Economic troubles have been bubbling away in Latvia for months, but the country’s government has so far stood strong in the face of rising pressure to devalue the currency to help mitigate some of the negative economic effects.
At the weekend, though, the clearest signals yet emerged that the country might be about to buckle: the government announced it was making budget cuts of 225m lats rather than the 275m lats expected, a clear contravention of its agreed terms with the IMF, which stipulated a cut of 500m lats.
Swedish media, meanwhile, reported the IMF might be on the verge of walking away and that Sweden’s finance minister Anders Borg had held secret talks with Swedbank and SEB to prepare them for the fallout.
Danske Bank provides a good time-line of the factors leading up to this latest alert (their emphasis):
On 17 September the Latvian Parliament surprisingly voted 52-28 against a bill containing fiscal fulfilment of the binding loan conditions laid down by the EU/IMF. This signalled a strong opposition to accepting the terms laid down. Notably the largest party in Latvia voted against the bill and even expelled an MP from its own party for having voted in favour of the bill (i.e. for doing the right thing in the eyes of the lenders).
The lenders have loudly protested this political refusal to live up to the loan conditions, and have so far remained adamant about Latvia’s obligation to comply with the terms agreed upon. The Swedish Finance Minister, Anders Borg, has warned that the lenders’ patience is wearing thin and that they will accept nothing less than complete fulfilment on the part of Latvia.
The Latvian government needs to improve its fiscal position by some LVL500m. The government has said that it can go as far as 225m in spending cuts and 100m in tax increases, but it will still fall well short of the lender demands.
Consequently, we are in a stand-off situation where the lenders seem to have tied themselves to the mast by refusing to change the loan terms, while at the same time the borrowers fail to show the political will to comply with these terms. Something has to give — in this case the ball seems to be in Latvia’s court — in order for the situation to be resolved.
A major Swedish newspaper has during the weekend published an article alleging that the Swedish Finance minister has contacted the management of Swedish banks with large Baltic exposure and warned them of an imminent collapse in the talks in Latvia. Moreover, the same article states that the IMF is pushing hard for a devaluation as the only viable solution. The contents of the article have not been confirmed by any government source, and must therefore be considered as hearsay until further notice.
No later than 23 October the Latvian government must submit its budget proposal for 2010 to the Parliament. The Latvian Parliament thus has another 2.5 weeks to gather support for further austerity measures, or face the consequences of failing to meet with its obligations.
Of course, with the IMF gone, the Europe Union would be left holding the fort in Latvia.
As BNP Paribas analysts wrote in a note on Monday, that possibility was likely holding back the euro’s performance on the day. As they wrote:
The EUR has been held back from rallying during European hours due to reports suggesting that the IMF might withdraw support from Latvia. The Swedish FinMin Borg has warned Swedish banks that the too relaxed fiscal policy of Latvia might force the country to devalue its exchange rate. There would certainly be spill over effects into the other two Baltic Republics and into CEE countries, leading to currency volatility. However, the Swedish equity market has out performed this morning rising by 0.9% indicating the ‘bad news’ is not much of a surprise. Anyhow, Swedish banks have depreciated assets held in the Baltics suggesting local currency depreciation will have little impact on bank balance sheets. In addition, in the case the IMF withdrawing from Latvia the IMF is likely to ring fence the impact, limiting the impact on CEE and in particular the Bulgarian currency peg. Given the uncertainties surrounding this issue the EURUSD will trade heavy, but we still favour buying into dips.
The OMX Riga, meanwhile, was down as much as 3.41 per cent on Monday (click to enlarge):
Related links:
Another Latvia wobble - FT Alphaville
Moody’s stands by Latvia, for now - FT Alphaville
Latvia’s not for turning - FT Alphaville
