16 Jun 2009 My previous
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| 2006 | 2007 | 2008* | 2009* | 2010* | 2011* | 2012* | |
| Gross domestic product, constant prices (%, annual change) | 12.2 | 10.0 | -4.6 | -18.0 | -2.0 | 1.4 | 3.0 |
| Inflation, average consumer prices (%, annual change) | 6.6 | 10.1 | 15.3 | 3.3 | -3.5 | -0.8 | 1.8 |
| Current account balance (USD, bn) | -4.5 | -6.5 | -4.5 | -1.8 | -1.4 | -1.4 | -1.3 |
| Current account balance (% of GDP) | -22.5 | -22.6 | -13.2 | -6.7 | -5.5 | -5.5 | -45.0 |
Lack of confidence symbolizing Rigibor and its recent massive jump was furthermore impacted by a few recent events and comments. First of all on the 3rd of June a government debt auction failed to attract enough bidders for 50 million Lats (€70.49 million). Secondly, a Swedish central bank former chief and a current advisor to Latvia Bengt Dennis commented that devaluation was all but inevitable.
There are several reasons why Latvia is so determined on not devaluating its currency. In the Baltics almost all banks are Scandinavian and people used to borrow in foreign currency (60- 90% of total loans). Consequently, if devaluation would happen it would definitely raise the default rates and would negatively impact the banking system, which is from 50 to 90% (dependant on a country) Scandinavian owned. Even though devaluation would benefit exporters, loan defaults and higher inflation according to the Latvian government would do more harm. Moreover, devaluation would mean that they would have to delay a so much wanted entry into the euro zone for later than in 2011- 12. In order to try to reduce possibility of devaluation Latvia’s central bank has been using its foreign reserves in its efforts to maintain the currency peg, by using more than $2 billion of its reserves. But Latvia is definitely not strong enough to solve its economic problems by itself.
| Latvia | Lithuania | Estonia | |
| Foreign-owned banks | 55.4 | 92.4 | 97.1 |
| o/w: Swedbank | 24.3 | 22.8 | 52.0 |
| SEB | 17.3 | 31.4 | 22.5 |
| Top 3 banks | 53.6 | 67.8 | 86.6 |
Last year the Commission and the International Monetary Fund created a €7.5 billion support package for Latvia. EU member states already agreed in January 2009 to grant Latvia a €3.1 billion loan. Moreover, they are currently assessing whether Latvia has strengthened its banking sector and have been able to meet the 5% of GDP budget deficit limit. These were the terms of loan granting for Latvia and meeting those requirements would enable them to receive the next tranche of €1.7 billion funds due in the late June. It is probably impossible for Latvia to reach the previously agreed aims, since currently the budget deficit limit is 9% and the banking sector is still in not much stronger situation. The budget deficit currently is larger not because Latvia’s government was spending too much, but because of the much bigger than expected economic contraction. Previously it was expected that Latvia’s economy will contract 5%, but the results showed a GDP contraction of -18%. The only possibility to get closer to previous IMF requirements is to tighten governmental spending even more, which is also not so easily possible, since too much tightening could sometimes lead to an even bigger recession.
The reasons this country receives so many attention now is the expected contagion effect of Latvian crisis for the greater Central and Eastern European region and their impact for Scandinavian banks. If not a strong Baltic countries trade ties, the similarities in macroeconomic imbalances in other Baltic countries, Bulgaria and Romania could scare investors from the region. Already the recent sell-off in the Polish zloty and Hungarian forint was largely impacted by concerns over potential spill over effects of Latvian problems. Baltics and Bulgaria have fixed exchange rate system and there could be loss of confidence in Bulgaria’s currency board as well. Although, the flexible exchange rate countries, such as Romania and Hungary already previously received the IMF rescue packages. Additionally, because of the dominance of Swedish banks in Latvia, Estonia and Lithuania financial system contagion would harm Scandinavian banks. According to the “Fitch Ratings” recent stress tests analysis, the “Swedbank” seemed to be the most vulnerable bank for the absorption of losses. Already, on the 10th of June European Central Bank lent a €3bn to the central bank in Sweden, to help country banks to cope with their exposure to the Baltics.
Consequently, I would expect that it is hardly feasible for Latvia to avoid devaluation, unless IMF will be lax on its previously agreed loan granting requirements and will provide a bigger loan. Recent ECB loan of €3 bn to Swedish banks could show a willingness to compensate for their losses, connected with the feasible devaluation (40% default rate of all loans is expected). Moreover, the contraction of Latvia was more than 3 times larger than it was previously expected (-5% expected, -18% announced). Additionally, it is not so definite, than the contagion effect will take place. Other closest victims- Lithuania and Estonia have better macroeconomic situations (e.g. better GDP results, budget balance and public debt % of GDP, lower inflation).
Argentina’s default – easily forgotten by investors. ("Bloomberg")