On Tuesday, we reported that Latvia’s government was taking legislative steps to change the sums lenders could collect on outstanding mortgages to better reflect the current market value of the properties.
We argued this was probably a move to sidestep the need for devaluation of the local currency — the lat.
BNP Paribas’ FX team on Wednesday, however, interprets things slightly differently. As they write:
The risk of a Latvia devaluation has increased after the Latvian government introduced measures protecting indebted local households and corporates from the side effects of currency devaluation namely the valuation rise of non-local currency denominated debt. The government has proposed to limit the amount a lender can collect from mortgage holders to the valuation of the underlying asset. Hence, debt value and asset value will be linked according to the government’s proposal. Swedish banks have dominated the Latvian markets and must now take most of the losses. Swedish banks have balance sheets strong enough to cope with these losses, but the shrinking equity ratio (due to loss realisation) within balance sheets will reduce bank’s capacity to lend and this will also affect the Swedish market.
Effectively, what they’re saying is that the amendments incentivise the case for devaluation by limiting the sums Latvians would have to repay on their mostly euro-denominated mortgages if the lat did lose value against the euro.
That is to say, the move could be more than just a policy tool to ease the pain for Latvians already facing negative equity and struggling to meet current repayments. The state may be buffering itself up for the consequences of devaluation.
BNP Paribas’ emerging markets team, though, disagrees to a point. While they acknowledge the move clearly indicates things are deteriorating in Latvia, they’re not convinced the measures actually increase the chance of devaluation. As they write on Wednesday (their emphasis):
The situation in the Baltics is coming back to the foreground with the new law being proposed in Latvia. The government wants to reduce mortgage liabilities to the value of the property. Given that property prices have plummeted by around two-thirds, it might be a big blow for the banking system. If the law is imposed, it would significantly reduce the households’ and companies’ sensitivity to exchange rate movements, we took profit on our short positions in Latvian CDS yesterday and we think that risk will now increase but do no make devaluation our central scenario.
Related links:
Defcon Latvia, again - FT Alphaville
Latvia’s not for turning - FT Alphaville
Swedbank sweats - FT Alphaville
