markets are not productive until deflation has taken its toll.

So basically the message is, whatever the final details of the new agreement, stay tuned and keep watching, since all of this is far from over.

Edward Will Not Be Going To Latvia In August

The little news of the day is that I will not be attending the conference on Latvia’s economic future which members of the Peoples Party are trying to organise for August, even though I was invited. As the Latvia Daily Diena (Latvian only I’m afraid) which reports on the preparations for the conference puts it “E. Hugh, who declared himself a defender of the lat devaluation, however, declined to participate, adding he’d like to maintain political neutrality.” Well, this is fair enough as a presentation of my opinion, but, just for the record, here’s what I actually did say.

First of all I would like to say thank you very much for thinking of me and inviting me to your conference….

….while I think a decision to accept the original IMF proposal of a 15% devaluation of the Lat, and pressure the EU Commission into euro entry was the best option last autumn, this is now no longer the situation. So while I was advocating devaluation back then, what I am saying now is that in my opinion devaluation is inevitable at some point, but that it will now be an unholy mess. Serious contagion problems will most likely ensue, and so in this sense I am no longer “advocating” Latvian devaluation. Ideally it needs to take place as part of a much more general solution to problems in the economies of the Eastern European countries who are members of the EU.

If Latvia is simply forced off the peg, then we should all watch out. I am in Spain, and I am expecting consequences here.

Thirdly, I am not in basic disagreement with the IMF, and would not wish to do anything which may make their work more difficult. Basically, from where I am sitting the issue is to put pressure on the EU institutional structure in an attempt to get them to recognise some of the basic ABCs of economics.

Lastly, I would emphasise that I am an economist, a mere technician of economic systems, and not a politician. I am explicitly non politicial, and am maintaining this stance both vigourously and adamantly.

Basically, as I said, I consider devaluation inevitable….. tomorrow, in August, after Christmas, in 2011, I don’t know when. I also know that the longer it is in coming, the more serious the consequences will be, due to the continuous degradation in the credibility of the associated institutions (IMF, ECB, EU Commission, EBRD etc). This is all now quite likely to eventually become (via the other Baltic states, Bulgaria, Hungary, Romania and even Ukraine and Serbia) a very serious problem, with potentially major global implications.

So there will be a before and after. After devaluation there will need to be a major rethink about where Latvia is going. Devaluation is not an end in itself, it is simply a means to an end, a begininning. We also need to think about how Latvia will earn its living, pay off its debts, and find its way in the world.

Long term structural, and strategic economic thinking are needed.

Here I think I do have a part to play. As you may well have noticed, my view is that the ongoing demographic deterioration of your country lies at the heart of your macro economic problems.

I think this deterioration needs to be addressed as soon as possible, and I see three large issue.

i) Productive capacity needs to be increased substantially. This means increasing the labour force, and this means (as outlined in the World Bank Report, From Red To Grey) facilitating large scale inward migration. Given the serious political implications of encouraging ethnic Russian migration into your country, I see only two viable source regions, the Central Asian Republics in the CIS, and Sub. Saharan Africa. Possibly this solution will not be widely popular with Latvian voters. Well, they do have the right to choose. Your country can take the measures needed to become sustainable, or you can watch it die, as the economy shrinks, and the young people leave. That, I think, is your choice.

The other two measures you need to take are contingent on the first being implemented, since without the first measure you will simply not dispose of the economic resources for the other two.

ii) A serious policy to support those Latvian women who do wish to have children. But with major financial advantages, not half measures, and propaganda stunts. You need policies that can work, and I know plenty of demographers with ideas.But this needs money. Important quantities of money. And gender empowerment, right across the economy, at every level. We have formal legal equality in the labour market, but evident biological and reproductive inequality, in that only one of the parties gets to bear the children. The institutional resources of the state need to redress this imbalance.

iii) Major reforms in the health system to address the underlying male life expectancy problem. You can only seriously hope to raise the labour force participation rates at 65 and over if people arrive at these ages in a fundamentally healthy condition. In economic terms, simple investment theory shows why this is the case. A given society spends a given quantity of resources on producing a given number of children, those who have citizens who live and work longer evidently get a better return on their investment. If you want to raise Latvian living standards, you have to raise the life expectancy. And this apart from the evident human issues.

OK, I am saying no for the moment, but I would like to stress that when conditions change, I would be more than willing to come to your country to try to help. But not for a day, for a month, and not to give a talk, but to work with some serious people who are willing to roll their sleeves up and do the serious spadework that will be needed to find those solutions you so badly need.

