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?

This entry was posted in A Fistful Of Euros, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

62 thoughts on “It Isn’t Only Canicular Heat They Are Suffering From In Latvia

  1. You are constantly discussing second order terms. Let’s concentrate on first order terms. 1,2 bn Lats of public money are frozen (in fact lost, because return on Lehmann securities will be no more than 1,3%) in Parex. Thats about 30 billon EEK. What would happen with Estonia’s public finances if you will have to unload from your public budget in very short time 30 bn EEK?

    If I read dv.ee, so I get to know that you can not push out even 4 bn EEK reduction, and the EUR accession is dependent on it. So try to imagine how to reduce 7,5 times more!

  2. BTW It’s not our first cut. Estonia have cut 2009 budget by some 15-16 billion EEK for now.

    What is your point? GDP of all Baltic countries have been down by similar %. According to your opinion for the Latvia the main reason was Parex and all other reasons are “second order terms” having impact only in Lithuania and Estonia? Nonsense.

    I’m seriously tired of you.

  3. Yes, thats my point. It is caused by your immanent wish to show that in Estonia there is something better “intrinsically” “internally” “arising from the force vitale of the eternal Estonian folk”. The statistics is rutless – the only thing better in Estonia is the absence of local banks.

  4. I do not have any idea what you are talking about “what I wish”. I prefer facts to your opinions Estonians etc and suggest it to you as well.

    “What are the facts ? Again and again and again – what are the facts ? Shun wishful thinking, ignore divine revelation, forget what “the stars foretell”, avoid opinion, care not what the neighbours think, never mind the unguessable “verdict of history” – what are the facts, and to how many decimal places ? You pilot always into an unknown future; facts are your single clue. Get the facts!”

  5. Parex did have relatively low market share of deposits (1.9 billion LVL at 2008) ? To be honest it seems (certainly I do not know all details), that deposit insurance not bailout would have been better option to handle this particular situation. If yes then Latvian government completely failed at their duty to act at the best interests of Latvia.

  6. Agree absolutely. Costs paying out the deposit insurance could be 30% of present costs (and 10% of expected costs). But if you have such a criminal banking institution tied to politics, which was paying large sums underground to officials storing there the public money for interest, it is pretty difficult to initiate a bankruptcy procedure. Additional problem was that the particular gevernment at the time of PAREX crash was the utmost corrupt and criminal government ever, 100% intransparent.

    In comparable conditions in 1995 when the Banka Baltija went bancrupt (it was the time when Maa and all other Estonian banks went bancrupt) no bailout was done and the summary effect on Latvian economy was minimal. Because then the corruption and government criminality was young, not so ubiquitious.

  7. My friend just came back from Riga where he was looking for brand new BMW offered by some local dealer for -45% from the listed price… Most probably not just because of situaton in economy but just because interior was BROWN-only 🙂

    If the Parex will not be sold in the future for any meaningful $$$ I would say that you have paid very hard for this corruption by changing your practically debt-free country to IMF-bailed wreck.

    All the best,
    Kristjan

  8. I have to agree, but it is hard to blame Latvia for that. It is just some evil disaster caused by global interests, and Latvia and Latvians had no voice here.

    To sold the PAREX – even with negative profit – who will purchase this black hole? From legal point of view it is a potential bomb, because (other as for Landesbanki and Kaupthing) there has even not been a process of registration of the creditor’s demands again PAREX. (Hawe you read something in your local newspaper?)

  9. Normally you do not read anything that usefull from newpapers. If negotiating with creditors I would certainly kept flush handle close. MUCH more concessions from creditors or…

    “It is just some evil disaster caused by global interests, and Latvia and Latvians had no voice here”.

    You had voice when you elected your Saeima.

  10. The voice of Saeima is irrelevant for International organisations. Similarly as the voice of Riigikogu and Seimas.

    Regarding unspoken issues, the first unspoken issue is – New Member States of the EU which do not have access to ECB have no benefits from participation in EU. Structural funds are unused, dependent on very long project crediting which do not exist anymore. Community programmes are distributed with a high level of protectionism. Everything is becoming a negative sum game for NMS.

    In Latvia and Estonia the irrational relationship to EU as protection against Russia has until now supported existing political structures. I do not think that elections in Latvia in 2010 will continue this irrational path. Local elections have shown that this irrationality has exhausted itself.

  11. I will always say Pro se without complete knowledge and without doing research and homework is not a good idea. Knowledge is your weapon when you are on your own.

    Thanks for your article.

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