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Tuesday, May 26, 2009

Payment By "Voucher" In Latvia?

This sounds like something straight from the Argentine history book. Yesterday someone left this comment on my Latvian Blog:

By the way, latest idea in Latvia is to issue vouchers as a substitute to LVL (thats in case Latvia doesnt get any money from IMF). So if you work in public sector, your salary partly will be paid in vouchers which you can use to buy food. And yes - it would also mean 'stable' LVL, at least on paper. I still don't really understand how it could possibly work in free capitalist economy. But it underlines how strong is the will to keep current LVL rate at any means, even if it means total collapse.

At the time I wasn't sure what to make of this, but then I saw that according to a report in the Latvian newspaper Diena, Central Bank Governor Ilmars Rimsevics visited the town of Liepaja on Friday, and told the astounded journalists assembeled there that: "The level of the expenditure shock we are receiving is so high that we can not cease to maintain this quantity of expenditure. So there is a shortage of funds, and we're forced to look at the different kinds of projects, which can help us provide for the foreseeable future. Taking into account that the money is not budgeted, it can be emitted in vouchers".

Rimsevics also gave an interview to the Russian-language newspaper Telegraf (published this morning) where he says more or less the same thing. Basically, the IMF are threatening to withold the next round of funding if the Latvian government does not move ahead with the agreed wave of budget cuts - which in some areas will be of up to 40%. Latvia received a 7.5 billion-euro bailout from the IMF and the European Commission last December. The agreement required Latvia to limit its budget shortfall to to 5 percent of gross domestic product. Since then, the economic outlook has turned far worse than anticipated and Prime Minister Valdis Dombrovskis's government is seeking approval to run a 7 percent deficit.

At the same time the Latvian central bank keeps having to buy the local currency (the Lat) to support the euro peg - last week the bank bought 6.4 million lati ($12 million), and this was the eighth consecutive week they have had to make such purchases. The longer it takes to reach agreement with the IMF - who are convinced that severe budget cuts will be expansionary in the short term (due to the improved confidence they will produce, see here), the more the bank will need to spend to counter those who are betting they will be forced to devalue.

The bank have now bought about 1.1 billion lati since September 2008, and such interventions have reduced Latvia’s foreign currency reserves by 36.7 percent compared with September last year. The flight to euros is also producing strong liquidity pressure inside the country, and the central bank cut its refinance rate to 4 percent on May 13, the second reduction so far this year, in an attempt to boost borrowing amid a liquidity squeeze and much harsher lending criteria. Basically, in order to keep lati in circulation, interest rates on the Rigibor, the local interbank lending market, have been driven up by 42 percent since 3 February to hit 13.7 percent on May 14 (for six-month loans). And this in an economy which shrank by 18 percent in the first quarter.

As I say at the start, all this - including the vouchers proposal - does now sound incredibly like Argentina, since issuing scrip money is exactly the kind of thing you get pushed into when you try unrealistically to hold a peg. It is the begininning of the end. The same thing, exactly, happened in Argentina, where they ran out of pesos and started to issue Patacónes, Lecops, Créditos, Argentinos and a myriad of other exotic bits and pieces of scrip. I give a bit of background on all this in this post on my Spanish blog, while Bloomberg's Aaron Eglitis has a useful summary of the general Latvian situation here.

SEB Accept Krugman's and My Point.

Currency devaluation in the Baltics would not lead to bigger loan losses for Swedish banks, the losses would simply come more quickly and be harder to deal with, according to SEB Chief Executive Annika Falkengren speaking in a radio interview on Saturday.
"In total we would have the same size of credit losses, but (if there is no devaluation) they would be a little more regular and over a longer time frame," SEB Chief Executive Annika Falkengren told Swedish radio. "In the case of a devaluation they would be pretty much instantaneous."

Now what was it Krugman and I were saying that everyone jumped down our throats for:
I’ve been saying this for a couple of weeks, but Edward Hugh has the goods.

Hugh puts his finger, in particular, on one gaping hole in the logic of the opponents of devaluation. We can’t devalue, they say, because the Latvian private sector has a lot of debts in euros, and a devaluation would make it very hard for borrowers to service those debts. As Hugh points out, the proposed alternative — sharp wage cuts, and basically a major domestic deflation — will also make it hard to service those debts. In fact, I’d be a bit more specific than Hugh: other things equal, a nominal devaluation and a real depreciation achieved through deflation should have exactly the same effect on debt service (unless some of the debt is in lats rather than euros, in which case devaluation would do less damage.)

Ms Falkengren has a very peculiar way of looking at things when it comes to analogies:
However, Falkengren said that devaluation without long term policies to get economies back on track was not a good option. "It's like peeing in your pants. It feels good, but only for a very short time," she said.

