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šuriks 17.02.2009 19:23

Are You sure mr. Hansen? President of the State Bank Mr. Rimševics still is not ready to discuss about currency.....

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Specs 17.02.2009 19:37

Well, it's funny that the head of the Bank of Latvia was urging to put the money in action, as fast as possible. I wonder if he was not aware of the terms of use of the financial aid? To be honest, this is pretty depressive -- there seems to be nothing that would improve the credit markets, not by single percent.

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Ingrīda 17.02.2009 19:53

Morten, it is admirable that you find something positive (re: MoF transparency in linking the letter)--but the reason they did this is probably quite simple: no one at the MoF really understood what it says, and they count on the general public having an ever weaker grasp of the issues (and English). You and everyone else observing the situation have every reason to be concerned. No rising and shining on the horizon until the kleptocracy has crumbled, I'm afraid.

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šuriks » Specs 17.02.2009 19:54

Unfortunately, you are right

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cinikje 17.02.2009 21:08

Morten, in Latvia transparency is prompted not by interests of the society, but by interests of the people who has somehow got into coalition gvt. I would even bet on the whole IMF/EC money that it was done so Mr NothingSpecial has smth to stick in the eye of enterpreneurs when those start to complain that gvt has done absolutely nothing to get interbank and thus external lending to get out of freeze and nothing to help small and medium enterprises restore competitiveness or even to survive (even if there is pretty nice possibilkities to devote significantly more than planned from EU funds)

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ppp 17.02.2009 22:07

The only (repeat - only) good thing they have done by keeping the peg in place is protecting the banking system. In Latvia the proportion of FX loans to total loans is the highest in Emerging (Submerging, if you like) Europe, so no defaults/NPLs caused by economic changes...now clearly this motive is a double edged sword. On one hand you have contribution to a greater good (and protection of your backside from those in Brussels) by not being the catalyst of financial services meltdown (yes, apparently it is not yet over, if you believe the press). On another, you have protection of banks in Latvia that are predominantly owned by foreign capital (we agree on putting Parex out of the picture, right?)...or protecting foreign capital over and above local one by making your exports less competitive...where is the sense in that? Can't see one, quite frankly. Scandi banks would have had to raise a couple more billion in capital...but you have to pay for the feast, right...there is no free lunch, is there? So, I am guessing all of those "nosingspeshls" are gone by the time next general election is on the table. In the longer-term, however, consumerism centred culture of Latvians will have to change...and I sincerely hope that the crisis is going to teach some of these people a good lesson for the future. You now have the knowledge...

Out

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:) » Specs 18.02.2009 00:22

Actually, BoL is right, the money should be given to the economy as soon as possible and, I believe, the governor did know every single issue of the agreement with IMF. Yet, there are not just one way of distributing the aid to economic units, one of the biggest challange at the moment is to restore normal banking market firstly among banks themselves and then the latter (i.e. banking for you and me) will follow naturally. Thus, one should work on how to use the aid to strengthen banks' balance sheets and meanwhile motivating them (carrots or sticks? well, it depends on banks' position, doesn't it?) to provide the resources to the economy's strongest units (which in turn shall generate the EUR inflow as well as pay taxes and wages and thus help the public sector). The problem, however, is, that they should overcome the problem when banks would use the resources received to decrease the exposure to Baltics and simply transfer the money out of the economy (back to Swedish pensioners perhaps?)

My personal opinion is that you really don't want to play around with the exchange rate. If Latvia devalues:
1) imports shall become more expensive (think about energy prices at first)
2) you would simply destroy savings in Lats (vs. EUR) - why should one keep their deposits in LVL then? given the high share of Fx loans, that would mean liquidity problems for most of the banks. Plus it would ruin all the confidence in LVL the BoL has build up during the last 17 years (including tough times during Banka Baltija and Russian crisis).
3) you would destroy the confidence (and capital) of those investors who have invested in Latvia. You just simply reduce their investment by certain percentage (vs. EUR). If you back-stab the investors, do you really believe they are going to come back? Do you believe that is a good promotion for the business environment?
4) Lots of households and enterprises shall bankrupt immediately. Just the next day when their liabilities in EUR have just increased by a certain percentage while asset value remains the same (obviously, vs EUR). And that is just the book value, not taking into account the market value which would suffer as well.

