The newly-appointed prime minister of Latvia, Valdis Dombrovskis, says his government is prepared to cut government spending by up to 40% in order to reduce the budget deficit and meet IMF austerity measures.
“There will be very unpopular measures, no doubt about this,” says Dombrovskis. “The question is, do we have a choice? In the current situation and taking into account our negotiations with the loan providers, we really do not have many choices.”
In March, Latvia missed a US$200mn tranche of the US$9.7bn rescue package approved by the IMF, EU and other lenders in December 2008. One of the conditions of the loan was that the government reduce its budget deficit to 5% of GDP.
This has proved difficult. Even with 40% cuts in government spending this year, the budget deficit would only fall to 7.7%, say government officials. The IMF itself admitted that austerity measures were proving “extremely challenging” for the government.
The previous government, of prime minister Ivars Godmanis, was forced out of office in January, following anti-government demonstrations in Riga, in which over 10,000 people protested against government mismanagement of the economy.
The economy is predicted to shrink by 12% this year, though Dombrovskis says the contraction “may be worse”, if the government introduces deep spending cuts. Unemployment has already risen by 50% since the crisis began.
Hard choices
Dombrovskis, who was minister of finance from 2002 to 2004 as part of the New Era party government led by prime minister Einar Repse, says his government is prepared to introduce the budget cuts that the previous government failed to do: “There were certain measures the previous government was not willing to take; for example, we dismantled boards of public companies. We significantly reduced salaries for executive boards of public companies. We also reduced the salaries of ministers and other top government officials.”
The IMF program with Latvia was built around the authorities’ strong determination to maintain the lat’s exchange rate peg. In one week in late April, the central bank spent around US$100mn buying euros to support the currency.
Dombrovskis says he is concerned about devaluation of currencies of Latvia’s trade partners like Russia, Belarus and Poland. He says: “All these countries are devaluating their currencies. Therefore it is very difficult for Latvian exporters to operate in those countries as we maintain our currency pegged to the euro.”
His comments raise the prospect that Latvia may eventually have to leave its currency peg in order to boost exports and save the country from an even more severe recession. Abandoning the currency peg would be a major blow for the foreign banks who are dominant in Latvia, including SEB and Swedbank.
However, the government is clinging to its plan to join the euro in the next three years: “As foreseen by the macro-economic stabilisation programme, which is written for a period of three years, we aim to fulfil the Maastricht criteria by 2012”, Dombrovskis says.
In April, Dombrovskis signed a formal agreement with the EBRD and Parex Bank, whereby the EBRD bought a 25% and one share stake in state-owned Parex for €84.2mn, and provided a €22mn subordinated loan to the bank.
Fitch became the second rating agency in April to downgrade Latvia to junk status and also reduced its rating on fellow Baltic states Estonia and Lithuania, citing a worsening outlook for all three nations.
Fitch said in a statement that it cut Latvia to BB+ from BBB-, taking it below investment grade. Standard & Poor’s in February was the first rating agency to downgrade Latvia to junk.
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