Latvia’s Economy Contracts Almost 18 Percent in Q4 2009

Well, as we say in English, it never rains but it pours. Latvia, which has had the deepest recession of all 27 European Union member states, contracted by nearly 18 per cent in the fourth quarter of 2009. ‘Compared to the same period of 2008, gross domestic product (GDP) value has decreased by 17.7 per cent,’ according to the national statistics office statement.

The fall was led by a 30-per-cent annual drop in the retail sector. Retail sales are now down by 36% from their April 2008 peak and there is little sign of any turnaround at this point.

Industrial output, which rose slightly over the quarter, fell back again in Deecember (by a seasonally adjusted 4.2%) following a sharp rise in November. Output is still down more than 17% from the February 2008 peak.

Latvian exports were down again in December, making for the second consecutive monthly fall. Despite all the fuss about internal devaluation the CPI was only down by 3.1% in January over January 2009. Prices are still far from being competitive, and no early rebound in export growth is to be expected. Over 2009 as a whole exports – at 3,571.6 mln lats – were down over 2008 by 19.4%, but imports – at 4,633.7 mln lats – fell even further, by 38.4% which is why the trade deficit reduced substantially, but note there was still adeficit. The deficit fell from 225.3 mln Lats in January to 69.7 mln Lats in December. Over 2009 as a whole foreign trade turnover totalled ay 8.2 billion lats, a drop of 31 per cent when compared to 2008.

Unemployment hit 22.8% in December according to Eurostat data, the highest in the European Union.

And even that famed “internal devaluation” seems to be working hellishly slowly. As I say, prices were only down by 3.1% in January 2010 over January 2009 (and probably even less on the EU HICP measure) according to the latest data from the Latvian statistics office.

Even the statistics office statement that GDP actually grew by 2.4 per cent compared to the third-quarter offers cold comfort, since this data is not seasonally adjusted, and the economy will almost certainly be back down again in the first quarter of 2010.

Meanwhile the consequences of this strong recession in Latvia – more and more Latvians are leaving in search of work elsewhere, while fewer and fewer young people feel confident enough to have children (see chart below) – will leave a long scar, which will be hard to heal, and which make the long term future and sustainability of the country even more uncertain.

As the Washington based CEPR argue “the depth of the recession and the difficulty of recovery are attributable in large part to the decision to maintain the country’s overvalued fixed exchange rate, because it prevents the government from pursuing the policies necessary to restore economic growth”. Maybe next time someone will learn the lesson before tragedy strikes, and not afterwards.

This entry was posted in A Fistful Of Euros, Economics and demography, 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".

21 thoughts on “Latvia’s Economy Contracts Almost 18 Percent in Q4 2009

  1. Just curious to know why do countries go into ERM with an overvalued exchange rate? Britain made the same mistake in the 90s.

  2. Blaat, they do not go. They become such.

    Ultima ratio – the Latvian experiment has shown that the PPI is very inelastic wrt austerity measures and internal tragedies. All this pervert process is becoming already disgusting – as somebody would ask why the prices for staying alive have not fallen in a concentration camp during WWII.

  3. Would somebody please explain to me, why the Baltic states (and Latvia and Lithuania especially) keep defending these hopeless pegs ? They are killing themselves over this defense, and the EU will not allow them into the EUR anyway, given the current situation. EU will use every excuse imaginable to keep them out, and even if one of the countries manages to adhere 100% to the Maastricht criteria, EU will just use the sustainability clause to ban them entry anyway. And it is not like the authorities in the Baltics don’t know this. I have it on very good authority, that they have been told this in no uncertain terms…. I just don’t get it…..

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  5. I dare say they read this article with keen interest in Athens. Their turn is next.

    Incidentally, if the bail-out for Greece takes the form of Germany buying Greek Bonds to support the market, then I can’t really see all much difference between this and another Bank bail-out. I would assume that Germany would be buying these Bonds from Banks that no longer wish to hold them because they are stinking up their balance sheets.

    So once again a chunk of risk gets transferred from investors to the State.

  6. They maintain pegs because of two reasons.

    1. In the case of smallest drop in value of their currencies, population will never use the currency again. This is a consequence of history – the savings of population there were wiped out several times by inflation, last time in 1991-1992. Also please imagine what popularity will that government have – they will be voted out immediately.

    2. The Central Bank is independent from government to a greater extent than in many other places (like US, where FR kneels before Congress). Their CB’s are likely modeled after German CB.

  7. Henrik,

    the really interesting question will be – why the IMF supported a programme based on the hopeless peg? Small remark – Estonia is not better, they have -15% GDP fall, and are still hoping to squeeze themselves into Eurozone.

    We can only make some assumptions, why this happened:

    the peak crisis of Latvia (caused only by one big bailout of the majot PAREX bank – very similar to DANAT in 30-ies), that means a pointwise perturbation, occured in November 2008. If the devaluation happened then, this would provoke a major butterfly effect. Exactly then the concept of contagion started to spread everywhere, which has become now a standard topic in economic literature. If Estonia, Lithuania, Bulgaria had devaluated for 40%, the Poland and Czech should devalue much more, and finally this could provoke a mass devaluation in CEE. That would immediately cause massive increase in outstanding loans (because they are for 90% in EUR and in Hungary CHF), and finally IMF would have to solve much more poisonous issues, as – should the CEE bail out the subsidiaries of western banks? Wrt to small size of Latvian programme, it was finally also for the IMF more convenient to (as they thought in 2008) – postpone the inevitable until the nonlinear dynamics has calmed down. The EU was totally afraid of massive CEE devaluations, because Germany had already competitiviness problems with 20% Polish devaluation.