Basically, my feeling is that the issues you face are so complex that public debate is unlikely to produce a very fruitful outcome at this point. You need a long term education process, and for the time being more or less technocratic solutions, but not the technocratic solutions you are being offered by the EU now (which basically won’t work), technocratic solutions which get to the heart of the problem and set your country on a sustainable path.

New Balkan visa rules: Serbia in, Albania still out

And the Montenegrins and Macedonians. EU Commissioner Olli Rehn just announced his recommendation that these three countries be granted visa-free travel to the EU starting January 1, 2010.

While many European readers will blink and shrug, this is a huge, huge deal for the region. For the last 20 years, it’s kinda sucked to be a Serb. Back in Yugoslav times, you had one of the world’s best passports. East, west, developing world… the Yugoslav passport was welcomed for easy travel in almost every country on earth. But after 1991, suddenly your passport was a piece of junk: nobody welcomed Serbs, you were often viewed with suspicion, and you had to fill out elaborate forms (and wait for months) to get a visa to enter the EU. Even after the wars ended, Serbia was still kept firmly at arm’s length.

A whole generation of young Serbs have grown up grumpy about this: they didn’t do anything, so why are they being punished, while young Croats and Bulgarians can freely travel to London and Paris?

No more. Assuming the recommendations is approved — and it’s almost a rubber stamp — then six months from now, Serbs (and Montenegrins and Macedonians) will be able to jump on a plane and just fly to anywhere in the EU, no visa required.

Mind you, they won’t be able to get work permits. It’s just travel. But still: it’s going to make a huge difference.

This being the Balkans, there are of course some complications.
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Serbia and Prishtina: further and further

Here’s an interesting article that I somehow missed when it came out a few months back. It’s a dialogue between Serbian writer Vladimir Arsenijević (who we’ve met before) and Kosovar Albanian journalist Migjen Kelmendi.

If you’re interested in Kosovo, read the whole thing: it’s all good. But this is the bit that jumped out at me:

Arsenijević: [I] really don’t known anyone in Serbia who is keen to maintain regular contacts with artists in Kosovo, or who thinks that it should be done. Books by Kosovo Albanians are not being published, so we have no idea what is happening there. Each act that assumes some good intention towards Kosovo Albanians has to be explained at great length. It is not that the police ask you to come down to the station for a chat, no, that does not happen; but you have to justify yourself in the most normal, everyday conversations. The problem lies in the fact that, when it comes to the Albanians, we are filled with anger, rage and a feeling of being losers; that we act like some injured partner or spouse who has been denied something that he believes naturally to be his own. If you say: ‘There is a great writer in Kosovo, who has written a novel’, they will talk not about the novel, but about the author’s nationality.

Karabeg: Mr Kelmendi, do Albanian artists from Kosovo want to work with Serbia, to have their books translated there, to exhibit their paintings, to have a theatre perform there, or do they want artists from Serbia to come to Kosovo, to Prishtina?

Kelmendi: No. They are definitely no longer interested in Belgrade and Serbia. They are fully oriented towards Tirana and Albania. It is there that they wish their works to appear. I would say that the Kosovo Albanians have turned their backs on Serbia for good. There is not the smallest wish to know what is going on there. It seems at times that Belgrade for them is a faraway city, that Serbia is a faraway land. They do not translate books by Albanian authors. Apart from occasional individual contacts, communication has practically ended.

Arsenijević: Belgrade was not very open towards Kosovo Albanians, and now we see this being repaid by turning their backs on Serbia.

This is, unfortunately, true. Kosovo is a young society — the average Kosovar Albanian is about 25 — which means that most Kosovars have no adult memory of peaceful, friendly interaction with Serbs. The Serbs north of the Mitrovica have as little contact with Albanians as possible; the Serb communities left in the rest of Kosovo are small and insular. Continue reading

The invisible hand of letting people know who’s boss

Edward links downblog to a piece by Ronald Bailey in Reason magazine. My precis of Bailey’s thesis runs something like this. Having children, per se, isn’t so expensive. Educating them, on the other hand, is very expensive. This is because the levers of a modern, free market, rule of law, enforcement of contract society are complicated and you need a lot of training in order to know which lever to pull, and when. In actuality, lack of training generally leads to denial of access to said levers and hence a lifetime of poverty, and no one wants that for their child. Hence the expense of education deters prospective parents from actually going ahead and having children; this is the ‘invisible hand of population control’. And it’s a good thing! This is because no one wants a tragedy of the commons situation, like you’ve got in all those poor countries.

