Why the IMF Supports the Latvian Currency Peg

My co-RGE blogger Edward Hughsome days ago wrote a compelling piece on why the IMF’s decision to agree a Latvian bailout program without devaluation was a mistake. He doesn’t mince words: Sticking to the present currency peg, Edward maintains,  constitutes “virtually the unjustifiable” according to “the implicit consensus among thinking economists.”

I happen to be the IMF’s mission chief who over the six weeks before Christmas led the discussions on the Latvian program. (And I also consider myself a thinking economist.) Let me therefore explain what considerations went into our decision to support for the Latvian authorities’ strong preference for a program built around the present currency peg. Along the way, I will also try to dispel Paul Krugman’s and Edward Harrisons’ claim that Latvia is the new Argentina..

Before I get started, I would agree with much of Hugh’s analysis of what has gone wrong in Latvia. The post-EU accession boom, fueled by rapid credit and wage growth, brought Chinese-style growth rates but led to an overheated economy (a point made by the IMF as early as 2005). The bubble burst in mid-2007, when foreign banks slowed their lending, and output has been decelerating ever since. The global financial crisis, by triggering the liquidity problems at Parex (the country’s second largest bank) dealt the final blow. As Edward rightly points out, the underlying problems go deeper, notably a loss of competitiveness (wage growth exceeded productivity and most resources went into non-tradables) and large stock vulnerabilities (the private sector built up high external debt, much of it short term).

The IMF-supported program addresses both the short-term liquidity problem–by providing official financing at low interest rates–and the long-term issues associated with an overvalued real exchange rate and the private sector’s debt overhang. Where I disagree with Edward Hugh, Paul Krugman and others is that the latter can only be addressed by nominal devaluation. The alternative route to external balance, adjustment via factor prices, may be drawn-out and painful. But at this point in time it corresponds more to the circumstances in Latvia than meets the eye from blogsphere. Here are nine reasons why.

First and foremost, this is the Latvians’ program. So even if we at the IMF were to favor a devaluation (which we aren’t), a program without national ownership would be doomed to fail. Edward believes that the Latvian’s very strong consensus in favor of the peg is misguided because it is rooted in misinformation. Based on my experience in Latvia, I don’t agree. The policymakers there are keenly aware of the choice they face. Why else would the Latvian parliament, with votes from the opposition, approve a supplementary budget that entails 7 ppt fiscal adjustment, including a 25 percent wage cut for all public servants? When he presented the program to parliament, Prime Minister Godmanis could not have  been more explicit about the alternatives and the sacrifices ahead. I myself spoke to the national tripartite commission (government, employer and employee associations) and I can only say that these people know what sticking to the currency peg will entail.

Secondly, a devaluation in Latvia would have severe regional contagion effects, especially given the fragile global funding environment. The spill-overs could well go beyond pressures on countries with fixed exchange rate in the Baltics and South-East Europe. For example, market confidence in foreign banks invested in the Baltics and similar countries would likely be affected, with implications for their ability to access wholesale financing

This is why, thirdly, Latvia’s preference for the peg is strongly supported by all foreign stakeholders, including the EU and its Nordic neighbors. They have put their money where their mouth is, providing three quarters of the total financial package of EUR 7.5 billion that backs the peg. In a remarkable show of solidarity, three new EU member states—the Czech Republic, Poland and Estonia—also contributed. The Swedish, Danish and Norwegian banks operating in Latvia are doing their part by publicly committing to support the liquidity and capital needs of their Baltic subsidiaries. Given the long-term bricks and mortar investments made in the region, it seems unlikely that they will cut their losses and pull out, as Japanese banks did during the Asian crisis.

Fourth, a devaluation would not significantly reduce Latvia’s external financing needs. While it would shrink the current account deficit further, private sector roll-over rates might not improve because the higher external debt to GDP ratio would likely result in credit agency downgrades to junk status and trigger the immediate repayment of most syndicated loans. Once unhinged, the peg may come under speculative pressures again and even larger external financing may be needed to credibly defend it at its new level.

