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. Talks will continue next week. One important issue – EU package does not provide ressources for peg maintenance, at least not direct ones. If IMF moves away, BoL will have to defend the peg only by its insufficient ressources. However, Rimsevics is concerned in the last time not so much about EU and IMF issues, as about selling for any price as soon as possible the bailed-out PAREX bank, as probably the true liquidity shortage there becomes evident.

  2. The very influential coalition Farmers union openly questions the IMF help.

    With all the experience with FU and taking in account, that it incorporates many former Soviet agricultural barons, the feeling is that not so much they are opposing the international financial arrangements per se, as they simply will not carry anymore the help to bankrupt PAREX and teetering Swedish bank subsidiaries and other pyramids, as this leads to total impoverishment of the Latvian population and sell-out of Latvian natural assets now and even more in the future.

    An additional issue is that the last EP and local elections have shown the abnormal unpopularity of present right-wing coalition parties. As a party dependent on broad masses, not elites, the FU will not bear anymore the IMF requirements. The formula of FU is either that Latvia with its enormous small population can survive on domestic resources and trade with Russia, as to sell-out everything to financial pyramids.

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  4. LONDON, July 27 (Reuters) – Emerging shares hit new nine-month peaks on Monday on global economic recovery hopes while news that Latvia had reached agreement with the International Monetary Fund (IMF) over the country’s budget provided a further boost to investor optimism.

  5. Edward, your total censorship policy in the Baltic Economy Watch reminds me old Soviet time… It’s so sad, that you are simply not interested about reality and want to have nice and clean room for your toughts about virtual “Baltic Economy”. Those countries have turned already from their CAD to surplus, inflation is down and there are some signs of bottoming. Deflationary way takes time and generates lot of stress, but it is working here. Better admit this.

  6. The situation is heating up – it seemed that agreement with IMF, but now one of the leading coalition parties – The Peoples Party – has announced that it is not ready to sign the agreement. It is interesting, because ‘behind the scenes’ leader of the party – Mr. A. Skele – has actually publicly supported devaluation.

    to TFtC – deflation is indeed working here in Latvia – imports has plummeted, retail sales has plummeted, inflation (obviously) is down, unemployment is soaring, bad debts are soaring (just take a look at latest banks results), real estate prices are falling at rate 4% per month etc. Deflation is working, but unless you wear pink glasses (or work for government or Bank of Latvia) there’s nothing to be excited about.

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  8. I think that there is only one measure for the effect of the internal devaluation, coherent with the official aim of the measures: the producer price index.

    According to Eurostat, PrPI indeed decreased in Latvia in H1 2009, however, slower as in Germany. That mens vis-a-vis Germany Latvia has lost its competitiviness even more in H1 2009.

    PrPI decrease in Estonia was less than in Latvia. In hungary there was an increase.

    Interesting fact, that in the best-off country Netherlands PrPI decreeases have been the maximal ones.

    Latvia is suffering mostly from PrPI increases in previous 3 years, it is not possible to correct that by internal devaluation.

  9. Perhaps the true reason is that there is need for bigger PPI correction from western producers than from eastern, where labour costs are (in Baltics) around 1/3 of that in West.

  10. jj wrote “The situation is heating up – it seemed that agreement with IMF, but now one of the leading coalition parties – The Peoples Party – has announced that it is not ready to sign the agreement. It is interesting, because ‘behind the scenes’ leader of the party – Mr. A. Skele – has actually publicly supported devaluation”.

    Claus V. already made a mistake when interpreting those local electons related smoke signals by some Latvian parties as sign of “imminent devaluation”. Perhaps Skele wants to get some extra half-points from his electorate and tries to make impression that he is the “last man standing” against “evil” IMF/EC.

  11. You can never argument only by wages – productivity is also important. Small countries will never have the productivity of Germany because they lack the internal market support.

    To TFtC: the devaluation threats from inside of Latvia are really negligible wrt present institutional setup. More problably you can expect a defolt.

    However, external threats are very serious – as the one coming from Lithuania.

    If Lithuania will weaken the peg, Latvian peg will fall in 15 minutes.

  12. govs: 1) check out why this document was written;
    2) read it.
    3) there is need to make some minor changes in Lithuanian legal acts to clarify responsibilities.

  13. Dear TFtC,

    have you seen today’s announcement about GDP fall in Lithaunia?
    22,4% in Q2, 18,1% in H1 !!!!!!!!!!!!!!!!

    This is the pount I wrote already some time ago – Estonia and Lithuania have much bigger structural risks as Latvia! In Latvia everything just happened earlier due to PAREX, but Estonia and Lithuania will unavoidably follow.

