thank you for the insightful article. I am rather convinced by your arguments, however you have failed to address one of my concerns when it comes to devaluation. Latvia does not have a great primary production sector, especially when it comes to energy. Thus, should Latvia devalue, its energy cost would rise sharply and thus also the production costs. Would this not in effect harm the companies’ short run survival chances as the prices, including the import prices would take time to adjust?

Also, assuming that for a certain product the value added is 50% of the end value, a 20% devaluation would essentially have only a 10% contribution to the competitiveness of Latvia.

Thank you in advance,
Ernest

“Devaluation will make it more attractive to send euros home. Isn’t that what’s to be avoided if you want to keep the population in the country?”

Fair point. The problem is that here there are no easy answers. If people are involved in internal deflation and high unemployment people are also encouraged to leave. The V shaped recovery offers more possibilities of employment, the effective devaluation of salaries is the same in both cases, so in fact wage deflation and devaluation are neutral on the advantages of emigration. A more rapid recovery encourages people to say. In fact, as people in the debate in Estonia are now pointing out, devaluation applies in both cases, in one it is devaluation of wages, and in the other of the currency.

This bit:

“Latvia is arguably the one country that most resembles Iceland, and not just because of the cold climate. The small, developing country’s lofty growth rates in recent years were fueled by heavy investment from elsewhere in Europe, massive foreign debt, booming consumption, and minimal savings.”

I don’t think they fully grasp the subtleties here. There are two types of problem. The one Iceland and the UK have, which is an assets liabilities mismatch of large proportions, and what Spain, Estonia, Romania etc have, which is a big CA deficit which has gone to fund an internal construction boom.

Obviously Iceland and the UK have the latter problem, but they have a double whammy. Spain eg, doesn’t have the assets mismatch exposure, since Spain was largely taking on synicated loans for local lending. This doesn’t mean Spain is OK, since it evidently isn’t, but the problem is slightly different.

Latvia is a hybrid, since it has BOTH problems. I quote the IMF report:

“Finally, standard debt sustainability analysis may not capture all of Latvia’s characteristics, given its dependence on foreign bank borrowing for credit intermediation and its role as an offshore financial centre. First, Latvia’s net foreign debt is much lower (around 70 percent of GDP), as it reinvests many of the non-resident deposits in assets overseas. The value and liquidity of these assets then becomes key. Second, much of its foreign borrowing is backed by domestic assets. Thus external debt sustainability will depend on whether these assets recover value and will be able to generate future returns to service the debt.”

This is a central and critical point, and I don’t think FP have gotten this point yet.

Basically Latvia is “cooked”, and we need solutions at the EU level, and we need them fast. More writing to come over the weekend.