Fifth, and now I turn to the internal adjustment discussed by several bloggers, there are advantages to a U-shaped  adjustment via factor price compression over the V-shaped recovery that is often  associated with a devaluation. (We estimated that a 15 percent devaluation, through the associated balance sheet effects, would have suppressed growth in 2009 by another 2 ppt, but led to a faster recovery in 2010)  As Mary Stokes points out, devaluation—depending on its size—would lead to a wave of defaults in a concentrated period of time. Latvia’s banks (both domestic and foreign) and its legal system are at this point not prepared for such a shock. By drawing out the likely rise in bankruptcies and nonperforming loans, the authorities have bought time to improve the country’s insolvency  regime, strengthen banks’ capital base and allow private debt restructuring. The program contains a host of measures to address these deficiencies as a matter of urgency.

Sixth, as again nicely argued by Mary, it is questionable whether a devaluation would quickly boost exports, given the global environment and the structure of its exports. Moreover, Latvia is a very small open economy and many of its retailers operate across in all three Baltic states and set uniform prices (for all three countries) in euros. The pass-through would be high and and the effect on the real exchange rate small. Re-orienting the economy towards tradables will require structural reforms which are envisaged in the program.

Seventh, Latvia has a very flexible economy, especially a quite nimble labor market. Wage cuts up to 25 percent may seem large, but let’s not forget that this comes after the tripling of nominal wages during 2001-07 (doubling in real terms) and that most of it will be accomplished by cutting bonuses of up to five monthly salaries. Latvia once before went through such factor price adjustments while maintaining its peg, during the Russian crisis in 1998. While circumstances may differ now, this experience suggests that it could do so again, especially in an environment where reduced employment options in the EU make emigration less attractive than a few years ago.

Eight, the large-scale fiscal adjustment under the program is in line with experience of successful such episodes elsewhere and therefore provides some assurances that it will not undermine the currency peg. Despite the pro-cyclical withdrawal of stimulus, budget restraint is needed to support real devaluation, reduce financing needs and make room for the additional fiscal costs of bank restructuring. Roughly one third of the adjustment comes from revenue measures (increases in indirect rather than direct taxes to support wage deflation) and two thirds from cutting expenditures (wages and spending on goods and services). It was important to us at the IMF and the authorities that the 2009 budget fully protects two essential expenditure categories: cofinancing of EU-supported capital projects and social spending, which is set to increase as a share of GDP compared to 2008. The program also contains institutional reforms to put the expenditure reduction on a permanent footing.

Finally, Latvia has a clear exit strategy from its currency predicament:  euro adoption. The authorities are determined to meet the Maastricht criteria in 2012. As I argued in a blog last year (“Avoiding the Portuguese trap”), entering the euro zone will not do away with the hard lifting necessary to address the competitiveness problems and high external debt. But it would once and for all remove the threat of a devaluation and thus bring much-needed investor confidence.

Latvia is at a crossroad. It needs to engineer a fundamental reorientation of its economy at a time when the global economy is in crisis. I concede Edward’s “biggest condemnation” (as he puts it) that, at least in the short term, the program does not contain policies to stimulate the economy. But, as I argued above, a devaluation would in the present circumstances unlikely deliver such a stimulus and may in fact make matters even worse. With fiscal policy constrained, sticking to the peg and toughing it out seems to be the only option for now, as long as the time is used to implement structural reforms the improve the financial system and reorient the economy towards exports. This is not to deny that this course of entails risks, not least a deflationary spiral or a fading of the present political determination to achieve the adjustment by fiscal, structural and income policies. In my view, these are risks worth taking, for Latvia’s and the region’s sake.