Devaluation is unfortunately a very, very bad choice, yet it would almost definately restore Latvia's competitiveness. Deflation (correction through price levels) is a long, long pain and it is definately not guaranteed, that it will work. If it really does not, deval shall be employed and then (deval + initial deflation) we are really ...-up :(

we should actually cross fingers for the agreement between the government and banks, that they work out a plan that suits for a mutual benefit and recovery. Easy to say, though, I guess...

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Agnese Melbarde 18.02.2009 04:34

Just a comment from the point of view of financial markets as of today: worries about Eastern Europe sent fears all through emerging markets today. The Wall Street Journal mentions Latvia today as the worst performer of the group.. I truly hope that the funds are going to be used for the intended purposes. I can only pray that the government realizes the immense responsibility they have and potential effects in case the funds are "funneled" away.. This is the first time when I'm indeed very concerned about Latvia's future. They have to get it right, I don't think there will be another bailout of any sort.

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2007115 18.02.2009 09:30

As Mr. Rimsevic (together with A. Strazds) argued last Friday immediate devaluation would not help, mainly because there are many inputs (energy, raw materials) that are imported (denominated in Euro), so the raise in competitiveness would be questionable.
The logical question arising from wage deflation plan would be, if it will work. Currently there is higher unemployment, but those who work receive rather high wages. The question is will there be an increase in productivity (raise in competitiveness) or output decrease.

Currently it seems that nobody (in power) actually knows what is going to happen. Central Bank and Government has to advocate the path already chosen. In one way they succeeded – Central Bank doesn’t have to spend hundreds LVL mil a week to keep the peg. Credibility is what current situation lacks, because according to recent development of situation, official statements and information which makes it to the press (Diena says that Ministry of Finance considers 13% drop in GDP, although the official version is 5% only) which could make someone (probably more realistic then pessimistic) that is going to be very bad, but nobody dares to tell us so.

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what wasn't done 18.02.2009 09:44

"PS I think the Ministry of Finance web site deserves credit for linking to this letter – transparency…"

If the MofF and/or Premier and/or ruling coalition had made it clear to the populace in December what the money would be used for, then the EU's letter would never have been necessary.

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Morten Hansen » what wasn't done 18.02.2009 11:18

Good one - point well taken!

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ppp 18.02.2009 11:21

OK, so immedieate deval does not / will not work...let's have a gradual one. Know Russian example it's not necessarily considered the "best practice" but look at the Rouble...it was gradually devaluing vs their basket since last year. Saving money for the Central Bank to (that's point number 2) guarantee interbank market lending to top banks (that does include private banks too - not only state-owned, just to be clear). So here are the steps. Also, it is well known and, sadly, documented in the media that our government is incompetent (to say the least). So why in the world do you not hire an international advisor to do the hard work for you? You owe the people at least that if you can't handle it yourself...agree?

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nn 19.02.2009 11:20

fixed peg protects only the rich benefiting from spread.. all others pay for this..

what is most terrible -- this approach of deflation is bound to fail.. it cannot fix the trade balance in less than 2 years.. the international support is over next year but addiction to credit will persist.. if the global credit is still frozen at this time (why not?) then lat will eventually collapse (or entire economy)

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Agnese Melbarde 20.02.2009 01:39

"Nice" Article in today's WSJ .. Here is an excerpt:

"As of December, Pivot [this is a inv. manager in UK..] continued to bet against the debt of Latvia, according to a note to investors. Latvia is now mired in a recession and dependent on assistance from the International Monetary Fund.

At the beginning of last year, the cost of buying insurance to protect against Latvia defaulting on its debt was €127,000 ($160,000) a year for each €10 million of debt, according to Markit Group, a credit-information firm. By year end it was €800,000, and earlier this week it touched €928,000.

Pivot's main fund was up 52% last year, according to the company's December newsletter." (JOANNA SLATER, WSJ, Feb, 19th 2009)

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Concerned 20.02.2009 23:55

So what's now? Can we speak about evaluation when our prime minister (who undersigned that letter, btw) is dismissed?

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latvian_economist 27.02.2009 09:19

Mr. Hansen,

Good article, I enjoy reading your blog since there is not much of discussion regarding currency devaluation and I am not sure about the competence of the Central Bank, unfortunately. Please give your thoughts on the following plan.

