Izabella Kaminska at FT Alphaville has the story (via Reuters):
The International Monetary Fund has put forward new, difficult conditions for Latvia to receive further loans, the prime minister said on Wednesday in a further sign the Fund is being tougher than the European Commission.
It isn’t clear at this point what these conditions are. Rumour has it they may be an end to the flat income tax, or a hike in VAT. A hike in VAT would be more hari-kiri, since this would again hit consumption AND would boost inflation at a time when they are trying to deflate to carry through an internal currency correction. It also isn’t clear whether this is a serious attempt to add new conditions (which I find unlikely, given how advanced the distemper is) or whether this is a way for the IMF to get themselves off the hook (ie leave the EU Commission to stew in its own juice) without having a public and potentially damaging break with the EU. The IMF need to find some sort of exit strategy I think (since Latvia evidently at this point doesn’t have one), or it risks losing its own credibility if it puts a seal of approval (by granting the next tranche) on something which most external specialists now think could end up in a very messy grande finale. Argentina ghosts are stalking the corridors in Washington, not because of the similarities between the two countries (they are, at the end of the day pretty different), but because of the way giving a final “kiss of death” loan to a country can ultimately come back and haunt you.
Update One
The local Latvian news agency is saying that if Latvia and the IMF do not sign the new agreement by Friday, Latvia may not see the next chunk of the IMF loan and it could jeopardize the further funding from the EC. This could be brinksmanship, but even brinkmanship can go badly wrong if the other party can’t concede. And who is the other party here? Latvia or the EU Commission, since they already said they are happy with progress. What a muddle!
Update Two – Thursday Afternoon
Bloomberg’s Aaron Eglitis reports this afternoon that Friday may in fact not be any kind of deadline. He quotes Caroline Atkinson, head of external relations at the IMF, in Washington, to the effect that the head of the IMF mission in Riga is returning to Washington this weekend as scheduled, while the mission itself would “continue its work.†This suggests there will be no final decision this week. She also said there was “broad consensus among all the parties involved†about the goals for Latvia, declining to go into specifics.
Rumourology has it that the IMF wants the government to become more effective in revenue collection, with the fear that the current contraction may be so strong due to the fact that part of the economy is disappearing back into a “grey area” as a backdrop. Various proposals are being floated around, but perhaps it would be better to wait for some concrete information before speculating about this.
Latvian central bank Governor Ilmars Rimsevics has also been holding a press conference in Riga today, and he took the opportunity to suggest that the country’s budget deficit was likely to grow to between 9.5 percent and 10 percent this year. If this is the case, then this would obviously put Latvia outside the 60% gross debt to GDP criteria by 2010, which would make euro membership as an exit strategy non viable over the relevant horizon in my view. Just a long shot, but maybe that is what they are all arguing about. The EU clearly has to offer the four peggars more in the way of a carrot, although they themselves need to remember – looking over at Slovakia and Slovenia – that mere euro membership is no panacea to cure all ills.
Edward,
1) a problem for Angela, because she insisted that EU support must be coupled with IMFs to protect savings of German Omas and Opas from expansive ECB politics,
2) contagion danger is extreme!!!
The new data show that one of tha main pillars of Latvian economy – Cargo – has grown on H1 2009 http://www.railwaymarket.eu/7702/Latvia+Profit+of+LDz+Cargo+up+25%25+last+year.htm
Taking in account the reality that the real economy of Latvia is based on Cargo, Chemicals, Pharmaceuticals and a lot of other sectors pretty stable during recession, it is a big question for me, if the situation in Estonia with its overblown mobile phone production and Lithuania under zloty pressure will be really better as in Latvia?
In case of Latvia there is only one problem – banking crisis. Meanwhile, information arrived this weekend that there is a big rethinking in Latvian government of banking bailout issues. There is a high probability in the present situation that the government will drop ill banks. In that case Latvia will not need any external loans because internal fundamental data is very good.
“In that case Latvia will not need any external loans because internal fundamental data is very good.”
Year-on-year 1st quarter GDP -18%, tax revenues on 2006 level, salary cuts by 20-50%, unemployment already around 15% and growing: those are just few of internal fundamental data.
Dear Hedgehog,
GDP fall -18% is due to crash of the banking and retail sectors, as well as construction, which were overblown during the bubble. STTL, overblown banks, nobody will miss you!
We had already comparable situation. In 1990-1994 the GDP of Latvia fell more than 54%. However, if you visited Riga in this time, there was nothing extreme. People were sitting in coffeehouses, transportation and utilities were working, the criminality was higher as during Soviet times, but this was the case for all CEE. This is due to the fact that the GDP fall came from contraction of Soviet military and heavy industry which did not have much resulting impact on Latvian economy.