    So in this light Lithuania is the first who has to devalue. Because Lithuania is oppressed by the devaluation by zloty. The all eastern market where Lithuania was so succesfull, is blown away by the zloty devaluation. The food and agricultural sectors of Lithuania will die if the peg will be kept.

  14. Dear TFtC, I do not see any differential btw LT and PL from the fact how the food prices are formed. In case of Russian market, anyway, you must take in account that products from Baltics are viewed there as healthy, whereas Polish ones as full with chemicals. Do not forget logistics, because in case of Baltics the rapid and efficient rail transportation is possible.

    In the past when currencies were more stable, Lithuania was exploiting very well its quota and selling in neighbouring countries. Now with the abnormal zloty devaluation even supermarkets in Lithaunia are full with Polish products, not to speak about Latvia and Estonia. Solely by import substitution Lithuania will halve its GDP fall.

  15. PLN was at the same as it is today in October ´08 (3 PLN=1 EUR) and at the spring EUR was 3.9 PLN, so it should be getting easier now. I do not notice much Polish products in supermarkets in Estonia, perhaps those are sold via discounters only.

  16. there are certainly same problems in Estonia for companies with more “commoditized” production. Those yellow bricks, what are mistakenly (and sometimes proudly) called cheese over here, are too similar to each other and therefore can be easily replaced by cheaper alternatives. So it is unavoidable, that you see articles like this: (Crisis deepening) and at the same time you read: production is taking off in Vändra). More value added. It just takes time.

  17. Sorry, dear Estonian, I do not understand what are you writing about. PLN has been devaluaed extremely during the critical period Sep 2008 – Apr 2009.

    Regarding situation in Estonia, you have more to think about your Nokia bricks. Despite the fact that Estonia did not have any banking crashes as Latvia did (and lost 60% of annual budget due to it), the production in Estonia in Q1 2009 with its -16% is really not better as in Latvia.

  18. Govs, you are right, I was looking at USD crosses, not EUR, my bad!

    About your “Nokia brics” problem – it was actually Ericsson, who bought factory from ELQ recently. And you can’t use some subjective measures “I do not like that” to make decisions about structural strenghts/weaknesses. Some circumstantial data show that Estonia is so far stronger. Look at credit losses in banks. Hard to fnd any signs about Latvian structural superiority there!

  19. Dear TFtC,

    this is exactly we are asking about: how could it happen that not suffering any losses from the banking crisis Estonia suffers so extreme GDP fall -16,5%, if the Latvia with its enormous banking sector crash suffers just -18%.

    Answer is simple: the structure of Latvia is much more sound. With still significant percentage of chemicals, pharmaceuticals, steel the structure of Latvia is much more stable during crisis. Estonia has no reasonable pharmaceutical factory anymore, and Eesti raudtee is 20% from Latvian rail.

    The demand after Estonian goods as Nokia bricks will not restore up to 2017, or even later.

    Just wait for H2 data. Lithuania has already announced -24,5%, despite the fact that they had very few losses in banks.

  20. I think in case of Estonia due to some biased Ansip-like-liberal-thinking there is widespread opinion that if the supply of Estonian goods is kept constant, then there will be constant money flow. However, supply-side liberal economy does not work during crisis. Everybody knows that who has read Keynes.

    If there is simply no demand for Estonian goods because 1) they are nothing special, 2) they are easy replaceable, the results for Estonian growth will be as bad as for Latvia, despite the fact that Latvia has stuck into extreme banking sector crisis. The only difference is that Estonian domestic finance sector is adding still some value, but added value by finance is an abnormality by the definition (see Krugman).

  21. Estonia is probably the last place where protestantic myths are alive, will say an economic anthropologist.

  22. govs: most of the banking losses arise from structural problems (too much loans to real estate development etc), do not try to turn this problem upside down. Let’s see after 2-3 years, how everything have evolved. I know some Estonians who have been busy buying some of those “structurally sound” bits of Latvian businesses. But in Estonia there are certainly also some very negative views about doing business with Latvia. Overall Latvian independence is considered to be some by-product of Estonian Independence war 🙂

    “Eesti raudtee is 20% from Latvian rail”.

    And surprisingly there is also big part from Russian rail as well! We can not change our geographical location.

  23. Unfortunately, I do not understand exactly what you mean by Independence here? 1919? Because in 1990 90% of Independence was brought by Lithuania, and Estonia just got free cheeseburgers from victims in Vilnius and Riga.

    Unfortunately, by its geographical position Estonia is very dependent from Latvia, because the alternative border is with Russia. If Latvia will fail, Estonia will become a Russian enclave.

    Structurally sound bites of Latvian business are just not sold. Some strange Estonians have just purchased the trash as newspaper “Diena” by Kalle Norberg stirring Russian money.

