Latvia not going the way of Iceland, says central bank governor

The governor of the Bank of Latvia, Ilmārs Rimšēvičs, says he is confident that Latvia is not going the way of Iceland. “The short-term debt of Iceland is twice as high as the total gross external debt of Latvia. Moreover, half of the banks’ short-term debt is in fact long-term”, he told an investor conference in London on November 4.

In October, the managing director of the IMF, Dominique Strauss-Kahn, warned that more countries could follow Iceland into virtual national bankruptcy. He identified the Baltic states as being especially vulnerable.

Rimšēvičs, however, assured delegates and journalists at the conference that Latvia has neither contacted nor spoken to the IMF about an aid package. He said that the Bank of Latvia has bought Lats250mn (US$463mn) in recent weeks to support the currency. “The peg will hold – I am very confident about that”, he said.

Under Latvia’s existing exchange rate regime, which is pegged to the euro as part of the Central Bank’s eventual goal to join the European Monetary Union in 2012, the Lat does not fluctuate against the euro more than 1%.

Eral Yilmaz, analyst from Fitch Ratings, says: “I am fully convinced that the Latvian authorities would defend the peg because a devaluation would have a high political and economic cost. Also, there are several market factors that significantly reduce the likelihood of a successful speculative attack on the currency, such as the low level of local currency public debt held by foreigners and the fact that the Swedish banks which own a significant part of the Latvian banking system are unlikely to help speculators take a position against the currency.”

Nonetheless, Fitch Ratings has downgraded Latvia from A- to BBB+ in August 2007 and then again in October 2008 from BBB+ to BBB-. “The likelihood of recession in the euro area has heightened the risks for economies with large external financing needs such as Latvia”, comments Yilmaz.

Latvia’s current account deficit peaked at 26% of GDP in the third quarter of 2007. It currently stands at 15.6% and is forecast to shrink further until it reaches under 10% in 2009, according to the ongoing trend. Latvia’s large current account deficit and reliance on bank financing makes the country more vulnerable to deterioration in global credit conditions. “Latvia is undergoing a hard landing. It has gone into recession recently”, Yilmaz concludes.  

The Latvian banking sector is about 80% foreign-owned. The largest bank in Latvia is owned by Swedbank, one of Sweden’s leading financial institutions.  On November 10, The Swedish National Debt Office included Swedbank in the Swedish government’s guarantee programme, which allows Swedish banks to issue loans with a government guarantee in order to refinance loans maturing between September 1 2008 and April 30 2009.