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Tuesday, May 26, 2009

Payment By "Voucher" In Latvia?

This sounds like something straight from the Argentine history book. Yesterday someone left this comment on my Latvian Blog:

By the way, latest idea in Latvia is to issue vouchers as a substitute to LVL (thats in case Latvia doesnt get any money from IMF). So if you work in public sector, your salary partly will be paid in vouchers which you can use to buy food. And yes - it would also mean 'stable' LVL, at least on paper. I still don't really understand how it could possibly work in free capitalist economy. But it underlines how strong is the will to keep current LVL rate at any means, even if it means total collapse.

At the time I wasn't sure what to make of this, but then I saw that according to a report in the Latvian newspaper Diena, Central Bank Governor Ilmars Rimsevics visited the town of Liepaja on Friday, and told the astounded journalists assembeled there that: "The level of the expenditure shock we are receiving is so high that we can not cease to maintain this quantity of expenditure. So there is a shortage of funds, and we're forced to look at the different kinds of projects, which can help us provide for the foreseeable future. Taking into account that the money is not budgeted, it can be emitted in vouchers".

Rimsevics also gave an interview to the Russian-language newspaper Telegraf (published this morning) where he says more or less the same thing. Basically, the IMF are threatening to withold the next round of funding if the Latvian government does not move ahead with the agreed wave of budget cuts - which in some areas will be of up to 40%. Latvia received a 7.5 billion-euro bailout from the IMF and the European Commission last December. The agreement required Latvia to limit its budget shortfall to to 5 percent of gross domestic product. Since then, the economic outlook has turned far worse than anticipated and Prime Minister Valdis Dombrovskis's government is seeking approval to run a 7 percent deficit.

At the same time the Latvian central bank keeps having to buy the local currency (the Lat) to support the euro peg - last week the bank bought 6.4 million lati ($12 million), and this was the eighth consecutive week they have had to make such purchases. The longer it takes to reach agreement with the IMF - who are convinced that severe budget cuts will be expansionary in the short term (due to the improved confidence they will produce, see here), the more the bank will need to spend to counter those who are betting they will be forced to devalue.

The bank have now bought about 1.1 billion lati since September 2008, and such interventions have reduced Latvia’s foreign currency reserves by 36.7 percent compared with September last year. The flight to euros is also producing strong liquidity pressure inside the country, and the central bank cut its refinance rate to 4 percent on May 13, the second reduction so far this year, in an attempt to boost borrowing amid a liquidity squeeze and much harsher lending criteria. Basically, in order to keep lati in circulation, interest rates on the Rigibor, the local interbank lending market, have been driven up by 42 percent since 3 February to hit 13.7 percent on May 14 (for six-month loans). And this in an economy which shrank by 18 percent in the first quarter.

As I say at the start, all this - including the vouchers proposal - does now sound incredibly like Argentina, since issuing scrip money is exactly the kind of thing you get pushed into when you try unrealistically to hold a peg. It is the begininning of the end. The same thing, exactly, happened in Argentina, where they ran out of pesos and started to issue Patacónes, Lecops, Créditos, Argentinos and a myriad of other exotic bits and pieces of scrip. I give a bit of background on all this in this post on my Spanish blog, while Bloomberg's Aaron Eglitis has a useful summary of the general Latvian situation here.

SEB Accept Krugman's and My Point.

Currency devaluation in the Baltics would not lead to bigger loan losses for Swedish banks, the losses would simply come more quickly and be harder to deal with, according to SEB Chief Executive Annika Falkengren speaking in a radio interview on Saturday.
"In total we would have the same size of credit losses, but (if there is no devaluation) they would be a little more regular and over a longer time frame," SEB Chief Executive Annika Falkengren told Swedish radio. "In the case of a devaluation they would be pretty much instantaneous."

Now what was it Krugman and I were saying that everyone jumped down our throats for:
I’ve been saying this for a couple of weeks, but Edward Hugh has the goods.

Hugh puts his finger, in particular, on one gaping hole in the logic of the opponents of devaluation. We can’t devalue, they say, because the Latvian private sector has a lot of debts in euros, and a devaluation would make it very hard for borrowers to service those debts. As Hugh points out, the proposed alternative — sharp wage cuts, and basically a major domestic deflation — will also make it hard to service those debts. In fact, I’d be a bit more specific than Hugh: other things equal, a nominal devaluation and a real depreciation achieved through deflation should have exactly the same effect on debt service (unless some of the debt is in lats rather than euros, in which case devaluation would do less damage.)

Ms Falkengren has a very peculiar way of looking at things when it comes to analogies:
However, Falkengren said that devaluation without long term policies to get economies back on track was not a good option. "It's like peeing in your pants. It feels good, but only for a very short time," she said.

But essentially she is right, devaluation is not a solution, only a route to solutions. Long term structural reform is needed either way.


Hynek Filip said...

This suicidal policy of the Latvian government reminds me quite strongly of the Czech politics of 1990/1991. At that time, shortly after the end of communism, most democratic Czech politicians (and the vast majority of the Czech public) feared at least some of the following: privatisation, foreign takeover of Czech companies, devaluation, floating exchange rate, sale of Czech real estate to foreign investors, etc. It is now obvious that in 1991, the communist Czech economy could not be transformed without devaluation, privatisation, support of FDI and especially sale of existing companies and real estate to Western investors. However, the resistance was enormous. According to the then Finance Minister, now President Vaclav Klaus (oh yes, the Vaclav Klaus), the reforms were most ardently supported by the outgoing communist Prime Minister Dr Calfa. According to Klaus, Calfa realised that he had no political future in the new system anyway, so he was able to support any policies he saw as reasonable.

So it would seem that the current Latvian government will hang on for grim death, just because those people believe they still have political future and that this future hangs on their ability to defend the peg. Maybe if their political careers were over anyway, they would let the lat float. Yet it seems that they want to stay put, so they will start printing vouchers. And I am very much afraid that it may well end with food stamps and soup kitchens.

Anonymous said...

Just fresh: Estonian new coalition has agreed, that they will start to increase the taxes.

Options: income tax to 25%; VAT to 24%. http://www.postimees.ee/?id=124231

They seem not to learn from Latvia.

Ingrida said...

The view from Riga: the government has adopted a do-nothing policy re: budget until the local elections on June 6. Meanwhile, the lat grows shakier and shakier. After the elections, the governmenet will wake up to find that they have even less room to maneuever, since a gullible electorate will have voted for oligarchs who have promised everyone a free lunch in exchange for the destruction of the last shreds of the rule of law. Sorry to be so gloomy, but it is incredibly frustrating to watch the corrupt, stupid and greedy prevail. Thank you for observing and writing. I only wish more people in power in LV read your blog--it is a total contrast to the platitudes in the local press. When the the hour of reckoning comes, those living in the Latvian language media space will be shocked, since no one has translated the bad news for them.