    Regarding the banking crisis in Latvia, it has nothing to do until now with structural problems. The crash of PAREX was caused by speculations with Lehmann securities. The bailout imposed by the EC has killed half of the liquidity in Latvia. Of course, Estonia was more clever by not allowing to exist for any domestic banks.

    Too much loans to real estate projects is much more characteristic for Estonia as Latvia, because in Latvia evwerything startet later, and did not develop to that extent.

  24. Indeed. I have been true fan of the stellar Latvian economy, probably one of the soundest in the Europe, myself! It is also agreed that some international organizations (IMF, EC etc) have finally started to admire all this structural strenght and visiting your country more often to learn!

    I would somewhat surprised if any real Estonian put money into “Diena” in this deal as Norberg was just a middle-man. BTW I just owned Grindex stock for nice 50% bounce, now I’m out. In old soviet times Latvian amfetamine made special forces run some extra days. Now the big part of business still seems to be “ointing” somebody in Russian hierarchy and having some fun while special relationships last… Not sure, if it’s sustainable.

  25. Demand for neuropharmaca is still there, indeed, only the substances are more sophisticated. You must be happy that you did not have stocks of Tallinn Pharmaceutical factory, which do not exist anymore. Ointing must work very well in Estonia also, because Latvian pharmaca is very present there.

    The case with Norberg is just a brilliant evidence how big the dependence of Estonian business on Russian money is. Of course, no better place as Russia where to sell cellular bricks produced by Elcoteq. In reality I do not see any important Estonian investments in Latvia, except, maybe average quality hotels.

    If Estonia will, for instance, build a bridge to Finnland, I will really admire this miracle. Then maybe Estonia will become something more as geographical appendix of Russia.

    Oh, and I read just now that Ebay plans to shut down the Skype. Really, what will be the comfortable Estonian pride after that?

  26. And how about the secret visit of IMF and Rosenberg in Tallinn? It seems, there will be a serious budget deficit in Estonia as well. Lets see GDP data for H1, however, they will first manipulated in Kadriorg.

  27. There can obviously be some side effects of pharmaceutical industry for local population… And indeed, Tallinn Pharma plant was closed down by Grindex and they “ointed” hard to get right to build some flats and offices instead. It is excellent place for living for the fans of trainspoting and timing seems to be as good as it gets 🙂

  28. Govs: “The crash of PAREX was caused by speculations with Lehmann securities”.

    Everybody can find annual report of the Parex here:

    Search for the “Lehman” and you indeed find some general whining about them. Crash of the Parex was not CAUSED by Lehman collapse. It exposed the unsustainability of their business model. Look at the pan-Baltic banks results. Loan provisions are severeal times higher in Latvia compared to Estonia. It’s not Lehman’s fault, also I do not think business practices of the Scandinavian banks were so much different in different countries.

  29. What can you find there? That this bank was holding 750 Mio LVL securities directly and at least 1 Bn loan to Parex Capital (securities arm), and all this is burned? You can read a nice article on FT Alphaville about PAREX, and compare it with the balance sheet of 2008. Details of PAREX are still secret.

    Larger loan losses in Latvia are just unavoidable, because the PAREX bankruptcy has alreday depleted 1/3 of Latvia’s state budget, and therefore lay-offs in the public sector have soared.

    Regarding bank business models – no Estonian can say something about that because no more bank business models are decided in Estonia. Everything is decided outside.

  30. Estonia: Decline in the economy continued in the 2nd quarter

    According to Statistics Estonia, by flash estimates, the gross domestic product (GDP) of Estonia decreased by 16.6% in Estonia in the 2nd quarter of 2009 compared to the same quarter in the previous year.

    In the 1st quarter of the current year GDP decreased by 15.1%.

    Compared to the 1st quarter, the seasonally and working-day adjusted GDP decreased by 3.7% in the 2nd quarter. The decrease decelerated compared to the previous quarter — in the 1st quarter GDP decreased by 6.1% compared to the previous quarter.

    Latvia -19,6%, Lithuania -22%.

  31. Thank you, as I understand, this is a page with jokes. Very funny. Even on jokes pages you have references to year 2008. It is now absolutely evident that none of Estonian strengths in 2008 are valid today, Elcoteq has died, and reopened Ericsson is 5 times smaller. Nobody wants to buy Estonian crap on the World market.

    It is just surprising how Estonia without banking crisis has falled to levels as low as Latvia (difference btw. -16.6% and -19,1% is really not that big).

  32. govs: It’s somewhat strange that Latvians do have a lot of jokes about Estonians. We have only two or so. Perhaps 1) Latvians are not funny or 2) we simply do not care enough?