The present situation is similar – overblown banking sector in Latvia was heavily involved in operations with Russia and other Eastern countries. As it contracted, direct impact on Latvian economy is not so big. The real problem is that the European Union imposed on Latvia the bailout of banks which were located in Latvia, but in reality had very little business locally. This has proven to be too expensive a program for a small country which has limited borrowing ability on the global financial marketplace.
Please, take in account that the grey sector of economy is returning in Latvia very rapidly, so real fall is by far not so immense. Already half a year I am paying everything in cash. If the government has not enough money, so it must stop the big EU infrastructure projects (which must be initially paid by Latvia, and only then EU is returning something in long time period). For Latvia they are not of much added value. As through Latvia is the only safe road to Russia, if every second EU truck will get damaged on the bad roads, Bruxelles will rapidly send enough money to repair everything without Latvian contribution.
The loan asked from EU and IMF is planned 100% for bank bailout. Due to EU regulations this emerges as budget deficit, this unusual bailout. Almunia has already declared very publicly that loan is only for support of the banking system. Internally the opinion sublimates that let the banks fall, anyway they have very few real active, and build a new big state bank.
Generally I fully agree with Hugh that this unusual action in Latvia is getting just sick. The concept of internal devaluation is dejavu Heinrich Brüning. It is not possible to gain something by deflationary policy if others are doing the same.
I am here not so much to defend Latvian situation. Much more am I interested in the new unusual concepts of contagion which poses an extreme danger to EU and to anticyclical policy in the EUR zone which seems not to exist due to the fact that Spanish workers have different interests as Angela and german Opas and Omas.
Dear Govs,
By the way in year 1995 when largest bank in Latvia collapsed (together with about 5 smaller) GDP declined only 1.6%
I have a view that comparisons with pre-market(1993) GDP are with little sense – how you can rely on those when prices where set totally differently and Latvia was just province of much larger country. And in 1994 people were poor and prices were low.
1990-1997 was time of major shift when underutilized assets and labor went into more productive use.
Of course here was bubble forming in Latvian economy since 2004 when Swedish and other banks started to pump money in. But now together with hot air fully healthy companies and industries are on the brink of destruction.
Looks like Latvia is heading for full crash and program of recent government will help it happen soon.
Dear Hedgehog, that is it, in 1995 the banks were not bailed out, and nothing important happened. Deadly ill institutions died, new ones sprouted in place of them.
In 2008 EU was afraid of butterfly effects and imposed that sick anti-market bailout of banks. In case of Latvia that meant immediate freezing of 30% of governmental budget for that purpose. As further consequence Swedish banks totally ceased issue of new loans and retracted just in Q1 2009 15% of loan market, closing credit lines for healthy companies as well (similarly to France during Heinrich Brüning Notverordnung period). Here you have the CEE problem.
Regarding major Latvian companies, that is absolutely new for me that there is something dangerous. Rail, airline, electricity, gas, chemicals, pharmaceuticals are even growing H1 2009. Wood product market is reviving. Agriculture is suffering from zloty devaluation, however, some industries as livestock are pretty well, because demand for high quality beef is high (not all want the polish chemical meet monsters). Fall in retails trade and financial intermediation is just natural. The sharp reduction in added value from internal services as education, research and health is just consequence of budget freezing due to bank bailout.
In core industries there are even clear further income sources. For instance, if Latvia will impose road tax to German levels, this will contribute +5% to national income.
In 1995 Latvia had no deposit insurance. If Parex was to fail immediate cost for government would be LVL 600 mil. (close to 1 billion euros). May be that would be less than actual cost now.
All major companies which need financing face situation when local banks don’t extend any loans or recall existing, but for foreign banks Latvia is out of bounds. If this is dangerous depends on why company need financing.
The tale of immediately necessary 600 Mio is maybe intriguing and touching, but very far from reality.
Of course, mismanagement led to increase of deposit insurance limits after PAREX bankruptcy to protect banks from Kassensturm. However, during 1995 there was no Kassensturm in Latvia (without any deposit insurance), so why it had to be in 2008? The law of deposit insurance valid at that moment provided for repay from Deposit insurance in three months AFTER FINISHING THE BANKROTT PROCEDURE. So how long would be an insolvency procedure for a bank like PAREX with lots of coded and unidentified accounts, liabilities and securities? 20 years? 200 years? The absence of insolvency procedure in case of PAREX is exactly the problem worrying the EU. Because nobody has even an approximate idea about the real liabilities of this bank. Iceland did a more clever procedure with Landesbanki with a preceding insolvency procedure and consecutive recapitalisation.
One point is clear – the old model of financial centre is dead for Latvia, so the EU can search another place where to make all the dirty business with Russia and other Eastern nonmarket economies.