Latvian prime minister Valdis Dombrovskis
might be forgiven for expecting a pat on the back from his
coalition partners. Since coming to power this April,
Dombrovskis has managed to secure more than E1.4 billion of a
total E7.5 billion international loan package. He has also won
a concession from the IMF that Latvias budget deficit can
increase to 13% of GDP instead of the previously agreed 5%.
By the beginning of October we are
to receive E200 million from the World Bank, which makes us
well set for this year and the beginning of next year,
Dombrovskis tells Emerging Markets in an interview in
But Dombrovskis seems more likely to
receive a dagger between the shoulder blades than a pat on the
back, with his coalition partners the Peoples Party
working to undermine him even as Latvias coffers fill up
What do they want to achieve?
Thats not very clear, but certainly they are changing
their positions on several issues where they formerly had a
clear position, says Dombrovskis.
What he calls the Peoples
Partys games stem from the unusual position
it finds itself in. It is the largest party in parliament and
government but retains hardly any support among the electorate,
who hold it responsible for leading the country into crisis
during the fat years to use former
prime minister Aigars Kalvitis phrase of economic
The Peoples Party was virtually
wiped out in Junes European elections but until the next
general election in October 2010 retains its parliamentary
muscle. It seems to be hell-bent on making life for
Dombrovskis, from the rival New Era party, as difficult as
The hope must be that he will be saddled
with the blame for the recession as well as the austerity
measures that were a way of combatting it.
Prominent Peoples Party ministers
have refused to implement further spending cuts. Indeed the
party indulged in brinkmanship over whether it would sign a
second letter of intent with the IMF, and one of its MPs
apparently accidentally leaked market-sensitive information
during a parliamentary debate called, at the Peoples
Partys request, on September 9.
Dombrovskis does a good job of hiding any
exasperation, preferring to point out the inconsistency of his
bothersome colleagues, for instance over the introduction of a
new property tax, which the Peoples Party says it
The decision to broaden the base of
real estate tax was already taken by the previous government
when we had Atis Slakteris as finance minister from the
Peoples Party. It was also agreed in the letter of intent
to the IMF signed by the Peoples Party, so really
its a bit unclear why they are changing their mind,
He rejects the Peoples Partys
claims that the agreements signed with the IMF contain any
sinister secrets. The [second] letter of intent has a few
technical provisions which are not made public. They are not
politically sensitive by any means, but at the request of the
Bank of Latvia and the Treasury they were not made public
because they include market sensitive information, he
says. They include plans for future placements on the
worlds financial markets.
We would give an unfair advantage to
the market by disclosing exactly what the plans are.
Thats normal procedure, and exactly the same procedure
was used in the first letter of intent. At that time the
Peoples Party did not seem to object.
Despite the evidence to the contrary,
Dombrovskis insists the Peoples Party arent
planning to destroy his administration from within.
Political stability is needed to negotiate with
international lenders thats understood even by the
Peoples Party, he says.
It may be that the return of political
chicanery is a sign that Latvias vertiginous recession is
bottoming out (if a second quarter figure of minus 18.7%
year-on-year can be described in such terms). But more likely
it increases the danger were the country to be thrown into
fresh turmoil particularly given the effect
political instability could have on the countrys already
weak ratings. Standard and Poors rates Latvia
BB, two notches below investment grade.
The three main
priorities we see to overcome the crisis are: first, fiscal
consolidation; second, stimulating the economy, and third,
establishing a minimum social security network, says
consolidation is most immediately linked to the international
loan package. We passed budget amendments in June which
included fiscal consolidation of 500 million lats, and we are
to decide on a further fiscal consolidation of 500 million lats
in the 2010 budget.
He says: Cuts will not be as
dramatic as this year because this year it was 500 million in
half a year whereas next year its 500 million for the
whole year. However, there are fewer places to cut.
With anger at the closure of hospitals and
schools as well as unemployment running at around 17%, the
question of Latvias euro adoption date has slipped down
the agenda even if nominally it remains a priority.
But with Latvia unlikely to meet the
Maastricht 3% of GDP budget deficit criteria any time soon,
Einars Repse, the finance minister, has adopted a strategy of
saying a firm date will be announced two years before it
happens with 2014 being suggested, if vaguely, as a
Neighbouring Estonia has taken a different
line. It was the second EU member state to enter a technical
recession, but throughout the downturn has promoted the idea
that replacing the kroon with the euro is its number one
priority. Barely a press conference passes in Tallinn without a
repetition of the mantra euro adoption at the earliest
Andrus Ansip, the prime minister, heads a
minority two-party coalition after a third party walked out in
a disagreement over changes to labour law designed to increase
the flexibility of the labour market.
