Potato crisis in Latvia

Latvian rubs lamp and finds genii.
Genii say, “What is three wishes?”
Latvian say, “I wish potato!”
Then, POOF! Potato! Latvian so happy!
“Oh! Is potato! Is potato!” say Latvian.
Genii ask, “What is next wish?”
Latvian say, “I wish you go away so I can enjoy potato!”
POOF! Too bad.
Was only lamp.

-Disgruntled Latvian

Wsj.com/Heard
August 25th, 2009

Aside from timing "exit strategies" as the economy strengthens, what worries central bankers? According to one, a fear behind the scenes at Jackson Hole, Wyo., was the state of Eastern Europe. His view: A "very severe problem" there could drag down a large European bank, "becoming a problem for everyone."

Oct. 6 (Bloomberg) -- Latvia risks a rating downgrade as the Baltic state has yet to push through “painful” adjustments needed to reduce its budget deficit and comply with the terms of an international bailout, Fitch Ratings said.

“Failure to implement budget cuts and remain on track with the European Union, International Monetary Fund program could lead to a downgrade,” Fitch said in a note published today.

“A delay to the disbursement of international funds to Latvia would leave fiscal and external financing gaps, undermine confidence and put renewed pressure on the exchange rate,” Fitch said

October 7th (Marketwatch) -- It's never good news when a government bond auction fails. It's particularly bad news when an auction fails for a note maturing in just six months. And it's really bad news when there isn't any bid at all. Yet that's what happened Wednesday when Latvia tried to sell close to $17 million of paper.

Ian Traynor in Riga
guardian.co.uk, Wednesday 7 October 2009 19.35 BST

The Latvian government was struggling to avert a financial meltdown today as ministers convened emergency talks with Scandinavian banks to discuss a bold and controversial plan to slash mortgage-holders' liabilities to lenders.

The scheme could mean billions in losses for the big Swedish banks most exposed by the small Baltic state's financial and economic crisis.

(That would be Stockholm-based Swedbank AB, SEB AB, Nordea Bank AB and a joint venture between Oslo-based DnB Nor ASA and Germany’s Nord/LB Norddeutsche Landesbank. Sweden on Tuesday put pressure on Latvia to fulfill required spending cuts, threatening to withhold payments from a 7.5 billion euro loan advanced by Nordic countries. About 90% of all Latvian loans are denominated in euros. -AM)

Banking sources in Riga warned that the radical proposal on mortgages, which could see borrowers repaying only a fraction of their loan, would backfire, deterring foreign investment, bringing already low bank lending to a complete standstill and wrecking international confidence in Latvia.

"Some balance has to be found between the interests of borrowers and the interests of lenders," the prime minister told the Guardian. "The real incomes of people are diminishing and it is getting more difficult to repay loans."

Dombrovskis has proposed new laws limiting liability in the case of mortgage default to the current market value of the property – meaning colossal potential losses for the banks, since most property borrowers are in negative equity.

"Mortgage borrowers can hand in the keys to the bank, and not be liable for anything," said Danske Bank, describing the scheme as "draconian". An economist at another Scandinavian bank in Riga said: "This would be economic suicide. The lending would stop overnight. You won't be able to rely on Latvian law. Foreign direct investment will go down."

The central bank promptly called for the scheme to be shelved. But the prime minister insisted his plan would encourage more responsible lending policies from the foreign banks, whose easy credit spawned an unprecedented consumer and property binge.

In the case of mortgage default at the moment, banks can repossess the property, take second properties if owned, and also recoup further debt from the future earnings of the borrower. The crisis in Latvia brought down Dombrovskis's predecessor's government earlier this year. He is seeking to avoid the same fate and has an election to fight next year. "There are very harsh measures taken already," he said. "Our fear is that massive tax rises will raise social tensions considerably."

"Patience with the Latvians is limited," said Anders Borg, the Swedish finance minister. "It's not reasonable that Latvia make a commitment in the early spring, and in autumn say they won't deliver.

Under the control of its strong central bank, Latvia's currency, the lat, is pegged to the euro, hindering the government's ability to depreciate its way out of crisis.

Analysts said the prime minister's scheme to limit debtors' liabilities to the banks could help him devalue, since it would also ease the pain of seeing euro loans becoming unaffordable.

But Dombrovskis insisted strongly he had no intention of breaking the peg to the euro. "My programme is based on the stability of the lat and budget deficit reduction," he said. "We are a very small and very open economy. Any competitive gain from devaluation would diminish immediately. Devaluation is not an option.

WSJ
By CHARLES FORELLE
October 8, 2009

Neil Shearing, emerging-markets economist with Capital Economics in London, said speculation has been building over the past few days that Latvia's government is on the verge of giving up on a central tenet of its austerity program by allowing a devaluation. That could goose the economy by making exports more attractive, and it would eliminate the expensive process of buying lats to maintain the currency's peg against the euro.

Devaluation would have serious consequences. The Swedish banks that made euro-denominated mortgages would see a sharp jump in foreclosures as fewer borrowers would be able to make payments. Latvia also would likely lose any chance of being allowing into the euro zone in the near future.

"Basically, there's a lot of speculation that the ground is being prepared for a devaluation," Mr. Shearing said.

Mr. Shearing said Estonia and Lithuania could follow suit with devaluations if Latvia led the way

(They are all in double-digit recessions. -AM)

Hungary, Romania and Ukraine are also vulnerable to contagion, he said.

How far Latvia's troubles would spread if it devalues its currency is an open question. Worries about devaluation have persisted for months -- another bond auction failed this summer- and financial markets and banks have had time to prepare.

'If it comes to a choice between a bad scenario and an even worse scenario, where the bad scenario is the goal of these 500 million lats and the worse scenario is that this international programme is stopped... Of course we will go more for this bad scenario,' Prime Minister Valdis Dombrovskis told Latvian radio.

Stopping the loan programme would lead to sharp reactions in financial markets and even greater problems for the economy, which faces an 18 percent gross domestic product drop this year.

Dombrovskis was later quoted by Baltic news agency BNS as saying that the government would likely have to draw up further budget cut measures.

The worries prompted the central bank to issue a statement criticising the government for sending out mixed signals that were creating a lack of trust in Latvia.

RIGA, Oct 7 (Reuters)

The head of the European Commission office in Latvia said the Baltic state had to live up to its promises, made in June, when it concluded a revised loan deal.

'If you conclude an agreement, you take on commitments, it is important to keep to them and not change the conditions every two or three months,' Iveta Sulca said.

Dombrovskis leads an unwieldy five-party coalition and has had trouble getting the parties to go along with tough measures. In the 2009 budget, the government already slashed public sector wages by 40 percent and old age pensions by 10 percent.