Christoph Rosenberg

27 Responses to "Why the IMF Supports the Latvian Currency Peg"

  1. Anonymous   January 6, 2009 at 8:34 am

    I understand your argument, but being an expat living here for 9 years and having a feel for what is going on from the man on the street as well as the business community. I have great concerns. Given all the technical analysis based on Latvia’s economic situation the numbers may seem to work given the country follows the prescribed financial diet.I do not see it happening, for instance a very large Restaurant group 14 Restaurants in Riga, has cut staff and raised prices. Not just the 3% added VAT but added around 8-10% thinking they need to make up for lost revenue from year on year sales. Simple items that were in December cost 12LVL are now 16LVL. So both the large and small business are cutting back on staff, salaries, and raising prices because their estimation of revenues must be met. The average Latvian has no idea what the term deflation is and deflation in my opinion will run rampant by the end of the year. Here the Mantra is better to sell fewer items at more profit than to sell by quantity and value. This will result in the crisis continuing for much longer? The same attitude from the businesses is if there were devaluation they would just raise the prices to the same level as prior to devaluation. Catch 22. This attitude is one that only the pain of this crisis will change but it will be long and drawn out as change is difficult here and new ways of thinking about business is not sought.The young people are looking to leave Latvia for Ireland the UK etc. anywhere there will be a higher wage. The outlook is bleak at best and I feel there is not enough thought put towards what may happen in terms of a return to a more black economy as businesses struggle to survive in a young fiscally naïve population.When the Banks need to show on their balance sheets their property assets that have dropped 20-40%. Literally what cost 2000 Euro per square meter in July 2008 can now be had for 1200 Euro and the prices keep dropping.Needless to say Latvia has a tough road ahead but I hope those making policy and will be able to adapt quickly to the circumstances that will show themselves by mid-year.

  2. Anonymous   January 6, 2009 at 11:25 am

    Having seen how prices in Latvia have risen in the last two years, I will not be visiting again. Tourism is important for most countries. Devaluation is a way forward to encourage foreign visits

  3. Anonymous   January 6, 2009 at 12:08 pm

    Latvia is quite a poor democracy if compared to other EU countries (the corruption level is as well quite high), therefore, I think, the risks that the political determinations could fade or at least these would not work for the well-being of the whole society are higher if compared to other countries in Europe. The increase in unit labour cost over the recent years made the entrepreneurs in this country less competitive (to a great extent) and the situation could be worsening now when some neighboring countries like Russia or Belarus have devaluated their currencies.

  4. Anonymous   January 6, 2009 at 4:01 pm

    I have lived in Latvia 6 years. I was here through the boom and I warned people there would be problems coming. I have been following the situation very closely for years.It seems to me that this bailout is for the banks much more so than the people of Latvia. I can tell you that people are angry and I worry that things will get violent here.I also worry that police corruption will become a very serious problem. I know of many stories of the police harassing foreigners here and trying to extort money from them.The first commenter is right when he says that businesses are just raising pricing in effort to make the same amount of money. That is how people think here. I could give so many examples of this. As business decreases prices will continue to increase until the business simply fails. I think it will take a generation or more for things to change here.One other issue is that the government here is not very expat friendly if you are not from the EU. I personally know several very wealthy Americans that were planning to invest heavily in this region, but gave up after trying to deal with the immigration office. If you call the immigration office 3 times talking to 3 different people and ask the same question you will get 3 different answers. Most of the people there do not speak English very well (or at all). They treat you like you are a broke gypsy coming to Latvia to be saved and then the best part is they make you pay a relative fortune in taxes to stay here by requiring that even board members have a minimum salary that is more than double the average salary here and they increase the amount you must pay every 6 months. I could go on and on about the problems with immigration here.The bottom line is if someone comes here to invest and employ people the government should be welcoming them with open arms! They do not. You are even taxed on dividends differently if you are a foreigner than if you are a Latvian.Oh and one other complaint. If you have an Internet business in Latvia and you ship goods to someone inside the country they require you send that person a CONTRACT they must sign and return to you. If you do not do this then you can get in serious trouble with the tax authorities. If the person you send the goods to does not return the contract (most do not) then it’s your problem. The damn tax authorities here need to get out of the stone age and enter the 21st century!Ugh… So much wasted potential. It’s really pathetic.

