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.

Estonian GDP Shrinks By An Annual 15.6% In The First Three Months Of 2009

Well, the best thing that can be said about this is that it wasn't as bad as the 18% contraction recorded in Latvia.

Estonia’s economy contracted the most in at least 15 years in the first quarter, making it the second-worst performance in the European Union. Behind the number lay a sharp fall in consumer spending and a plunge in industrial output. GDP was down by an annual 15.6 percent, the sharpest drop since at least the first quarter of 1994, according to the flash estimate from the statistics office. The fall follows a 9.7 percent drop in the last three months of last year.

The 15.6% year on year was significantly above the consensus forecast for a drop of 12.8 % and even above more "realistic" forecasts like the Danskebank 14.6% guesstimate, and will obviously have implications for all sorts of things, but in particular for the government budget deficit forecast.

The latest round of GDP numbers from all three Baltic states - Lithuanian contracted by 12.6% and Latvian by 18% - all indicate extreme weakness in the respective economies.

Today's number obviously lends support to the idea that Estonia's economy might decline by more than 15% in 2009. A lot depends on what the next quarter looks like. If the slowdown accelerates the final annual number might be even worse.

According to the statistics office release, output was broadly down for the majority of economic activities, but the steepest decreases were in manufacturing, construction and the retail trade. Weak external demand added to lack of internal price competitiveness meant exports were a further drag on manufacturing performance. Industrial output fell by more 25% year on year in each of the first three months and retail sales have now been falling for 11 consecutive months. Exports plunged 29 percent in January and 25 percent in February.

The weakness of the GDP number means the budget situation will inevitably have deteriorated further, which means that if the deficit target of 3% of GDP is to be maintained the Estonian government will need to respond with even more painful cuts in spending. In general, the performance does not change the outlook for Estonia to fulfil the Maastricht criteria this year, but it does mean that sticking to the criteria is getting to be a harder task with every passing day.

The Agony Continues - Latvian GDP Falls By 18% (Updated)

Latvia's economy shrank by nearly a fifth (year on year) in the first quarter, according to the latest flash estimate from the national statistics office. Obviously this is a dreadful state of affairs, and illustrates just how difficult the country's chosen adjustment path is proving to be.

Gross domestic product fell 18% year-on-year, and Statistics Latvia reported that the decline was broad-based, with manufacturing down 22%, retail trade down 25% and hotel and restaurant services output 34% lower from a year earlier. "The economic situation is of course very serious," Latvian Prime Minister Valdis Dombrovskis reportedly told a press conference in Stockholm, and who could disagree.

GDP fell by an annual 10.3% in the fourth quarter of 2008, while the economy contracted over the whole of 2008 by 4.6% following 10% growth in 2007. This is evidently what is meant by the expression "boom-bust".

The latest GDP numbers from Latvia suggest that the actual situation is in fact worse than the already pretty gloomy expectations. In many ways the “worst case” scenario for the medium term outlook for Latvia has now become a reality. Taking into account further tightening on the fiscal front the downturn could become even more pronounced in the coming quarters.

The weaknesses in the economy seem to be pretty broadly. The decline in both the manufacturing and the service sectors continued in Q1. The export sector has been contracting steadily, due both to slack global demand and uncompetitive domestic prices.

Industrial output was down by 23.4% in March, according to working day adjusted data from the statistics office. Manufacturing fell by 26.6%, electricity and gas supply by 14.1%, while mining and quarrying activity actually increased of 25%. The strongest reductions in industrial output were in textiles - down by 59.2%, in the manufacture of motor vehicles, trailers and semi-trailers – down by 52.9%, and in the manufacture of machinery and equipment - down by 47.2%.






Foreign trade has been dropping, and in March 2009 total trade turnover at current prices was 700.6 mln lats, up 8.3% (or 53.7 mln lats) on February, but down 29.7% (or 296.3 mln lats) on March 2008. Exports reached a low in January, and have climbed slightly since then.

Over the whole quarter trade was down by 32.7% (or 963.9 mln lats) over the first quarter of 2008. Exports fell by 26.0%, while imports were down year on year by a whopping 36.5%.

70.8% of Latvia’s March exports went European Union countries, and another 15.1% went to CIS countries. The principal export partners were Estonia (13.3% of total export), Lithuania (13.0%), Germany (10.2%), Russia (8.7%) and Sweden (7.2%). Since all five of these main trade partners are themselves in strong recessions at this point the outlook for improved exports (even were Latvia competitively priced) is not exactly promising at this point.

The drop in imports does, of course, mean that the trade deficit has been steadily improving (see chart below), which means that despite the drop in exports, net trade has actually been positive for GDP in the first quarter.

Price Inflation Still Far Too Strong

One of the key points in Latvia's "non-devaluation" strategy is to get the wage and price level down quickly. Since the only relief can come from exports as the global recovery starts to take shape it is important that as much of the internal deflation process should have been carried out by that point. However when we come to the reality it is important to note that progress has been slow, and far from satisfactory. The consumer price level was down in April by 0.4% with respect to March, but compared to April 2008, consumer prices had still increased by 6.2%. Obviously much of this inflation is already inbuilt, but in the absence of independent monetary policy it is obviously clear that the Latvian government should be doing more to speed this up, otherwise all this is going to take an eternity, the pain will be unendurable, and much of the structural damage well nigh permanent. The Latvian economy could look worse than the Florida coast after a hurricane has passed.




