The Latvian national currency, the lats, has become one of the most expensive currencies in the world. And that despite the fact that the country is on the verge of bankruptcy and may find itself unable to fulfil its internal obligations, never mind the foreign ones. With an increasing intensity, economists from New York to Barcelona have been saying that Latvia should opt for currency devaluation to aid the crippled economy. But in the country itself, the topic of devaluation is being consistently, or some may even say, stubbornly, ignored.
The Lats has been pegged to euro since 1 January, 2005 at the rate of 1 euro = 0,702804 lats with +1% fluctuation. Many international economists (Edward Hugh and Nouriel Roubini, among others) and some local ones, point out that the zealous, regardless-of-the-costs policy of keeping the peg is becoming too costly for the already weakened Latvian economy. But Ilmars Rimsevics, the governor of the Bank of Latvia, remains steadfastly determined to pursue it. He is convinced that the policy remains the right one and dismisses critical remarks as "irrational, irresponsible and silly." His main argument in favour of keeping the value of lats untouched is that 82% of the 16.4 billion lats worth of loans in Latvia have been issued in euros. Should the lats devalue, the borrowers, he argues, will have trouble paying back their loans.
It is worth noting that the aforementioned ‘trouble' would also affect Rimsevics himself, because last year, at the height of the real estate market, he bought a flat and land for 750 000 euros. What the governor fails to acknowledge is the fact that some Latvian people will experience, if are not already experiencing, problems with their mortgage payments because of the massive layoffs and pay cuts for government employees, reaching, in some cases, 30% of their pre-crisis salary. With Latvian economy shrinking by 18% in the first quarter of 2009, similar cost-cutting is inevitable in the private sector, too.
The management of the Bank of Latvia is becoming lonelier by day in its desire to preserve the lats but is not losing its resolve to ignore other arguments, presented both by local and foreign economists. One can spot some signs of mounting pressure in Rimsevics' rhetoric. More and more frequently, he appears to be losing his nerve and calls those suggesting devaluation ‘pseudo-economists', even if the ranks of his opponents include such stellar names as Roubini.
So far, business leaders have not been forthcoming with their opinion on the issue. They are the ones to whom the government pins its hopes in filling state coffers with much-needed cash, but they may have a hard time delivering it as they are rapidly losing market, both at home and abroad. On the one hand, business leaders admit that devaluation would serve as an additional boost for their business, on the other, they are trying to find arguments in favour of keeping the peg intact. In fact the economy has become a hostage to the euro-borrowers who chose this currency over the lats because loans in the national currency simply were, and still are, too expensive. The base lending rate for the lats, set by the Bank of Latvia, is 5%.
A forbidden topic
For many years, the topic of devaluation of lats has been a ‘holy cow', something not to be disturbed. In 2007, Latvia started experiencing high inflation, which rapidly reached double digits, and the competitiveness of Latvian businesses suffered. In February 2007, the first voice in favour of using devaluation as a mechanism for restoring it was raised. It was Morten Hansen, head of the Economics Department of the Stockholm School of Economics in Riga. The official response was quick and strong: the economist was accused of incompetence. Later the same year, another Latvian economist, Alfs Vanags of the Baltic International Centre for Economic Policy Studies, suggested the same. And he, too, was told to mind his own business and focus on the issue of raising productivity instead.
The lats survived the first wave of growing inflation, which started in early 2007 and reached its peak in May, 2008 hitting a record, 17.9%. However, with problems in the economy mounting, the discussion on devaluation sparked again with a renewed passion. Those who initiated the discussion were, once again, accused of ‘spreading rumours' and ‘feeding the panic' over the stability of lats. The official response to the renewed debate brought back memories of the USSR: in December, 2007 the Latvian parliament passed amendments to the Criminal Law introducing a new section, Dissemination of Untrue Data or Information regarding the Condition of the Finance System of the Republic of Latvia. According to the new law, a person "who commits knowingly the dissemination of untrue data or information orally, written or in other ways regarding the condition of the finance system of the Republic of Latvia" can be sentenced to up to two years in prison, community service, or a fine of a maximum eighty minimum wages. Citing the new law, the Latvian Security Police last autumn arrested Dmitrijs Smirnovs, lecturer at the Ventspils University College, who had expressed his opinion on the future development of Latvian economy, banking system and lending institutions in a round table discussion published by the local paper Ventas Balss. Musician Valters Fridenbergs also ended up in handcuffs after encouraging the audience to listen the concert till the end "before rushing off to the nearest ATM." These arrests sparked a discussion as to the proportionality of the police's response and the word ‘devaluation' in people's conversations was jokingly replaced by the term ‘the D word'.
Section 194 of the Criminal Law is still in force and therefore anyone who dares start a discussion on the current state of Latvian economy and the ways of dealing with the crisis may end up on the Security Police's black list. The government and central bank officials claim that any mention of possible devaluation in mass media adds to the run on the lats.
Economists press on
Latvian government has decided to protect the lats and instead is implementing income devaluation through pay cuts. The ‘no devaluation' option was agreed with the international lenders and both the IMF and the European Commission have recently confirmed that the euro-peg is an "anchor of stability" in Latvia. "Given that we have chosen the policy of cutting costs and income we have to continue pursuing it. It is not sensible to hop back and forth between two different solutions," says investment banker Girts Rungainis.