    • Anonymous   January 8, 2009 at 10:33 am

      such a shame Latvians can’t be more forward thinking, I’m in the property business in the uk Romania and (unfortunately) Latvia. when the xxxx hits the fan part of the test is how educated are people about the economy and general matters, I feel most (but not all) working Latvians are greedy, lazy uneducated -or more to the point with a soviet style work in the factory mentality- and unable to deal with what horrible fate awaits them this year….unlike Romanian people that are educated business minded people.. I wonder what will happen to all the Latvian girls that survived using one or more guys to support them? wish I could sell my flats and get out but I doubt its possible.

      • Anonymous   January 8, 2009 at 2:03 pm

        I know many Latvian girls here whose “rich” (by local standards) boyfriends have lost everything. So many girls here are hunting for guys with money now…

  5. AA   January 6, 2009 at 5:24 pm

    As a Latvian, I’m dissapointed about the fact that our govt. and currency was bailed out. As a chap intending to live here for some 70-80 more years my concerns are long-term.Firstly, crisis provided a long needed opportunity for improvement in critical thinking skills, understanding in basics of economics&finance of the general populace.Economic hardship is the best motivator to think, while happy borrow-and-spend times for a public not used to individual responsibility under Soviet occupation gave little incentive think ahead. National psyche needed correction.Secondly, I do believe that omnipresent high-level political corruption explains great share of unrealised potential in terms of productivity growth during last decade and will continue to impede the country for decades to come. Hence for long term investors I advise following the development of political culture. For the culture to move away from the current Italo-Russian oligarchy/plutocracy model to a more just Nordic model significant changes have to be made. I do believe they are possible. Un-bailed crisis would have provided an opportunity for a bigger leap..

  6. raZbi   January 7, 2009 at 3:16 am

    Just one question to Christoph: what Latvia produces?

  7. Vladimir   January 7, 2009 at 4:36 am

    With all the respect to the author’s knowledge in macroeconomics and experience within IMF I still have to argue the decision taken. On my opinion this will lead to complete deterioration of the Latvian economy and will eventually call for devaluation under even more unfavorable conditions, than today. I will address all the nine points one by one:1. When you bail out someone it is your program, not theirs. And it is up to you to ensure, than the proper measures will be taken, if you hope to get your money back. Our current leader’s lack knowledge in economy (they do not understand what will happen and thus their opinion and commitment should be ignored). The program, designed in 10 days (by lawyer and kolhoznik) cannot be considered neither reliable nor the most effective. It should be IMF’s task to offer such a programs to countries. (You monitor the country, and have plenty of time and resources to provide at least the general terms).2.The region is already in trouble because of the peg (you should not hold the peg if you do not enter euro zone in next 2 years), and by saving Latvia you just increase the future problems for our Baltic neighbors (they will save the peg instead of abandoning it and become even more uncompetitive).3. This is true – Scandinavian banks have more than 1.2 billion lvl in their Latvian banks capital, not speaking about credit portfolio. Devaluation – is a direct loss. You can hide (to some extend) loss from credit portfolio, but not from currency revaluation. So, it is much cheaper for them to give Latvia credit line (which should be paid back btw), than to allow currency to be devaluated and bear direct loss by themselves (Sweden has to continue saving SWEDBANK and SEB and local losses most probably will be covered by Swedish government).4. That is pure theory. We have to create added value, something that can be sold either locally, or internationally. The fastest way to reestablish local competitiveness is devaluation. (That will make us eat local potatoes, and not the imported goods). Then we will generate money to pay international dept. The help we need here is debt restructuring. (Replacing dept to banks with debt to IMF, World Bank, etc.)5. 25% cut in salaries + higher taxes + high costs of utilities (for example natural gas costs are up 70% from 1st of October and will not drop at least till 1st of July) will trigger bankruptcies as fast as 15% devaluation (if not faster). We will need to restructure mortgages anyway (may be a good approach could be to enforce conversion of all private debt in local currency and veto on any non LVL credits, combined with fixed rates 5-6% at the most). As for the legal system, you cannot let it get to courts. You have to come up with alternative solution anyway. For example, you can make those people, who cannot deal with the payments rent the flats instead and give the ownership of this flats to the specially created vehicles (with a buy back option for 20 years). The main point is that you do not need too much timeto work out such a system (and to buy this time by increasing debt is not an option on my point of view).6.This is true, but current solution creates unfavorable conditions for investors and this definitely will not stimulate GDP growth. With devaluation there still is a chance………….7. This is bull shit (sorry). What is flexible? When a huge amount of money was injected in local economy easily increased, especially real estate sector. But what is happening now? Capital outflow destroyed real estate, and nothing new appeared to take this place. So what flexibility are you talking about?8. There is nothing I can say about this, but just a single word – ARGENTINA. Please review carefully 1999-2002 developments supervised by IMF………9. You are right. But investors can hedge, you probably know that? And they prefer to invest in opportunities (which are also created by devaluation). I am not an investor myself, but i do not believe, that the main driver for investor is: “My currency risks are fully protected!!!”