I can see the following problems with Bailey’s argument, in no particular order, and not worked through, since this is not an essay:

(1) There’s your local commons, and then there’s the global commons. Further, population and global resource depletion need not be coupled; the small population of a developed society may take more in the way of resources from the world than the much larger population of a less developed society;

(2) The length, complexity and cost of education need not be coupled to the total skill demand in a society; to take a picturesque example: piano tuning is a difficult skill to acquire, but it’s easy to imagine a society that generally prefers simpler instruments and has no pianos at all;

(3) In actuality, the length, complexity and cost of education is often to do with status display; in many (most?) societies, education is a positional good purchased by the parents;

(4) The cost of education need not be the only, or even the main deterrent to having children; it’s possible to find low birth rates in actual societies where most (or even all) formal education is state provided (and hence, obviously, the cost of that education is shared between all taxpayers);

(5) It’s fairly well established (I think) that freedom is not something that necessarily flows from rule of law and enforcement of contract; it’s possible to have a society where many citizens have relatively little freedom yet all contracts are honoured;

(6) In the context of (5) above, we should probably ask what Bailey means by ‘economic freedom’; his gist seems to be ‘those freedoms enjoyed by the better off’;

(7) A society where a majority composed of not so well off people is deterred from raising children – and where, by contrast, a few well off people have lots of children – is not necessarily a very nice society. I’d suggest there might be gentler ways of avoiding tragedy of the commons situations.

It Isn’t Only Canicular Heat They Are Suffering From In Latvia

Maintaining the peg also requires substantial political commitment. If this commitment were to falter, there is a risk that the execution of the difficult but necessary policies required under the authorities’ program could also weaken. However, all political parties are strongly committed to the exchange rate peg.

How the world changes in six months. The above lines come from the IMF “Republic of Latvia: Request for Stand-By Arrangement – Staff Report” of January 9 2009. But just today we can read in a Baltic newspaper:

“Reliable sources tell LETA that the International Monetary Fund (IMF) has stipulated that the loan agreement document must be signed by all ruling coalition parties in Latvia, thereby showing their resolve to implement it.”

The reason the IMF are now so edgy is spelled out by Reuters Political Risk Correspondent Peter Apps:

A string of other countries are also facing stark cuts, and analysts say in many – like Latvia – domestic politics could well intervene as elected politicians are unwilling to face the political consequences of cuts demanded by the IMF and wider financial markets.

So what the IMF are evidently worried about is the possibility that some coalition members may support the agreed measures just long enough to get the payout, and then effectively disown them. This seems to be a far cry from the substantial political commitment that was earlier considered to be so essential to maintaining the peg.

And the issue goes well beyond Latvia, since as Apps points out, a string of other countries are in a similar if currently marginally better condition, including Bulgaria, Romania, Lithuanis and Hungary, all busily making cuts while coming to rely more and more on multilateral lenders.

So if there is no clear resolution to Latvia’s growing dispute with the IMF, the European Union could end up facing a dilemma – whether to bail out troubled emerging European countries who won’t make cuts or face the consequences of not doing so. As Lars Christensen, head of emerging markets research at Danske Bank in Copenhagen says:

“This could be a test case for Europe….In Latvia, it’s domestic politics that really become the driver. The question is what the EU would do if the IMF walks away.”

A good question.

In the above quoted IMF document, they also make the following point:

Correcting currency misalignment without nominal depreciation is extremely difficult, as experience from other currency board and fixed exchange rate countries continues to show. Large external financial support and sustained wage and fiscal discipline by both the private and public sectors are required. Failure could entail substantial reputational risks for both the authorities and international institutions.

The last sentance is important, failure could entail substantial reputational risks for the international institutions involved, in particular in this case for the IMF and the EU Commission. This loss of credibility should the peg eventually collapse in chaos is one of the considerations that lead some of us to argue strongly from the start against going down this road. But few would listen.