    Why the peg is kept alive until now – there are very few reasons, and they are not easily visible.

    At the moment Latvia is only a big counter-example that shows that austerity measures no way lead to competitiviness improvements, because there just do not exist any economic mechanisms which translate austerity measures into PPI decreases.

    The remark of drb – crap, of course. The population has minimal savings, so they will use to buy their food ration with the money they get paid out. The independence of Latvian Central bank is a chimera, because the Law about the Central Bank can be changed with simple majority, and the currency board can be every time moved out of CB, as is the case, for instance, in Poland. Lithuania has already proposed changes in law, and the ECB had been already running mad during this Summer.

  8. Why to defend “those hopeless pegs”?
    Simply, private credit here is denominated mostly in euros. Currency devaluation would essantially waporize most creditors: big chunk of middle class with barely affordable mortgages and many businessess. Then entire banking system would be waporized.

    Also, public debts are also in euros. Budgets would be hit sudden jump in debt service payments.

  9. Why to defend “those hopeless pegs”?
    Also
    3. Devaluations would increase prices of necessary imports: primary oil (gasoline) and already high winter heating costs. Those increases would hit nearly all population, thus are politically inacceptable.

  10. To Skel,

    middle class will disappear in any way, the austerity measures will punish them with a high acceleration.

    Public debt was very low in Baltic states, in Estonia – absent. If not the bank bailouts imposed by EU, they would be never a problem. Now Latvia due to bailout costs is in situation similar to Iceland.

    Prices of imports, as it seems now very obvious, are influenced much more by high monopolisation degree and taxes. If devaluating, gasoline and natural gas taxes which are set to increase 100%, will be not necessary. An example of accelerated devaluation is that the fall in oil prices for 50% translated in 3% changes in Latvia. So a much bigger problem is extreme monopolisation of everything during internal devaluation process, because of dying of firms.

  11. Thank you to your responses to my question. If I am right about the carrot that is EUR membership disappearing, then it seems to me that the economic argument for maintaining the peg disappears with it. I appreciate the argument about the debt, but Mr. Dombrovskis suggested last year, that primary mortgages should be non-recourse, and I would be very surprised, if this suggestion doesn’t take on a life of its own in the run-up to the election in September. Seeing as I work for a bank I probably shouldn’t go there, but the proposal would in my opinion be a vote winner. Another aspect, which has not been touched upon, is foreign policy. I am fairly ignorant about the details in Baltic history, but when Finland voted yes to EU, it was very much motivated by a desire to break free from the Russian shackles for good. Seeing as the Baltic states have a, shall we say, mixed history vis-a-vis the big neighbor, is that mechanism a big driver here as well ? I would understand it if such a concern overrided the economic factors in the minds of the Baltic citizens. I belong firmly in the sceptical camp concerning the EUR (easy when you are a Dane), but I always tell my Finnish friends, that I would have voted yes, if I had been a Finnish citizen.

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  13. Henrik,

    about what time moment are you speaking regarding the realtionship with Russia? 1940? 1990? Now?

    Latvia joined the EU after already being a NATO member, so an argument of EU being counterweight to Russia was limited. Wrt to NordStream pipeline it is still not clear if the big danger is coming form East, West oder North.

    During the present crisis communication Russia is seemed by many as an escape of hopeless situation. If there still existed the old good Tsar Russia, Latvians will join it with a 99% vote.

  14. This was why back in 2008 I recommended the Baltic countries should avoid repeating Finland’s folly from the early 1990s. Almost exactly the same situation with among other things a bank crisis and external shock. The ultimate poison were bloody-minded politicians and central bankers who for an overblown fear of “what will the markets think” turn defending the currency peg into such a virtue that they are ready to drive up unemployment to nearly 20%.

    So what did the markets actually think? The speculators saw an impossible equation and attacked the Finnish currency. The government responded by attempting an internal devaluation by getting the unions to agree to lower wages. Fortunately the unions in the export-oriented industries refused to play ball, because they had literally nothing to gain from that arrangement. Talks collapsed and shortly thereafter the currency was devalued. Oh how the politicians hated losing face. But lo and behold, exports took off and growth finally resumed.

    The enlightened self-interest of unions and capitalists beat myopic stubborness of “public servants”.

  15. Staggering. It does appear that Latvia’s economic policy is being decided from the grave by the moldering bones of Andrew Mellon.

  16. to Gov from Latvia & Henrik

    Gov, speak for yourself: I’d never be for joing any kind of Russia and that’s why I voted for adhesion in EU. Only.

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  18. Govs from Latvia,

    For some reason, I was of the impression that it was IMF which actually was in favour of devaluation right from the outset (but did not insist if the government can come up with alternatives – more stringent budget cuts etc)

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