Oct 2, 2009
Latvia probably will devalue currency (c) Capital Economics
Latvia will probably devalue its currency in the next year since the government may not be able to continue cutting spending in line with its international program… We think it’s more likely than not that Latvia will devalue… [Real effective exchange rate] needs to decline by “about” 25 percent to return to levels in 2004 “when the bubble started to inflate,” Shearing said. The real effective exchange rate has weakened 3.5 percent from its peak. A Latvian devaluation will mean Estonia and Lithuania are likely to follow suit and devalue their currencies…
That’s what Bloomberg released today. Quite a strong message from Capital Economics. Will it raise the next economy run?
No reaction in the forward markets yet, ~0.2% jump up.
12 months EUR-LVL forward
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Trouble in the Baltic states? (Source)
Meanwhile, the Baltic states are a potential flashpoint. With their currencies pegged to the euro, they can only restore competitiveness through falls in wages and prices, a so-called ‘internal devaluation’. This has resulted in falling domestic demand and growth: in Estonia GDP is set to slide by 14% this year. This sort of devaluation is “painfully slow and very damaging to democratic solidarity”, says Ambrose Evans-Pritchard in The Daily Telegraph. For example, in Latvia, which is being propped up by the IMF, the prime minister has had trouble pushing through austerity measures amid resistance from his coalition’s “powerful party chiefs”, says The Economist.
Further conflict with the IMF could result in Latvia’s currency peg with the euro being abandoned, which other Baltic states would be likely to follow. That would trigger “a renewed bout of financial market-selling” in the region and send defaults on foreign-currency loans soaring, says Capital Economics. In short, eastern Europe is the developing world’s sick man. Given all the potential pitfalls ahead, it’s too soon to join the investors rushing back into the region.