Beyond the immediate issues of the peg, there are also serious structural considerations which make this kind of “body-with-two-heads” approach less than desireable in delicate situations such as this. Even if all we have here is – as some would suggest – a soft-cop hard-cop duet, the policy of letting the EU Commission permanently play the role of soft cop is hardly desireable, especially for the message it will be sending to Southern Europe, where our improvised duo may soon find themselves once more forced into action. And especially also for financial markets where nervousness about the ability of Europe’s complex institutional structure to handle the evident continuing weaknesses in the banking system is still highly evident. Leaving the impression that the EU itself is not able single handedly to deal with its own recalcitrant offspring is not exactly the best way to convince the sceptics.

Today’s Latvia Roundup

The exact state of play in the negotiations with the IMF is still far from clear. Latvia’s Prime Minister Valdis Dombrovskis said on Thursday that talks with the IMF were making progress on issues of pensions and taxes and results of the talks are expected early next week, but since we have been getting news like this for some days now it is hard to draw conclusions.

Izabella Kaminska at FT Alphaville thinks the analyst community is increasingly interpreting the deadlock as yet another (and possibly decisive) chink in the armour of Latvia’s euro-peg defence, citing in particular the latest research note from the RBC Capital Markets’ emerging markets team. While Capital Economics’ Neil Shearing is even more explicit:

Relations between the IMF and Latvia are deteriorating quickly, raising the prospect that the loan programme that is vital to maintaining the country’s currency peg could collapse altogether….. with relations between both sides souring, and the pain in the real economy intensifying, it remains to be seen how long a new agreement will hold. Indeed, there is a growing risk that the programme could collapse altogether, which would spell the end of the currency peg and trigger a round of debt restructuring.

As for me, I agree with Neil, this situation has now become so unstable, while the internal devaluation is working so slowly, that the Fund really need to think about how to handle the damage containment issue. The crisis is far from over in the East and South of Europe, and the risk of a spark from this whole fiasco setting either Athens or Madrid alight is most certainly non-negligable. I advise all concerned to think very carefully at this point about the implications of what they are doing, for the sake of all our well-being. The Maginot line may still be far from broken, but a distant fortress on our outer defence ring may well be about to fall. Let’s just learn the lessons shall we?

Escaping Original Sin in Hungary?

According to the well known textbook in international economics by Maurice Obstfeld and Paul Krugman [1] the notion of original sin refers to the fact that many developing economies are not able to borrow in their own currencies but are forced to denominate large parts of their sovereign debt in order to attract capital from foreign investors. The argument then goes that if and when the goings get tough those countries will face difficulties paying off their liabilities and once the dust have settled the sin, as it were, has only become more binding when these same economies yet again venture onto international capital markets.

It is interesting to ponder this story in relation to Eastern Europe where far from being a sin the ability to denominate liabilities in foreign currencies such as Euros and Swiss Francs was almost seen as a virtue of modern capital markets during the boom years which followed the famous meeting in Copenhagen which saw the European family expand to 25 countries, a number which now has risen to 27. On the face of it, it is not difficult to see where this virtue came from. Aggressive expansion by western European banks into the CEE and a low volatility environment ultimately driven by the notion of a road map towards convergence bound to bring forth an equalization in living standards and, in the case of many CE economies, a certain membership into the Eurozone underpinned the fact that the ability to shop foreign currency loans was hardly a sin, but a natural counter product of the newly formed European community.

Now, all this has capsized and those economies who where so busy raising rates going into crisis in order to quell the massive inflationary pressures, which further intensified the flow of foreign currency loans, are now effectively stuck with no ability to tweak monetary policy since the low rates which are needed are either impossible (in the case of the Baltics and their Euro pegs) or de-facto impossible in the context of e.g. Hungary and Romania. Moreover, and in a world where major central banks are stuck at the zero bound and where the level of volatility may itself be volatile as we move from optimism to pessimism all that liquidity may yet again prove to be a destabilising factor in the context of Eastern Europe where we were all, I am sure, amazed, to learn a couple of months ago how some analysts were advising clients to play the carry trade with Eastern European economies as designated targets, for more on this see this post.

So what does all this has to do specifically with Hungary? Well, today we learned from Finance Minister Peter Oszko that Hungary would certainly prefer to issue local currency debt in the future, but given the fact that the IMF loan is not, by nature of it being a loan, permanent Hungary also need to find a viable way to make its policy tools work most effectively. The following excerpt is from Bloomberg;

Hungary doesn’t plan to raise foreign-currency debt in the “near future” and will increase sales of forint-denominated bonds to finance the budget, Finance Minister Peter Oszko told Nepszabadsag. “In the short term, the budget doesn’t need foreign- currency denominated financing sources,” Oszko said in an interview with the Budapest-based newspaper. The Finance Ministry has confirmed the comments to Bloomberg. “Increasing forint-based issuance is more worthwhile.”

