Latvia is poised to devalue its currency at least 15 percent by the end of 2010 to boost exports and cut the budget gap as the economy contracts at the fastest pace in more than a decade… deficit may grow to a record 10 percent of the economy this year, twice the initial 5 percent target set last year by international agencies that provided a 7.5 billion- euro ($11.2 billion) bailout loan. Latvia may already have taken the first step toward devaluation after an announcement on Oct. 6 that the government was considering rules to cap mortgage holders’ liability, which would help limit losses from a devaluation.
More and more scary bells each week are coming from Latvia. After the announcement the yield on sovereign bond due 2018 rose almost 1 percentage points, CDS jumped >20%. In last two weeks Latvian central bank had zero net intervention in FX market. Would be ridiculous for Mr. Rimsevics to spend another billion euros on defending currency. Probably he will not. Creditors would be flamed out otherwise.
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Finance Minister Anders Borg has had talks with the major Swedish banks and warned of a near economic collapse in Latvia… The international community’s patience is very limited… In secret talks with the Swedish banks have Anders Borg explained the growing pressure that exists within the International Monetary Fund (IMF) to force Latvia to a devaluation… Since it is difficult to safely assess Latvia’s ability to pay and with conditions for recovery, one cannot completely exclude the risk of a major default.
According to translated version of SVD.SE, whatever that could mean. Anyway, one of the major barriers of devaluation could be removed by the Latvian government…
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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?
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Original memorandum of intent of the government differed from what had been published. Two issues from the published document had indeed been removed at request of the Bank of Latvia and the Treasury. One is related to some information that can put investors into more advantageous position relative to the Treasury in sale of government debt. Another was able to create more benefit for speculative attacks on Latvian Lat. One particular number could harm the whole country interest.
That’s how Wednesday’s Latvian press described the deal between Latvia and IMF.
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… Current account has been balanced, inflation is falling back, foreign debt will not exceed 60% of GDP, which is a Maastricht criteria level… Our current account deficit is not in double digits… This is not because the overvalued currency, but because of huge lending… We just need to have more communication…
Latvian year to date trade deficit is LVL -145mn including both goods and services. Its income balance (the rest part of current account) was LVL -300mn in 2008, and the last time it was positive in 2002. But mysteriously, income deficit reversed to a surplus this year! How? Why? What affects? Mr. Rimsevics, can you please communicate on this topic?
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Some time passed since the last post in this blog. One might say – nothing happened in Latvia, despite all the effort of the author, and things are going well. Despite huge drops in real GDP, budget deficit, all those real estate and labor problems, or IMF’s bickering regrading credit – Latvia will eventually get out from the hole. God bless those people. But the Latvian government will not. Neither will the central bank.
Now i started to believe that Latvia’s problems emerge due to lack of reliable official information. Let me explain.
Firstly, on 2 of April the Bank of Latvia (BoL) decided that it would be most convenient for all not to disclose where and how much foreign FX reserves of the country are held. It seems of low importance, BoL says, and will protect the country against the speculative attacks of investors. Yes, right, speculators most probably will invade into the financial system, but primarily due to its shitty fundamentals. Show me somebody who cares about where saving are of Latvia are held? Unless they are distributed to the local banks! This subsequently leads to the second thought.
Check one revealing graph:
This is how Latvia’s FX reserve change in how they should have changed according to the officials. The BoL says they only sold EUR 155mn in March. However, comparably FX reserves dropped more than EUR 1bn. Where do money flow? Nobody knows, I won’t be surprised if Mr. Rimsevics also doesn’t know. But I can assume from the current environment that this money is transfered to troubling local banks. The BoL intervenes into the market not directly, but through those arrogant little institutions, I assume. In exchange of being speechless, the banks could be allowed to use some of the FX reserves to sustain liquidity and minimize panic… Ah right! This money could also be stolen or missed in accounting! This leads us to the third and final (oh thanks) point – accounting in Latvian.
