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Wednesday, June 17, 2009

Another Round in Latvia?

By Claus Vistesen: Copenhagen

I will forgive my readers if they think that my coverage of the recent debacle surrounding the potential for an imminent devaluation in Latvia has been a bit asymmetric. I mean, here I was; throwing fuel on the bonfire when it looked as if the cracks would make the edifice tumble and now as it seems that those cracks have been temporarily mended, I have gone silent. Well, not entirely then, and this post is thus to show that I actually do attempt to provide a balanced coverage.

Consequently, it seems as if the defences will hold in Latvia, but the apparent vote of confidence from the IMF and the EU commission and thus promises that the external loan financing will continue will not come for free. In order to make due on the loans the Latvian government is planning an unprecented range of spending cuts amounting to an astonishing 10% of the entire fiscal budget according to Bloomberg reporter Aaron Eglitis. These massive cuts include, among other things, a 10% pension reductions and a full fat 20% wage reductions for state employees. As prime minister Dombrovskis is quoted; these cuts should be more than enough to please the debtors in the form of the EU and, most notably, the IMF to whose mercy Latvia finds itself. One would surely hope for Dombrovskis that he is right.

And by all means, it does seem as if markets have been calmed so far [click on picture for better viewing].

As we can see overnight rates have fallen to much more comfortable levels the past few days and we have even had the news that the central bank were actually selling Lats in the open market in stead of its hitherto valiant efforts to maintain the peg, by sucking up domestic Lat liquidity pushing overnight rates up to a massive 100-200% according to a number of, I should say, unofficial reports. Medium term financing in the form of the 3 month and 6 month RIGIBOR remain elevated compared to last month, but so far the massive squeeze in short term financing seems to have abated. Overnight rates consequently fell from an officially reported high of 24.60% to 8% on the 15th of June and further down to a soothing 5% here on Tuesday.

Does it end here then? This seems to be the inevitable question we must ask ourselves.

I have my doubts. First of all, it is difficult to see the big difference here. The fundamentals still look anything but solid and the underlying weaknesses remain. As Edward noted recently in a thorough analysis of Latvia's long term economic potential, the crisis has long and deep roots which go beyond the question of default now or default later. More importantly however, Latvia has now effectively begun a great experiment to see whether it pays off to literally dismantle one's society with the aim to fulfill a distinctly narrow economic objective in the form of a fixed exchange rate. To add insult to injury, the peg itself is not the main goal. Eurozone membership is, and apart from the obvious question of whether such a membership would be a desirable outcome for Latvia at all, I have my serious doubt that we will ever get there.

But that is somwhat for the long term. In the short term, the horizon is still littered with uncertainty and I tend to agree with Danske Bank's Lars Christenses as he dryly notes:

“There really hasn’t been any fundamental change,” said Lars Christensen, head of emerging markets at Danske Bank A/S in Copenhagen. “The only thing that has changed is how long they can postpone a devaluation. The issues are still there, and what will happen when they need the next loan installment?”

This sounds about right to me and although it distinctly seems as if Latvian policy makers are determined to do whatever it takes, the costs will be immense and one has to wonder whether the fort will hold forever? I don't think it will.


Miacek said...

I recently read (in Estonian media, most likely), that Latvia's central bank is squandering reserves by buying the lats to ensure the exchange rate. So that, the thing Russia's central bank was doing before the 1998 default.

j said...

These wage cuts arent going well - Health Minister just resigned, unions will go on strike tomorrow, teachers are planning to strike on Sep 1 (first day of the school).

Edward Hugh said...

"These wage cuts arent going well"

Not going well, not going well....

That has to be the understatement of the year :)

Unfortunately, this was all reasonably forseeable. It is like they are all reading out a script they have not had time to read out in advance - though the script was in fact written long ago - and are having to improvise on the fly.

I think they had not got the faintest idea what they were talking about when they started to use the term "internal devaluation".

Unfortunately, now the markets are likely to draw their own conclusions about the viability of this for countries like Spain and Greece.

Daniels said...

One great trick is to pay civil servants the same rate, but only for 4 days work, or to force unpaid leave. This does not really help productivity - but gives the illusion of budget cuts. And of course, the massive state-owned enterprises have not done any cutting and can still use their monopoly positions to increase prices.

Jay said...

as far as I know did Poland, Hungary, Romania and Bulgaria apply for IMF help, too.
Are the wage cuts in the course of meeting the preconditions (budget housekeeping) for IMF help in the other countries possible, too?
Thanks a lot


Latvian abroad said...

The things might not have calmed down so much. Today, one-week Rigibor is up to 32.60%, highest level so far. And there are unconfirmed rumours that Latvia might get the next tranche from EU but not from IMF.

j said...

I suppose RIGIBOR is so high because of upcoming long holidays - next working day in Latvia is Thursday 26th. Until then anything can happen.