Hungary sold 1 billion euros ($1.42 billion) of debt last week in its first offering since the flight of investors forced it to take a 20 billion-euro bailout from the International Monetary Fund, the European Union and World Bank in October. The country is working to wean itself off emergency financing. The IMF-led loan, which “secures a comfortable situation,” runs out in March 2010 and the government must work to ensure the country can finance itself from the market at lower rates by then, Oszko said.

“The July auction’s primary importance wasn’t to secure financing but rather to strengthen confidence in the country,” Oszko said. A “smaller” foreign debt sale is possible in the future as “it’s our basic interest to be active in the market.” Hungary could next target U.S. investors with the sale of dollar-based bonds, the newspaper Napi Gazdasag reported today, citing Laszlo Balassy, a Budapest-based executive at Citigroup Inc., which helped organize last week’s sale.

It should immediately be clear that this represents the original sin issue in full vigour although somewhat in reverse one could argue. Consequently and notwithstanding the obvious problems facing Hungary in the context of lowering rates, the country needs to balance the between issuing debt in foreign currency which would mean further currency translation risk and an even further entrenchment of the high domestic interest rates or issuing in domestic currency which might not be possible at current rates (i.e. rates would need to go up further) or simply not viable given the future financing needs.

To put all this in the context of a solid macroeconomic analysis I am in luck since Edward has just dished out an up to date look at Hungary’s economy. As Edward notes straight away, Hungary has now embarked on the great experiment also currently being tested in Latvia of internal devaluation and the long hard climb, through deflation, towards the competitiveness Hungary so badly needs. Now, I know that I tend to move closely together with Edward on many accounts but I dare anyone not to share the sentiment expressed by Edward as he points to the obvious point. The current strategy taken in Hungary to battle the crisis is not working and at some point one really has to stop to ask why.

One striking data point is the fact that while the real economy seems in absolute free fall real wages are still rising and given the inevitable point that Hungary needs wages to fall, and a lot, absent devaluation one wonders silently what kind of contractory jolt the real economy needs in order to engender this effect. Meanwhile, Hungary has also recently pulled out the good old trick of raising the VAT something which will surely to push up the main inflation index, once again pulling in the wrong direction.

As usual Edward is thorough, very thorough, and I can only suggest to spend the 20 minutes it takes to superficially digest his points. Especially the point about a monetary policy trap is mandatory reading. In terms of a summary of the situation the following gets to the heart of the matter;

And in case you had forgotten, here is what is happening to Hungarian GDP: while wages and prices are rising steadily, GDP is in free fall. Year on year it was down 4.7% in Q1 and Hungary’s government currently expects the economy to contract 6.7 percent this year, the most since 1991. My view is a total policy trap is in operation here, since neither monetary (interest rates are currently 9.5%) or fiscal policy are available, so there is little support to put under the economy at this point. The only way to break the circle in my opinion is to let the forint drop, bring down rates, and restructure the CHF loans.

As will no doubt come as a big surprise, I completely agree. Hungary needs to address the already existing asymmetry inherent in the economic edifice which should entail a strategy on how to deal with the stock of CHF loans on the households’ and corporates’ balance sheet. This also gives a final spin on the actual topic of play in this entry.

In all probability the dilemma difficulties facing the Hungarian treasury in terms of constructing a viable and solid platform on which to finance its operations is greatly dependent on the issue with the already existing fx denominated loans. If Hungary were to construct a credible and realistic solution to the issue of how to write down/pay off the stock of CHF loans my guess is that the original sin would be a little easier to escape even if not all together.

[1] Who follow the lead of Eichengreen and Hausmann.

Mario Draghi States The Obvious

The Italian economy will need to expand at a faster pace than averaged over the past decade for the government to be able to reduce Europe’s biggest debt. “We will emerge from the economic crisis with more debt and higher unemployment,” governor of the Bank of Italy Mario Draghi said in testimony to a parliamentary committee on organized crime. “In order to reduce them, we should be able to grow at a faster pace than over the last 10 years.”

Well, growing more rapidly than over the last ten years should not, in theory be difficult, since according to my calculations, and using the forecast of the IMF, the average rate over the last decade will be more or less zero by the end of next year. That is to say, GDP by the end of 2010 should not be much above GDP in 2001. Wanting to grow faster and actually doing it are, however, two different things. Indeed, I reckon the Italian economy is just as likely to contract over the next decade as it is to grow if you look at the trend line in the chart below.