The only really bright spot is that the tradeable sector does seem to have responded rather more rapidly than the rest (as theory would predict) and export producer prices are now falling rapidly.

Company finances are strained, as internal demand is weak and financing conditions tough. In addition, the position of the Latvian consumers is difficult, as unemployment has shot up and wage growth has slowed. 2009 is likely to be a very difficult one for Latvia, and the government faces the twin challenge of both keeping the budget deficit within a limit accepted by the IMF in order to receive the rest of the emergency loan, and of breaking the back of the economic contraction which is currently spiralling away out of control.

Households are obviously also having a hard time, and incoming data on the rise of non performing loans in Latvia is becoming preoccupying. NPLs (loans that are more than 90 days overdue) as a proportion of the total rose to 7.8% in March (see chart below), and while this level is still not excessive, it is that rate of increase that causes concern.


Retail Sales In Freefall

Retail trade turnover was down in March by an astonishing 27.3%.

Compared to February sales decreased by 2.6% on a seasonally adjusted basis. Compared to the last quarter of 2008 retail sales decreased by 14.1% in Q1, while compared Q1 2008 there was a 24.5% drop.



Unemployment Also Up Sharply

Obviously one of the factors driving the increase in non-performing loans is the rapid rise in unemployment. In fact, as elsewhere the rate of increase eased in April, but still the rate of unemployment rose to 11% and the numbers unemplyed to over 120,000, according to the latest data from the State Employment Agency.




At the present time the government is working towards a deficit of 7% of GDP, above the 5% initially agreed to with the IMF. According to the Prime Minister discussions with the IMF about allowing a larger deficit are ongoing. Maintaining the deficit within the 5% of GDP limit is turning out to be increasingly difficult as the economy has contracted much more sharply than anyone anticipated.

According to Latvian economy Economy Minister Artis Kampars the economy has now reached the bottom and on the point of recovery. Kampars said this in an interview with LNT television. Asked about the gross domestic product decrease of 18% in the first quarter, Kampars said that it was logical and expected, but the GDP will start increasing later on this year.

He also said that regardless of the significant fall in the GDP, the government is not planning to revise the budget amendments, which are based on a 12% GDP drop.

Basically this whole view could not be farther from the truth, since the worst is yet to come, even if this may not be in terms of ever stronger rates of contraction. 18% is we have to hope "unrepeatable", as a year on year figure, and the contraction in the future may well be slower. But this is not what matters. The hardship of the Latvian people will undoubtedly increase, as will what is called the level of "distress" when it comes to paying loans. I see no recovery on the horizon, and even though the rate of contraction will almost certainly decline, positive growth is a long time away, and it would be a brave person who was willing to forcast any sort of growth in any quarter before we hit 2011.

Worst of all, the government, the European Commission and the IMF seem to have no exit strategy here. Like the Vietnam war, this recession may prove to have been a lot easier to get into than it was to get out of. Hanging on in the hope of a euro entry which may never be possible is no strategy. Those who didn't want to devalue got the Latvian people into all this, now perhaps they can explain to them how to get out, since the answer isn't obvious, as budget cut upon budget cut only feeds the contraction, which feeds the unemployment, which feeds the rise in non performing loans which feeds the bailouts which feeds the need for more spending and more cuts in services and staffing, which feeds the contraction and so on.

We need to break the circle, or are we just, like Dicken's Mr Mikawber simply going to hang around and wait for something or other to turn up? And if we are, then I'd be firmly locking and bolting the back door, since all those able bright young and educated people will be sneaking off elsewhere as soon as recovery starts up across Europe, and they won't be coming back, and then we really will be in a pickle, won't we? Or are we hoping they will be like his wife Emma, who let her maxim be "I will never desert Mr. Micawber!"

Non-performing Loans In Latvia

This is all so tragic, and so foreseeable (viz, my original post here, for example).

Krguman on me:

"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."

Krugman on himself:

"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.)"

The Latvian Financial and Capital Markets Commission yesterday with numbers on domestic loans currently in arrears.

By the end of Q1 2009, loans in arrears in Latvia amounted to 20.5% of the aggregate loan portfolio of Latvian banks (up 5.5 percentage points from the end of 2008). The aggregate loan portfolio of the Latvian banks was worth LVL 16.4bn (approx. EUR 23bn) at the end of March 2009. Of the bank loans issued to households in Latvia, 22.1% were in arrears at the end of March 2009. Furthermore no less than 21% of mortgage loans were in arrears by March.

Danskebank on the Commission report:

We are quite concerned about the speed at which the non-performing loans are rising. Considering the gloomy outlook for the rest of 2009 NPLs are probably set to increase even more. We highlight that there is not a 1:1 relationship between NPLs and loan losses, but nevertheless these data cause us to believe that bank loan losses will go much higher than current levels – particularly in Latvia but also in the other countries.

And finally Krugman, who can speak for both of us here:

"This looks like events repeating themselves, the first time as tragedy, the second time as another tragedy."

Amen to that!