But essentially she is right, devaluation is not a solution, only a route to solutions. Long term structural reform is needed either way.


Daniels said...

Yes, Latvia seems to be going through it struggles again, like in the (re)declaration of independence. And the problem is that the budget has not been approved (or even sent to the parliament yet), because the (new) ruling coalition does not want to appear bad to the electorate.

Stupid? Perhaps, but one of the candidates for Mayor of Riga (who helped drive the economy to its knees by distributing pots of money to his friends and family) is promising lots of new jobs, more investment and so on, without mentioning where the money will come from. Many voters seem to believe him, so perhaps the government is right to believe in the naivete of the voters too.

By the way, the government also passed a law to raid the pension fund (cool 100 million) even though the IMF told them not to. That should be good for Mercedes and BMW :-)

j said...

By the way, today PM dismissed the voucher idea, told that it would be 'hidden devaluation' and one should ask CB governor that he meant by speaking about vouchers.
However that doesnt sound very convincing, because just few months ago (now former) PM spoke openly about special bonds which can be used to pay salary to state employees. I dont see big difference betwwen salary bonds and vouchers.

Edward Hugh said...


"I dont see big difference betwwen salary bonds and vouchers."

Absolutely. They are just different forms of commercial paper. They promise to pay traders who accept them in three months, or whatever, assuming things will be better, and so on.

Dombrovskis is also quoted in the press this morning as say ing Latvia’s government is discussing ways to cut spending with the International Monetary Fund and the European Commission given the economy is shrinking faster than forecast.

“We will have to talk with international lenders on what will be done about the planned decrease in revenue,” the premier said on Latvijas Radio today. “Will expenditure mechanically be reduced in order to reach a 7 percent budget deficit or are there other solutions?”

My feeling is that the IMF will give on the 7%, but they will demand concrete results in return.

But even so, the problem may deteriorate, since while the estimated 2009 contraction has now been changed to by the government to 12 percent, the central bank is expecting the economy to contract about 16.5 percent this year, and if the central bank are right this has implications for revenue. Which is what this whole argument may be about at present.

Anonymous said...

I hearing Latvia will devalue soon after June 6 or maybe on this day. June 6 is election day. I have many friends who are very connected with rich political elite of Riga and I am told they all are making positions to benefit from devaluation. I am told they will make Lat equal with Euro. Maybe just nonsense. We will all know soon!

Robert said...

I also read in the swedish news that Latvia is making preparation for devaluation soon.
Also Sweden seems to make preparations as the Riksbank (Central Bank of Sweden) has taken a loan of 100 billion swedish krona (app: 9 billion euros).
It seem that the swedish gouvernment will bail out its banks rather then bailing out Latvia. Could also be that it is not up to Sweden but the IMF to decide on more money to Latvia.
And since the devaluation of the LAT will lead to devaluation for Lithuania and Estonia I guess that is why Mr. Borg is focusing on the banks instead of the Baltic countries.

a said...

"I also read in the swedish news"

Could you give a source?


Robert said...

To a:

On this site, http://di.se/ , look for article "Ny baltsmäll hotar" and "Gunnar Örn: IMF avgör Lettlands öde"

Edward Hugh said...

Hello Robert,

Well, something does seem to be afoot. Danske Banks just issued this warning:

"The event risk has risen sharply in the Baltic markets and we advise utmost caution. Yesterday, the Swedish central bank Riksbanken said it will increase its currency reserve by SEK 100 bn through a loan from the Swedish debt agency. Investors seem to believe that this is a buffer to deal with potential problems arising from the Baltic crisis."

Which I have posted about, and which I think is reasonably explicit. Once the central bank governor starts quarreling in public with the government the days have to be numbered.

Unfortunately, in these situations, investors are already clear long in advance, it is just the ordinary citizens who are the last to know.

Edward Hugh said...

And thanks for the Swedish links Robert.

j said...

Here is the link in English (I suppose the same story) :

It is also interesting that Mr. Shkele (who is one of the most influental persons in Latvia) today said in local newspaper that 'organized devaluation' (ie by 15-30%) would be the best solution for Latvia. It looks like tide is truning.

Anonymous said...

Polish economy seems to be in GREAT condition during CRISIS - GDP 0,8 in PLUS !!! so danish banks are saying shxxx about baltics - there is big difference between Poland and Latvia - look only into GDP and population ;)

Polish Zloty /PLN looks strong much than other baltic currencies.

ineltron said...

Inflation before was much too high in Latvia. Now the bubble is bursted and deflation breaks its way through.