    • Guest   January 8, 2009 at 5:33 am

      Interesting thoughts. Some of them unfortunately factually so wrong that will damage also the rest of the opinion. “Capital outflow” destroyed real estate. What capital outflow? Have banks closed down or left the country. Have there ever been short-term portfolio investments (in significant size)? Please look the total growth of bank lending closely from the 2000 till today. Very closely please look year 2008. In the environment where economy is contracting at 5% annual rate (if not quicker) it is miracle that total lending has not collapsed but even increased.

      • Vladimir   January 8, 2009 at 6:46 am

        Capital outflow means that money are taken away from the system (by eastern neighbores that take away deposits from local banks, by scandinavian banks that repatriate money and by locals who use their savings to support day to day expenses). As for the lending, when you look at lending growth you have to understand, that it is already restructuring + capitalizing of interest and penalties. Banks have stopped credit real estate since late 2007 (the only exception was transferring mortgage from one bank to another hunting for lower rate, which now also stopped due to drop in real estate price).

  8. Vlad   January 7, 2009 at 6:27 am

    Great to see that IMF officials that make or break my country’s destiny have a blog!I think most people who are for devaluation do not understand what are the Latvian problems to begin with. Everybody in Latvia (that is private persons) holds debt in EURO. This is for many reasons, but mostly because the EURIBOR rate is much more attractive than RIGIBOR (>10%). With RIGIBOR at such a high rate, even financially educated people have no other choice but to have their mortgages in EURO. Banks were very active in providing mortgages over the last 5 years and majority of professionals have no savings and a loan of around 30-40% of the income. Those people have good salaries, they are financially stable, but only if (1) they still have a job, which is difficult in the current times, and (2) the peg continues to hold.If the peg is taken out, the devaluation will bring together a wave of defaults, and as bankruptcy courts is something completely new to people, a lot of normal working people are looking at the double whammy – losing a job and losing all belongings. The wave of defaults will then provoke another bank run, where some well known Scandinavian banks will try to get rid of the real estate that’s constantly falling in value.The idea that devaluation will bring prosperity by making exports cheaper and imports dearer is Econ101 statement, that will just not work in the Latvian situation – considering relatively high labor mobility and the dependence of Latvian economy on imports. The EU accession was supposed to bring higher inflation to Latvia, and there should be no economist who is surprised by double digit inflation growth, given that we import energy, we increased taxes in line with EU and we have lower barriers for labor mobility outwards and a tight close policy on immigration.With regards to the price/value levels in Latvia – it has become awful in the recent times, and those who can’t adjust will go away painfully. The efficiency in Latvia is one of the worst and there is no export strategy or even perception of what Latvia is good at.Latvian “economic miracle” was merely mass access to cheap scandinavian money and a resulting real estate bubble that made lots of people crazy reach or just crazy. Now, to solve it government needs to ensure that we have some real economy to back us up in the difficult times, measures similar to what Russia is introducing now.