However, an ever-growing number of economists are saying that, apparently, propping the national currency is becoming too-expensive an affair for Latvia (so, the legal implications of discussing devaluation have not stopped the debate). Although a coordinated wage cut could in theory approximate the effects of a devaluation, it is extraordinarli difficult to achieve, and will in any case have different impacts on borrowers and lenders.
Spokesman of the Bank of Latvia Martins Gravitis dismisses the arguments of devaluation supporters as ‘laughable'. Despite the results of a recent survey by the leading daily Diena, which showed that nearly half of the population would like to hear a ‘serious discussion' on the subject of devaluation, paternalist attitudes still prevail in official circles. ‘The people' are perceived as ones who do not understand the issue and a public discussion on such matters is therefore unnecessary and potentially harmful as it would lead to further destabilization. Another popular official line is that the experience of other countries that have gone through similar crises is irrelevant in Latvia. It seems that the ranks of those who "do not understand" include the undesirable economists, in other words, those who argue in favour of devaluation. If ‘the D word' is discussed by officials at all, it happens behind closed doors in the government meeting rooms to which the devaluation advocates have no access.
"Rimsevics [the governor of the bank of Latvia] believes that he is the only one who can speak on the subject of devaluation competently. It seems that he no longer sees any options for backing away. He is experiencing psychological problems. People are just being told, in a mantra-like manner, that devaluation will be a great calamity," says Janis Ogsts, who has worked as the senior broker for Swedbank and is now one of the economists discussing the issue of devaluation in his blog. He believes that, thanks to the internet, the discussion has spilled into the "real life" and is convinced that devaluation is an issue of "when" rather than "if". The stubbornness of state officials is going to cost Latvian economy dearly, he says.
The fact that officials are reluctant to listen to expert advice is obvious to Uldis Osis, an economist, business consultant and the first finance minister of independent Latvia. He says: "everybody is talking about devaluation of the lats, except for the government and the central bank, which has declared that in no case it will devalue."He points out that, in the name of the stability of lats, businessmen are losing market and are forced to close factories and let off workers thereby increasing the army of unemployed. Besides, suffering goes beyond the remaining exporters for whom the expensive currency means shrinking export markets. Those businessmen who are working locally are affected too, because they are unable to compete with imported goods that come from the countries whose currencies have recently fallen in value, such as Poland.
Last week, not a single day passed without Latvia's name being mentioned in the international press. Columnists and bloggers, The Financial Times and The Times, Latvia Economy Watch and A Fistful of Euros, all have been talking about the "when" of devaluation and the cost of postponing it. As Copenhagen-based macroeconomist Claus Vistesen points out, "this is called a market discourse and although the commitment to maintain status quo may be there one cannot make the waters go back." The Bank of Latvia may continue chanting the mantra, "we will not devalue, we will not devalue", but it may find itself in a position that will contradict this song.
The worst is yet to come
The survey by one of the biggest banks in Latvia, DnB Nord shows that, in April, optimism among the general population started growing. 15% believe that, in a year's time, the situation will be better. But a 2% monthly increase of optimism is more likely to be related to the beginning of spring (which is always a welcome change in this northern country where winter temperatures may reach minus 20 degrees Celsius) rather than to a real improvement. Besides, both economists and government officials are convinced that the hardest time is yet to come. In the autumn this year, the situation could even turn critical because many people will simply run out of money.
By early May, the unemployment rate had already reached 11%. However, the social support system has not been amended, which means that only those who have been paying social tax for 20 years are eligible for a 9-month unemployment benefit. If the period of social payment is lower, 10 to 19 years, then the benefit expires after 6 months. And those whose official working life is shorter than 10 years can only hope to receive support for 4 months. Employment experts estimates show that currently about a half of the 50 000 unemployed are not receiving any benefits. In the autumn, the numbers are very likely to go up whilst the funds available for social needs will continue shrinking.
The new Latvian prime minister, Valdis Dombrovskis, who came to power in March following the fall of the previous government, has repeatedly stressed: if the country fails to receive international help then in July or, possibly, even June Latvia may face default, in other words, it will be unable to fulfil its international obligations and will not have money for paying public servants and other state employees. Ivars Ijabs, a prominent Latvian political scientist, has even argued that the country is rapidly approaching the classic definition of a failed state.
Late last year, the IMF and the European Commission agreed to lend Latvia 7.5 billion euros over the period of three years. However, after the first payment of 1.6 billion, further funding stopped. In March, the 200 million euros due from the IMF did not arrive and it is not clear whether the June payment will come either. International lenders are waiting for the structural reforms that were promised but never implemented.
The latest statistics on the Latvian economy, published by the Latvian Statistics office in early May, were shocking even by the global downturn standards. In the first quarter of 2009, Latvian GDP had shrunk by 18%. Economy minister Artis Kampars has admitted that the cost-cutting measures will likely have to be even harsher than previously expected and new ways of stimulating economy will have to be found to stop the freefall. But does that mean that the government is ready to talk to experts, initiate the discussion people are so eager to hear and start acting decisively? So far, there is very little to suggest that this is the case. Last week, prime minister Dombrovkis pledged to push through budget cuts and ensure the inflow of loan payments. "These rumors and speculations [about devaluation of the lats] should finally be stopped," Dombrovskis said in an interview to a Latvian TV station. „The currency will not be devalued!" We will not devalue, we will not devalue. And we will not talk about it either. Not yet.