    Root out at least some of your corruption and you will do better in the future.

    Agreed, difference is not that big.

  33. “Nobody wants to buy Estonian crap on the World market”. Ok, let’s compare how much of the crap can Latvians sell.

    I’m in some trouble how to found exact figures about quantity of crap, but perhaps we should take a look at the basic statistics?

    for Estonia export/GDP is appr. 60%

    and for Latvia 39%.

    This data is certainly not up-to-date but you get general idea about reality.

  34. govs: about ELQ. I guess that at the best years (2005?) they employed about 3500-4000 in Estonia. Now ERICY took over 1200 and most probably few hundred workers continue with ELQ in Tallinn. So it’s certainly not “5 times smaller”. Get your facts straight.

  35. Generally I could accept 2 advantages of Estonia compared to Latvia:
    1) more saturated corporate governance. However, corruption is widespread also in Estonia,
    2) enormous political lobby of educational workers and scientists in the parliament which blocks anti-innovation decisions of the businessman. This stabilizes areas as research and education which are extremely dependent on long-term commitment.

    However, on the other hand, Estonia has no rotational axis as Riga is for Latvia and has been in the last 20 years of the Imperial Russia. Latvia has to invest less for self representation and proper packaging.

  36. Regarding opinion about Scandinavians in Latvia, sorry, but Latvia does not identify itself with Scandinavian region. In a recent poll, 60% identified theirself as part of Reich. We are not Scandinavians, an we do not want to be ones.

  37. Difference between 23 and 38 is substantial, but not principial. Latvians generally tend to be more self-citical as Estonians.

    Regarding the high fertility in Nordic countries – it is a direct consequence of high share of moslems, negros, phillipinos invading Nordic countries.

  38. I have played some years basketball (just for fun) together with some Croatians, Latvians, Lithuanians, also I have made several job interviews and have been employer later for Latvians etc. So I’m not sure, that “Latvians generally tend to be more self-critical than Estonians”. We are not much different is this respect. Most of younger Latvians I have met have been open minded (perhaps even more, than Estonians, but it’s certainly very subjective) and reliable. In meetings with older generation I somehow dislike their addiction for hidden tape-recorders and all this (for me so Soviet time) nonsense about business titles, hierarchy etc.

  39. Do not agree, Estonians are famous for self-proclamation and self-advertising. Unfortunately thats becoming boring. How it could happen that in Estonia with its non plus ultra government, banks, debt etc. the GDP fall is only marginally less than in Latvia?

  40. Because we all did have same kind of colonization by Scandinavian banks. Just to get all those Baltic clients hooked for long years with their pension pillars, fees etc banks used cheap mortgage loans as a teaser. Because of the competition between banks this process was abnormally fast and created real estate bubble and screwed up structure of economy. As Estonia is (presumably) most liberal of Baltic countries I would guess that distortion from “normal” could be thoretically bigger in Estonia than in Lithuania, where everything is a bit slower and real estate bubble did not reach to similar proprtions.

  41. By judging your comments over time I do not expect you to agree with anything I say (same applies to Edward H.) All those silly facts I provided are just statistical nonsense compared to your own view! You (as all Latvians) are self-critical and 100% objective about your home country, indisputably structurally one of the strongest economies of the planet. Happy now?

  42. Stock indices in August:
    Vilnius +43,44%
    Tallinn +34,03%
    Riga +20,82%

    Two reasons:
    1) Latvian situation is calming down
    2) Buyout bid from Telia to Estonian Telecom and Lithuanian TEO’s minority shareholders.

    BTW In the spring I recommended to Edward to buy those two instead of making himself fool with “Open letter” etc. But all my comments in Edward’s “BalticApesEconomyWatch” have been deleted as not hysterical enough.

  43. How bank colonisation is related to GDP fall is not clear regarding Estonia. In Latvia this colonisation point is unimportant because A-Bomb of Latvia is the PAREX bank. I think that Latvia will never overcome this A-Bomb explosion. So lucky in Latvia who has diversified business.

    Regarding you saying in 99% of points I do not see any advantages for Estonia compared to Latvia.

  44. I would guess that Parex’s share of the total bank lending in Lativa was only 11-12%. Please pay attention how much of the lending was financed not by local deposit base but by Scandinavian savings. Now think about what have happened after Scandinavian’s have applied some restrictions here in Baltics, trying to keep local loan/deposit rate under some ceiling, to look better in their stress tests.

    “Regarding you saying in 99% of points I do not see any advantages for Estonia compared to Latvia”. Good. So you have your “rotational axis” or whatever. Basically we are the same. Let’s move along now, nothing to see here!

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