Today the press mentioned that foreign creditors of Latvia decided to audit its budget financial performance. Funny and sad they discovered two things. One – the Latvian government does not have any centralized database of revenue collection, its simply doesn’t know from which sources the money is fulfilling the budget. Two – it doesn’t know how many people are currently working in the government and each ministry in general, thus, the government doesn’t know how it spends its money. But they certainly know that devaluation is not possible and fat Santa Claus will visit them in December. I don’t know how they are going to tackle the crisis – cutting somebodies’ heads?
Encouraged by a message from Bank of America with precise projection of Baltics devaluation I have decided to summarize why the analysts could be right in their estimations. Apart from inflation, economic recession and credit crunch, as stated by the BoA, I would like to stress other interrelated macro economic phenomena, which theoretically should be ended by a change in currency rates. Mainly, these are:
1. Hot money effect
2. Current account deficit
3. Reserves/ M2 + Gross external debt coverage
4. Low competitiveness
5. Parex Bank… and international relations
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Swedbank and Latvia are major friends today. If you listen to someone speaking about Latvia just wait a few moments and you will enjoy expressions about Swedbank. Or other way, if someone is articulating about Swedbank, she will certainly stick few words about Latvia. Causality is uncertain but base is obvious: Swedbank and Latvia are major problems of each other. Latvian currency is losing value, Swedbank – confidence.
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Panic has started.
Discussed by John Hempton in Bronte Capital, Baltic banks are insolvent. The reasoning is the following:
Well if the Lati devalues (as would seem inevitable) then Hansa Bank has to pay Euro to Swedbank – and as its assets are in Lati it would be insolvent.
If the Lati doesn’t devalue its only because people (ie Swedbank) are prepared to continue to fund it. This is not pretty at all. All in Hansa owes Swedbank over 30 billion Swedish Kroner – all denominated in Euro and which can’t be paid. The equity capital of Hansa (roughly 7 billion Swedish Kroner) is also going to default.
To protect Baltic economies, firstly, central banks should have enough willingness and reserves to long Baltic currency and short Euro with gold. While the rest of the world is doing vice a versa. Any thoughts who is able to spend more capital: hedge funds or Baltic central banks?
Secondly, people must inject more Euros to Hansabank, SEB and other banks to diminish their loan-to-deposit ratios and make shareholders of Swedbank calm. Any one is willing to buy litas or kronas from the bank and give them all your Euro savings?
Yes, we do! Banks have been clever enough to hedge their currency risks by lending in Euro to residents of Baltic States. And we have been borrowing in Euro, protecting banks and exposing our own assets. The great scheme that has been working until recently, when borrowing capacity was more or less sustainable.
Today, it’s not true. Banks’ credit risks are topping due to bad loans coming from the Baltics. Inflation does not allow to reduce interest on domestic currency denominated loans and decrease demand for Euro. People do not funds banks anymore. Contracting GDP growth is pushing away foreign investors. Consequently, to make their shareholders calm, both Swedbank and SEB should closed down their Baltic branches. Until they will be forced to.
Today is the first time since September 26, 2007, when Latvian currency returned to its unpleasantly low position against Euro. However, if in autumn momentum was rising, this time it is the sharpest one day price drop of Lat against EU currency. In one day LVL depreciated more than 0.5%. Is it only a mystery happening each Friday the 13th or financial markets started to doubt in Lat?
Technically 0.7060 level is important for Lat, as it is a second 1-year lowest LVL-EUR rate. If it is broken, we should expect further depreciation until another important limit to test – 0.7074, which is 0.2% higher than Friday’s closing price. This point was reached when Latvia was flooded with SMS’s containing rumors about Lat devaluation. On short term-graph, resistance line is broken, and probably does not already play any significant role. Technically, the question is whether another 0.7060 is a strong resistance level. Economically, not necessarily.
Monday’s, opening price shall judge this interesting case.
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