  9. Anonymous   January 7, 2009 at 11:04 am

    > “I think most people who are for devaluation do not understand what are the Latvian problems to begin with. Everybody in Latvia (that is private persons) holds debt in EURO.”This is well understood Vlad. I still think a gradual devaluation of the Lat would have been better for the country than the route we are going now. Clearly the government is hoping to limp into the Euro and they think things will be miraculously better then. All you have to do is look at Greece to see that being in the Eurozone doesn’t automatically mean you are safe. The Euro is going to be under a lot of pressure the next few years and I won’t be surprised to see countries LEAVE the Eurozone.

  10. Anonymous   January 7, 2009 at 11:06 am

    This bailout was to prop up Swedish banks at the expense of the Latvian people because the West is scared if they don’t do it then these problems will spill into their countries. This is not the EU helping Latvia. It’s the opposite.

  11. Anonymous   January 7, 2009 at 11:53 am

    One further point: Krugman and his ilk, not the IMF, are now the ones advocating one-size-fits-all policies, by clamoring for a devaluation every time a fixed XR regime faces speculative attacks. That strategy would only further encourage those same attacks, on Latvia and others, in the future.

  12. Cynic_   January 7, 2009 at 12:34 pm

    The most interesting and I’d said, amazing thing in the whole “Latvia begging the IMF” saga is the fact of complete absense of any notion of deregulation&privatisation. Actually what IMF, WB and other lenders do now is salvaging the current system which is illiberal both politically and economically. As a matter of fact, international wellwishers&money-givers supply means to preserve the status quo indefinitely. While saving LVL-to-EUR peg was a sine qua non for sheer survival of the general population, the rest of the bailout package’s content is a life raft dropped pointedly to governing clique.Economy is and will remain stiffled by the red tape. The role of public sector in the absense of deregulation&privatisation will grow (as it did for the last 5-7 years), further sapping the strength from private sector. And by _public sector_ I mean not schools&hospitals, but state- or municipally-owned commercial enterprises.Hell, Latvia have a lot of thing to sell, thus avoiding completely or at least making less acute its need for IMF&Co financing. Shares in two major national telecoms and national airline, fully publicly-owned railroad, three major seaports, heating, water, utility and transport companies in every city, town and hamlet, two airports, national energy company, state forrests (the single-largest ownership in the region), plenty of state-owned companies dealing with such unstately affairs like road repair and construction…With assets like these who in the world needs IMF? It’s obvious why government never dared to even speak the word “privatisation”. All these companies are the power and money-supply base for governing elite, who brought the country to present sorrow state and now tasked to save it. But the position of IMF in this regard has no reasonable explanation.Privatisation would not only bring in some hard currency needed to support the lats, but it would make the economy as a whole much more competitive just because new private owners would not tolerate nightmarishly wasteful management of these state-controlled “enterprises”.Actually, in a certain sense Latvia is much more socialist country than Lukashenka’s Belarus. And, thanks to IMF&Co benevolence and its willingness to turn a blind eye towards real reasons for Latvia’s near-miss with default, will remain like this… The chance for __real__ structural reform was flushed down the drain.

    • Guest   January 8, 2009 at 4:58 am

      This shows the diffrence in theorethical approach and practical understanding of the situation!

