The IMF’s mission to Latvia should have finished last Friday. But with no agreement on the international body’s second instalment of aid yet, many are beginning to question the very survivability of the current international lender model in emerging Europe.
Writing for Barclays Capital, Christian Keller comments (our emphasis):
Although the Latvian Parliament did approve the announced budget cuts on Tuesday this week, the IMF response posted on its official website was rather lukewarm, suggesting that the measures were still not enough for the IMF to feel comfortable enough to continue the support of the Latvian peg with its own money.
Typically, the EU disbursements have followed those of the IMF in the sense that the EU left the IMF in charge of “managing” the programmes (ie, undertaking the economic assessments) and then would disburse its funds following the completion of IMF reviews. For example, this has been the practice in Romania and Hungary. Now it seems that in Latvia this IMF-EU cooperation could break down, with the IMF declining to conclude its review even though the EU wants to make its own disbursement.
As Keller points out, Latvia doesn’t necessarily lose out if the IMF does breakaway.
The EU instalments should be enough to cover its short-term liabilities. However, the deadlock still represents a major split in political opinion over what’s best for Latvia and critical issues like devaluation. In short, the EU appears happy to carry the country’s collapse because it is currently in its best interests to do so. Latvia’s ejection from the ERM2 would be far more reputationally damaging. What’s more, as a small economy, at this stage the EU can afford to follow the aid path.
For the IMF, burned previously via its Argentine experience — where it backed an equally ill-advised currency peg for far too long — the consequences of acting against Latvia’s interests would also be much more reputationally damaging.
As Keller writes:
From a practical funding perspective, this is not earth shattering, as the bulk of the money in Latvia does indeed come from the EU (EUR 1.2bn in this disbursement versus a mere EUR 200mn from the IMF). Indeed, the IMF’s relatively small contribution to the Latvia programme always seemed an indication of its discomfort with the idea to “defend” the Baltic pegs. The IMF’s unwillingness to go along with the EU at this review, however, would further highlight the divergence in views between the EU and the IMF, renewing the intellectual debate whether the “internal devaluation” strategy proposed by the EU and the Latvian authorities can work (see our research notes on the issue).
Meanwhile, Danske Bank analysts point out just how mixed up the whole affair has now got (our emphasis):
All the indications are that the continued negotiations between the Latvian Government and the IMF are going far from well. The negotiations were supposed to have been wrapped up on Friday. However, it has been announced that they will continue this week. Apparently, the IMF wants the Latvian Government to tighten fiscal policy even further. Last week the Latvian central bank said it was against any form of tax hikes in order to improve the budget situation. We find it odd that the Latvian central bank seems to think it has a power of veto on fiscal policy — and the fact that it has come out with this kind of statement could make it even harder for the IMF and the Latvian Government to reach a deal on the pay-out of the next instalment of Latvia’s IMF loan.
Dire results from Sweden’s SEB bank on Monday — following in the footsteps of equally disappointing results from Swedbank on Friday — only emphasise the pressing urgency for a sound Latvia solution. The bank reported much weaker-than-expected second-quarter operating profit totalling SEK 618m versus an expected SEK2.31bn, mostly on a sharp deterioration in its Baltic portfolio. Here follow some key paragraphs from the statement:
Related links:
D-day in Latvia- FT Alphaville
The IMF/EU Commission rift on Latvia deepens – A Fistful of Euros
Trouble in Latvia, again – FT Alphaville
The EU in 140 Characters – FT Alphaville