And in Latvia’s case, from your own central bank if necessary. As Reuters reports on Monday (our emphasis):
FRANKFURT, June 29 (Reuters) – The European Central Bank has urged Latvia to rethink plans to siphon off half of its central bank’s profits to help rebuild the country’s battered finances. Latvia’s government plans to up the amount of central bank profits it takes, to 50 percent from the current 15 percent.
The ECB finds this particularly disturbing because, as pointed out by Reuters, it believes it could ultimately lead to the perilous state of central bank negative equity for the Latvijas Banka:
“The use of central bank financial resources may be counterproductive from the credibility point of view if confidence in the financial stability and independence of the National Central Bank is undermined,” the ECB said. “It is important to shield the rules related to the distribution of profits from third-party interests and to ensure a legal framework that provides a stable and long-term basis for the central bank’s functioning.”
Latvia is hoping to avoid state bankruptcy and devaluation of its currency as it struggles to cope with the financial crisis. The ECB warned the plan to divert central bank profits could leave the Latvian central bank in deep financial water, owing more than its assets are worth. “In principle it is not optimal for the central bank to create reserves only after transferring a large portion of its profits to the Treasury,” the ECB said. “Should Latvijas Banka run into a situation of negative equity in the future (i.e. losses exceeding currently accumulated reserves), it would be hard to rebuild it out of the stream of future `net’ earnings under such an arrangement.”
Meanwhile, Harvard’s Ken Rogoff has joined the cohort of economists and analysts urging Latvia to bite the bullet and devalue. Rogoff told Nordic wire Direkt on Monday, as reported by Bloomberg, that the IMF made the wrong decision when it allowed Latvia to keep its currency peg.
In fact, he suggested a quick devaluation would really be the best option for stricken Baltic nation. He admitted, however, this is unlikely to be the case now that European and IMF loans are coming Latvia’s way — the effect of which is only to delay the inevitable.
Bloomberg goes on to paraphrase:
In a normal situation, Latvia would already have devalued the lats and defaulted on its debt, Rogoff said, according to the news agency. World leaders have decided no countries should be allowed to fail and Latvia is benefiting from that, he said.
And Rogoff really should know. Not only was he formerly chief economist at the IMF, he is also co-author of This Time is Different: A Panoramic View of Eight Centuries of Financial Crises – an exhaustive economic retrospective of financial crises gone by.
Related links:
Latvia’s Achilles heel: deposits – FT Alphaville
Is Latvia the new Argentina? – VoxEu.org
Latvia – more parallels with Argentina - FT Alphaville
Crisis averted; Latvian central bank buys euros - FT Alphaville