Officially the euro target date remains
2011, which central bank governor Andres Lipstok says is
But with the economy expected to contract
by 14.5% in 2009, Jurgen Ligi, the finance minister, says
spending cuts in addition to those already made will be
necessary in the 2010 budget. Sensitive areas such as
healthcare will be affected. Next year the need still
exists to also cut real, basic wages, Ligi told the
Estonian parliament on September 16.
Violeta Klyviene, a senior Baltic analyst
at Danske Bank, believes Estonia is in a better financial
position than the other Baltic states, but the chance for early
euro adoption is on a knife edge.
Despite recently implemented fiscal
tightening, the risk of breaching the 3% of GDP budget deficit
in 200910 is significant, she says. The
Estonian government hopes to be in line with the GDP target
mostly due to additional dividend income. However, Eurostat
might classify this as extraordinary income and exclude it from
the deficit calculation.
Lithuanias Andrius Kubilius seems
the most steady of the three leaders one year on from his
election. But with Lithuanias GDP dropping by even more
than Latvias in the second quarter of 2009 20%
year-on-year its a relative notion.
The economic situation is
stabilizing, though we cannot talk about it coming back to the
level of recent years, Kubilius tells Emerging
Markets in Vilnius.
Despite the fact that the recession
in the Baltic states has been deeper than elsewhere, all of us
are stabilizing at around the level we were at in 2006. But we
are confident we can keep our public finances stable. He
is reluctant to name a target date for euro adoption.
Kubilius appointment of Ingrida
Simonyte as finance minister has acted as a stabilizing
influence: she has been sure-footed so far in balancing the
need for budget cuts against a desire for economic
The biggest mistakes in the past
were related to the perception that the convergence process can
be very speedy and at no cost, says Simonyte. For
management of public finances, an important lesson is that
financial commitments for the future must be sustainable not
only in the medium term, but even in the long term to prevent
public debt from sudden increases.
Eurozone membership remains a top
priority she says. The current crisis shows clear
benefits of being within the eurozone. Much will have to be
done in the area of public finances as the fiscal deficit,
being above the Maastricht limit, will be a challenge for the
next two years. Due to the uncertainties over the economic
outlook, it is not easy to name any concrete date for euro
Simonyte says: A need for possible
financial assistance cannot be ruled out, and Lithuania as a
member of the EU and IMF would use this opportunity if
Nordea bank economist Annika Lindblad says
the focus this autumn will turn towards Lithuanias next
Eurobond placement. The confidence of private-sector
lenders would support the notion that no rescue package from
the IMF is necessary, she says.
But no matter what paths Estonia and
Lithuania plot individually, they run the risk of having their
euro aspirations dashed by Latvia if it is forced to devalue
its currency a strategy favoured by the Peoples
Party, says Neil Shearing, an emerging Europe analyst at
London-based Capital Economics.
I suspect that what happens in
Latvia will govern what happens in the rest of the
region, he says.
If Latvia should receive a competitive
boost via a devaluation, then it will deepen the
competitiveness problems in Estonia and Lithuania, with a good
chance that if Latvia goes the other two currencies will also
The contagion could spread throughout
central and eastern Europe, Shearing believes. Latvias
attempt at an internal devaluation via falls in
wages and prices in the real economy may be brave, but it is a
Such is the scale of the falls in
wages and prices needed to restore some semblance of
competitiveness that I find it difficult to believe we are
going to see this process through. There is no historical
precedent for it no one has ever managed to boost their
real exchange rate while keeping the nominal rate
constant, he says.
Provided Latvia manages to weather the
storm, Estonia and Lithuania could join the eurozone in 2013,
Lindblad predicts, with Latvia crossing the line later.
Although the risk of devaluation in
Latvia has subsided, the neighbouring countries will continue
to monitor the situation, as devaluation could prove disastrous
to the currencies of the other Baltic countries as
But this hardly addresses the logic of
euro adoption. Small, open, export-oriented countries
desperately need to be able to run their own monetary policies,
argues Maya Bhandari at Lombard Street. It is a mystery
that countries in the region are still looking to the euro for
support, she says.