In Latvia, don't say it with flowers. Riga's central market. Photo by Desmond Kavanagh.

Latvia on the brink

For a long time the country with the highest growth in the EU, Latvia finds itself staring into a financial abyss. Seeking to economise its way out of the crisis by slashing public spending, it may even have to devalue its currency.

Published on 30 June 2009 at 08:56
In Latvia, don't say it with flowers. Riga's central market. Photo by Desmond Kavanagh.

We had no political will, we lacked economic and entrepreneurial foresight, the government was pathetic. Now we face the existential question: Will Latvia survive?

Pretty strong language – especially when you know who said it: Latvian president Valdis Zatlers. Civil servants are taking a 20% pay cut, pensions have been pruned 10%. That was the only way for Latvia to get any more money from the International Monetary Fund and the EU: money without which the government would already be going broke in July.

How could it come to this? How can it be that the same national economy that for years grew faster than any other in the EU is suddenly on the brink of a financial abyss? The answer is, in a word, debts. Nowhere else in the European Union did the banks extend so much credit, and nowhere else did that produce such an overheated economy. And because Latvia’s economic boom was based almost entirely on credit, the international crisis packed a full wallop there.

In December 2008 the IMF and the EU already had to provide a quick fix to the tune of €7.5 million because Latvia couldn’t raise credit on the international capital markets any more. So wherein lies the remedy? Certainly not in the nation’s overindebted consumers or companies. Nor in the government either, which will have to resolutely retrench for the next two years at least to meet IMF requirements. So it’s no wonder foreign countries – particularly Sweden, which has such close ties to Latvia – are mulling a remedy that seems unthinkable even to Latvians themselves: devaluing the Latvia lat, which is currently tied to the euro with a fluctuation band of plus/minus one per cent. Devaluation would make Latvian products cheaper abroad and the export sector more competitive. But that would be capital punishment for many Latvians who see the strong lat as the anchor that kept the economy from going adrift after the inflation-ridden early 1990s.

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And that is not the only argument against devaluation. For one thing, the European Central Bank has ruled out the possibility of introducing the euro in Latvia any time soon if the currency is devalued. For another, who is to guarantee that a devaluation will be kept within fairly orderly bounds and will not culminate in the kind of complete currency collapse that rocked Argentina? The risk of a run on the banks is not to be ruled out, if only because many Latvian depositors can convert their lats into foreign currency at the click of a computer mouse. What’s more, other Eastern European currencies also tied to the euro could come under pressure, too – first in Estonia and Lithuania, then in Bulgaria.

In the meantime, Latvia is trying to recover its competitiveness by slashing wages. In Germany that would be utterly impossible if only on account of its strong trade unions, whereas organised labour hardly plays any role in Latvia. The only question is whether this sort of devaluation will actually do the trick – and kick in fast enough. On the one hand, by dint of the crisis Latvia has again become a country with plenty of cheap labour. On the other hand, however, domestic and foreign investors are still holding back.

Whether the country can cope with this uncertainty will depend above all on its ability to regain its reliability. And to do that it will have to adhere to the IMF’s strict regimen and stick to its austerity policy. If it succeeds, Latvia really deserves to be admitted into the euro club. But that will be an uphill battle to say the least: Sisyphus would have considered his job a cinch in comparison.

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