China struggles to apply its own unique version of internal revaluation

Dropped into today’s IMF press releases is a brief account of the IMF board discussion of China’s annual economic surveillance report by the IMF staff.  The trick word here is “annual”.  Unlike most countries where there is indeed an annual report that gets discussed by the board, China’s last discussion was all the way back in 2006.  Apparently the holdup was the renminbi and in particular the US view that it was massively undervalued versus the reluctance of the Chinese government to have any such statement in print. 

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Hungary Struggles To Apply Its Own Unique Version Of “Internal Devaluation”

Just what the hell is going on in Hungary? This is the question which even the most cursory inspection of the latest round of data coming out of the country leads me to ask myself. What the hell is going on and just what kind of correction is this the IMF are presiding over here?

In May, according to the latest data from the Hungarian statistics office, in the Hungarian private sector real wages were up, and employment was down. Meanwhile in the public sector, real wages were down, but employment was up (contrary to what was supposed to be happening). A recent programme to get workers off the unemployment roles and back to work seems to have had the perverse and contradictory impact of offsetting the fall in private sector employment by giving a sharp boost to public sector employment. So while total employment has remained more or less stable, the balance has shifted, and in the wrong direction. Meanwhile, in an attempt to stem the bloodletting in public finances (the economy remember will probably contract by about 7 percent this year) VAT was raised – by the significant margin of 5 percent (from 20% to 25%) on July 1st, giving consumption, which was already falling sharply, another sharp jolt downwards. Not only that, the Hungararian economy, in order to maintain the value of the forint more or less where it is (all those forex loans) was supposed to be having a major downward correction in wages and prices, yet inflation (which was already at an annual 3.7 percent in June) will surely now be given a hefty kick upwards. So, I ask myself, how does any of this actually make sense, and to who? And meantime the problem of the forex denominated loans remains, and goes jangling around (like any good jailor does) in the background, putting an effective stop on monetary policy just as fiscal policy switches over to complete contracton mode. This is why I talk of “internal devaluation”, since the Hungarian authorities (with the agreement of the IMF and the EU Commission) seem to have decided that, rather than resolving the issue of the CHF loans once and for all, they will down the same road that is proving to be so disastrous in Latvia, even though they have their own currency to devalue, should they choose to do so.

At the end of the day, the big question which we are all left with is, whether this structural shift in employment, away from the private sector and towards the public sector, and the increase in the consumer price index to be caused by the sharp VAT hike, plus the ongoing rise in real wages, really is the outcome the IMF support programme was intended to achieve? Continue reading

Why Latvia Is In Such A Mess

Hat Tip to Aleks Tapinsh – “No wonder this country is in such a mess. Someone posted this video of a payday at the Elkor electronics chain in Latvia. The paycheck as you can see comes in an envelope, in cash. No one pays any taxes. And everyone happy. Or not”.

Second example: Prime Minister Valdis Dombrovskis cited in a press conference in Riga yesterday the fact that some companies, including state-owned companies like Latvian Railways, had tried to cheat the social security system by significantly raising the wages of some of its employees (in his example from 1,000 lats a month to 12,000 lats a month), thus apparently raising their pay into the social security system. That way, if a person gets laid off, they’d get 70 percent of the new and improved wage.

Now two recent quotes from my blog interpreting yesterday’s comment from the Economy Minister – (Viz: “Representatives sitting in Washington and educated at Yale do not fully understand what is going on in Latvia”)

“To provide with logic behind quote of the economics minister, I believe he thought that the EC and IMF does not realize the scope and importance of grey economy in the country. With that figure hard to estimate (ranging from 15%-40%). Any increase of Tax base will only push the economy on the gray side both for individuals (tax exemption on income earned) and for companies (unaccounted cash revenue, forgone taxes,etc). Thus resulting in even less tax revenue that initially had and larger budget deficit to balance. As for VAT tax, as a sign of protest, some of the local companies have publically annouced the full closure of their business if the VAT is raised to 23%.”

“Yep, stupid comment when at the same time you are reaching out your hands to receive their money… That said, the IMF does not really fully understand if they think they can introduce e.g. a progressive income tax and raise more revenue. Very hard to do in a country that does not believe that higher taxes will benefit the population and where tax avoidance is an art mastered by most.”