Latvia risks becoming first EU member to face economic meltdown
Pastor Dale Morgan
Latvia risks becoming first EU member to face economic meltdown*
Latvia is in danger of becoming the first European Union member to face
total economic meltdown, experts have warned.
By Adrian Blomfield in Riga
Published: 7:17PM BST 11 Jun 2009
Latvia has been urged to devalue its currency or risk the collapse of
its economy
The tiny Baltic state's government has been urged to devalue its
currency or risk the collapse of its economy – despite fears such a move
could cause turmoil elsewhere in Europe.
Although devaluation would damage Latvia's ambitions of joining the
euro, financial analysts said it was the only hope of avoiding a
catastrophe after an international bail-out failed to reverse the
country's fortunes.
Timothy Ash, head of emerging market research at the Royal Bank of
Scotland, said it had already seen its economy shrink 18 per cent in the
first three months of the year.
"They are merely delaying the inevitable," he said "The IMF medicine
hasn't worked. I don't see a way out for these guys. You have an economy
that is hugely recessed. How is it going to grow?" "Without a
devaluation, you end up in the same place. It just takes longer to get
there."
Latvia is trapped in a situation similar to Britain on the eve of its
Black Wednesday withdrawal from the Exchange Rate Mechanism in 1992, but
on a greatly magnified scale.
Experts say devaluation would mean the central bank would not have to
spend its fast-dwindling reserves and could speed an economic recovery,
as it has elsewhere in eastern Europe.
Even so, the financial pain for the many Latvians who have borrowed in
euros would be so severe it is unlikely that Enars Repse, the country's
finance minister, would take the option.
Devaluation could also force Latvia's Baltic neighbours into abandoning
their currency pegs to the euro and threaten the future of Swedish banks
that leant heavily in the region. The resulting panic could also
destabilise other troubled economies in eastern Europe.
Morten Hansen, head professor of the Stockholm School of Economics in
Riga, Latvia's capital, said: "There is a definite fear that if you have
devaluation in one country you could see it spread and not just within
the region. One can think of it as a Pandora's Box."
Latvia this week announced an emergency austerity programme it hopes
will persuade the International Monetary Fund to resume a frozen
bail-out package.
The emergency funding, worth £6.4 billion, is the country's sole
financial lifeline but was suspended in protest at the government's
failure to reduce spending. Valdis Dombrovskis, Latvia's prime minister,
says that, without the cash, the country could go bankrupt this month.
Latvia's descent into financial chaos is the result of a cocktail of
fiscal imprudence, irresponsible lending and a failure to recognise the
signs of an overheating economy, economists say.
Between 2005 and 2007, Latvia's economy expanded faster than anywhere in
Europe, recording double digit growth three years in a row. Freed from
the strictures laid down to achieve accession into the EU, which Latvia
joined in 2004, the private sector borrowed with abandon.
As the economy boomed, the Latvian government increased the number of
civil servants dramatically and paid many of them more than their
counterparts in the private sector.
When the global financial crisis struck, drying up credit lines,
Latvians' borrowings amounted to 137 per cent of Gross Domestic Product,
more than anywhere else in Europe.
Riga's skyline now bears testament of a boom turned to bust. Cranes
towering over the city's elegant art nouveau façades lie idle. Newly
built luxury apartment blocks lie empty, even though property prices
have fallen 50 per cent.
But the recklessness was not just on the part of the Latvians. Swedish
banks saw untapped markets and happily moved in, lending without
question as they watched their profits soar.
When Zinta Vitinja wanted to open a dairy farm outside Riga, a Latvian
agricultural bank turned her down because she lacked sufficient
collateral. But Swedbank were much more easily persuaded.
The crisis struck and Mrs Vitinja was unable to meet her repayments. Her
cows have now been slaughtered and her family home repossessed.
Many Latvians fear they could soon be in the same position. Over 200,000
households – a large proportion in a country of 2.4 million people –
have mortgages, 90 per cent of which are denominated in euros and held
by Swedish banks.
With the Lat heavily overpriced, any devaluation could lead to massive
defaults, bringing misery to many Latvians and threatening the balance
sheets of the Swedish banks.
Some Latvians are already stashing euros under their mattresses and
speaking fearfully of Argentina where, during a similar crisis in 2001,
police searched homes to force citizens to change hoarded foreign bank
notes back into local currency.