  13. Latvian   January 10, 2009 at 10:13 am

    As a Latvian reading the commentary I can see problem for all the analysts. There is already quite a stock of the analysis of Latvia’s situation from macro perspective. But as you should know, every theory is based on some key assumptions. The problem is that those assumptions do not include following:1. Corruption is prevalent in most of the government institutions and controlled entities. Every area of economy is divided among interest groups behind political parties. They have silent pact not to intervene in each other territories. The ministries in government are divided on the political principles. This is allocation of the sacred cash cows for political elite. If you consider government decision for cuts, it does not take into account efficiencies and inefficiencies of individual institutions. Rather it takes one-size-fits-all approach. The reasons are mainly two – first is tiny capacity of government management resources and second it would be “unfair” to cut more from one political group than other.2. If you consider the structure of Latvia’s GDP and exports, you can easily see that we are not able to attain or sustain current account other than negative. We don’t have many current industries that would gain from increased competitiveness. Government do not have any real sense what is the industries that would bring much needed growth.3. Our education system is very largely outdated. Most of the students are working in parallel. The higher education is just a formal tick mark for CVs. It is perceived as such by students and by lecturers. Poor education means poorly skilled employees.4. Our votes can be easily bought. We have a 3-6 month memory of any scandal perpetuated by political elite. After this period most of them buy their image with best PR and advertising available in Latvia.5. There is lack of new wave politicians since no one can succeed without backing and money from current corrupt elite. People are disillusioned to step up since all the money is held by narrow political elite. Money determines elections here (and in US). Even if there is some bright new politician coming on the stage, nobody believes him. Everybody in politics is suspected of fraud and backing some of the interests. The distrust of politics is unbelievably high. It is depressing.6. State Revenue Service is like KGB – unreasonable and full of power.I could go on with some more micro reasons but it is not the point. Latvia need painful bleeding so we are forced to make structural, political changes needed. Otherwise it is just redistribution of the wealth.

  14. Anonymous   January 12, 2009 at 2:42 pm

    The comment by “Latvian” is spot-on concerning the structure of the endemic corruption in the government.It is hard to assess what percentage of the IMF funds will by siphoned off – 20-50% I suppose. And who knows if the money that actually goes through to the real cost of a project is being spent in a useful way.Is it reasonable to put the next generation in hock with the current corrupt government stealing borrowed money?There is a lot of talk about strong oversight of the IMF money. You have to realize that the political elite have made an artform of making papers to disguise their theft. A forensic accountant would go crazy trying get hard proof that could be used in court.There is a large government protest coming. Hopefully the bums will be thrown out, but I am not holding my breath.Latvian resident

    • Anonymous   January 13, 2009 at 4:36 pm

      The protest was today and it turned into a full scale riot here! Tear gas, blood in the streets, riot police…Photos here: http://foto.delfi.lv/album/18577/

  15. Anonymous   January 15, 2009 at 4:56 am

    There is, in fact, an additional argument supporting the IMF line. Even if devaluation were a good idea in principle, it clearly is not indifferent in which conditions it is carried through. Krugman himself writes in his latest book that, when devaluating, is is crucial to keep in mind that “immediately following the devaluation, you must give everysignal you can that everything is under control, that you are responsible people who understand the importance of treating investorsright, and so on. Otherwise the devaluation can cristallize doubtsabout your economy`s soundness and start a panic.” Well, in view of what is happening at present, that is a very tricky rule to follow.

  16. Guest - Smaka   January 19, 2009 at 2:59 am

    The IMF present programm is just an utopy. Neither there is such a political consensus over the programm nor public acceptance. The key issue is Swedish banks which will be forced to enormous write-offs if the devaluation will happen and a lot of loan contracts will go to force majeure state.

  17. Anonymous   January 29, 2009 at 5:06 am

    As a feline living in Ukraine, I can sum up the author’s rationales in one sentence: “devaluation of the Lat would sink several Swedish banks, therefore we could not devalue.”Everything else the author wrote is just enabling.

  18. bsetser   February 1, 2009 at 1:57 pm

    Christoph — are there examples of successful real adjustment in the context of a hard peg through fiscal contraction that you would point too? the usual problems are:a) the adjustment is slow, and it is hard to fill the financing needs associated with the adjustment (especially if depositors in the crisis country start to move funds offshore). investors don’t like filling large financing needs in the context of a contraction.b) the political consensus usually is such that there is neither a consensus in the early stages of a crisis in favor of moving off the peg or for the kind of nominal wage cuts that really are needed to bring about the needed real depreciation, especially when the “pain” from nominal wage cuts isn’t necessarily evenly distributed.one final question, or perhaps suggestion — you mentioned strengthening bankruptcy regimes to deal with rising foreclosures and the like, and argued slow adjustment has the virtue of allowing time to strengthen various national institutions. true enough. but if real debt values are doing up as nominal wages are falling but nominal debt isn’t and collateral values are falling too, isn’t there some merit to a program that allows a general reduction in nominal household debts as well as strengthening enforcement of contracts? how does the program envision dealing with the internal debt overhang?p.s. i take your point that the new IMF cannot force countries to adopt a policy program that they don’t own, but of course the real question is whether the IMF finances those programs or not …

