Letland diep in de problemen door crisis (en)
EUOBSERVER / BRUSSELS – Despite the severity of EU-imposed austerity measures, a currency devaluation would cause greater suffering for Latvian citizens the country's prime minister told EUobserver and other journalists on Wednesday (10 June).
"If we go through this fiscal consolidation at least we can do it in a controlled way and try to protect at least certain categories of the population," Mr Valdis Dombrovskis said after meeting with European Commission officials in Brussels.
"If we go for other alternatives, that being devaluation …there are no exceptions for anyone and the practice of different countries shows that this tends to go out of control," he said.
The small Baltic state is in a difficult bind at the moment. Having secured a €7.5 billion loan led by the EU and the International Monetary Fund last December, the country's escalating budget deficit has prompted lenders to halt loan payments until the problem is solved.
Added to this, a government debt issuance valued at 50 million lats (€70m) last week failed to attract bidders.
The European Commission and IMF insist that the Latvian government improve the state of its public finances despite concern that further efforts to reduce the country's budget deficit could provoke greater social unrest in a country that has already seen riots and the fall of one government this year.
"The situation since December has worsened all over Europe, but in particular in Latvia, so the programme needs adjustment," European economy commissioner Joaquin Almunia said on Wednesday.
All eyes on the Latvian parliament
Keen to restart loan payments, the Latvian government announced on Tuesday that it intends to claw back 500 million lats (€700m) from this year's budget, the third announcement of its kind this year.
Earlier budget adjustments resulted in a 15 percent reduction in public wages, followed by a further 20 percent reduction.
As well as this third knockdown in salaries, the latest measures include a reduction in the total number of public servants, the introduction of a progressive income tax system, a new real estate tax and, from 2011, a rise in VAT and social security contributions.
It will be a bitter pill for many Latvians to swallow, raising the question as to whether the country's single chamber parliament will agree to the measures when they vote next week.
Although trade unions have been consulted over the proposed budgetary adjustment, one Latvian economist this week described the proposals as "economic murder".
Depending on the parliament's decision, the commission and IMF are likely to decide later this month whether to hand over a €1.4 billion slice of the €7.5 billion loan.
Even if the parliament agrees to the new cutbacks and the next payment is secured, there is no guarantee that the threat of a forced devaluation will have been averted, with ratings agency Fitch saying on Wednesday that the likelihood was "significant and rising".
Paying for past mistakes
The Latvian economy is predicted to contract by 18 percent this year according to the latest data, but despite the export advantage devaluation would bring, the country's government appears resolute in its attempts to maintain the lat's currency peg against the euro.
Last week alone the country's central bank spent €237 million propping up the lat, rather than abandoning plans to join the euro, which Mr Dombrovskis says can still be achieved by 2013.
One fear is that a currency devaluation would greatly increase the value of the country's large private sector debt. As recently as 2007 Latvia was enjoying double-digit growth, with company and household borrowings rising dramatically as Swedish banks poured money into the small economy.
A devaluation in the lat and the corresponding hike in value of these foreign currency denominated debts would create "very serious difficulties" says Mr Almunia. "We want to avoid at any price this very serious situation."
Mr Dombrovskis is candid when asked how Latvia's difficult situation arose.
"We had double digit growth and yet didn't balance the budget …anti-inflation measures were implemented with a large delay, there were no restrictions on credit growth and [we had] a real estate bubble," he says.
"All the kind of problems you can think of," he adds.