  19. G.Jacobsen   February 25, 2009 at 2:24 am

    Christoph*s comments are spot-on. I would only add that Latvia should adopt the Euro now.Even a unilateral adoption, without EU approval, of the Euro is technically/financially possible due to the currency board regime. Adopting the Euro would provide further stability.Unfortunately the IMF program does not provide stability as it is dependent on politics. Therefore the devalutation threat still looms until the Euro is adopted.The threat of a devaluation deters investors and creditors/banks and encourages local companies to raise prices in anticipation of a devaluation.Also the threat encourages companies to sell Lats and hold funds in Euros. Due to the currency board regime any selling of Lats further decreases the monetary base and sends interest rates up.It is about time that the Latvian central bank and the Latvian government admit publicly and loudly the obvious, namely that they lost completely control over monetary policy as the Swedish banks have effectively taken over the role as the central bank, due to their aggressive lending in Euros.The central bank has virtually no tools whatsoever as the economy is already largely eurorized.It would be extremely helpful if the EU and the IMF would facilitate a very swift transition to the Euro.Surely if the Kosovo and Montenegro can adopt the Euro, which are not even EU members, then Latvia should be able also. Whether it meets the Maastricht criterea is completely irrelevant in the current situation. Any further delay just aggrevates the situation.The recent Latvian downgradings by Fitch and S&P to junk status highlight that the IMF program changes little if credibility is not restored in the real economy. Adopting the Euro now is one of the necessary steps to achieve that.

    • G.Jacobsen   April 7, 2009 at 12:57 am

      Interesting:LONDON, April 6 (Reuters) – Struggling eastern EU members should switch to the euro without full euro zone membership, the Financial Times reported on Monday, citing an IMF reporthttp://uk.reuters.com/article/marketsNewsUS/idUKL649731120090406?pageNumber=1″ECB member Ewald Nowotny said unilateral adoption was legally impossible”I cant see anything in ERM accession contracts that would prevent Eurozone candidates from adopting the EUR as a parallel currency.By allowing banks to hold their minimum reserves at the central bank in Euros and also allowing companies to pay taxes etc. in Euros, countries can effectively adopt the Euro without going against the letter and spirit of the ERM contracts.Introducing the Euro as a parallel currency would effectively abolish national currencies as most economic entities would switch into the safer currency.

  20. Guest   March 18, 2009 at 8:33 pm

    Greetings from Riga .. well I could agree with quite a lot of issues discussed in the article, and currency peg, as it has huge non-economic rationales behind but: “Wage cuts up to 25 percent may seem large, but let’s not forget that this comes after the tripling of nominal wages during 2001-07 (doubling in real terms) and that most of it will be accomplished by cutting bonuses of up to five monthly salaries” argument is completely not valid.Yes, nominal wages have tripled in some sectors (financial intermediation, real estate ect) but now they get cut independently of sectors, resulting in seriously harming education and health sectors, where people already used to work receiving salaries just enough for maintaining basic living standards for their families. Currently many rural schools and hospitals get closed, actually limiting the basic needs for people with already fewer opportunities. Our unemployment rates already have increased over 20% in several regions and combined with rapidly decreasing support for agriculture I can only say that I’m very lucky to live in capital, as I see very little development and growth perspectives in other parts of country in near future (and actually we can forget about any regional equality for a long time). I do not know many that capable nations as Latvians so it’s, of course, not a question, if we’ll somehow manage to come out of this crisis, but the 25% is not decrease in wages of the top government officials and people who tripled their income during the last decade or decrease in bonuses, last all have gone quite long ago. I would like IMF and EU to take more care of us – not forcing polices that make no sense for our country and economic situation and maybe considering that we joined EU and pegged out currency to Euro thinking that EU will to some extent also take responsibility of something more than Maastricht criteria.