1. Devalue the lat gradually, i.e., expand the peg corridor for lat, to say +/- 20% rather than hold on to the current +/- 1% peg. This is, I believe, very much in line with the demands IMF made earlier. To me, this sounds like economically sensible policy aimed at restoring Latvia's competitiveness. The matter of fact is that we are not going to be able to maintain the status quo fixed exchange rate regime. Traders are already shorting lat, and that is a very bad sign and markets are usually pretty good at signaling games, which is essentially the function of any free market where prices are used as signals. I am very afraid we may end having a textbook case of "an attack to the Central Bank" which will run out foreign reserves to fulfil all demands for foreign currencies. And that would mean a classical "shock" therapy and devaluation overnight. I see many benefits in devaluing lat gradually rather than waiting until sudden devaluation is inevitable.

2. The biggest fear regarding devaluation of lat is the fact that ~75% of loans in Latvia are made in EUR. In the case of devaluation, it will create social mayhem. I propose the following: mandate all commercial banks that issued these loans to convert them to lats at the current fixed exchange rate. Banks arguably would lose some profits the enjoyed from the interest rate spread between lat and eur but this does not seem to be very significant loss against the potential gain to the society. This plan may be hard to execute practically although it is hard from impossible, considering that the current worldwide economic situation requires innovative solutions (look at the U.S. right now). I want your opinion on this thought especially.

All comments are welcome: latvian.economist@gmail.com

P.S. Mr Hansen, if you prefer, you can send your answer to my mailbox if you prefer not to express publicly your opinion regarding such controversial matters. I would completely understand.

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ppp » Re: latvian_economist 27.02.2009 22:03

1. How do you short the lat? What idiot broker will lend you lats vs. EUR or USD when we have all this noise on our hands? Nobody with at least some knowledge of current situation will do such a trade. The only exposure you can get* is through CDSs or some other syntetic tool that is v. distant from the real "plain vanilla" exposure
2. Pls take into consideration asset-liability mismatch on banks balance sheets this requirement will create...what you propose is essentially shifting the burden of devaluation from borrowers to lenders...don't think it is going to fly...ever...or you risk to bankrupt all banking system who have EUR or any FX exposure on liability side

*why would you want it?

My plan of action was spelled out in the article re Parex (one of the many:)

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latvian_economist 28.02.2009 02:01

Thanks, Mr. Hansen! Point well taken about shorting the lat.

Mr. Hansen, I know you are know a proponent of strong fiscal policy and "internal devaluation" but it was not that long ago when you along with Alf Vanags seemed at least willing to consider devaluation, maybe not an extreme one, let's say 1:1 Lat: EUR. I do believe that such a possibility must be considered. I am not even sure why the government is such a proponent of “internal devaluation”, i.e, reducing real wages and raising employment as opposed to simply devaluing currency. There seem to be no real benefits from this as opposed to foreign exchange devaluation. Devaluation seems to be much more clear-cut and faster and would save a lot of populism coming from the government. Nobody is even sure that internal devaluation actually works – Keynes surely would disagree as him and many others believe that wages are quite sticky and does not succumb to downward pressure so easily. I think that the peg corridor should be widened which we will “naturally” lead to a foreign exchange devaluation, which is what Latvia desperately needs right now. Action is needed fast and the tools of “internal devaluation” obviously don’t deliver – they required a lot of political capital and bargaining and hence involve an extremely long time lag (the gvt in Latvia has done not produced a single sensible proposal since last fall maybe?). Devaluation and/or widening the peg corridor may be less painful and surely much faster and leave less room for political populism. Mr. Hansen, I would appreciate your opinion on this?

Another problem with pumping money into the Parex: to be fair, the U.S. has also made this exact mistake. Hence, Parex does not put the money into the credit channel (which is essentially frozen in Latvia) but rather keeps it on the balance sheets (which is exactly what the U.S. banks are doing as well). Parex should have been required explicitly deploy this money through the credit channel and the government is sure in a position to do so with owning Parex and Hipoteku Banka as well (yes, this is controversial, but gvt has to get involved with lending to strategic industries!). To be clear, Parex did not face a liquidity crisis, but a confidence crisis. Confidence crisis, I argue, cannot be fixed by just adding liquidity. I strongly believe that right now we are in the confidence crisis and liquidity is not the answer – confidence is! Banks (i.e. Parex in the case of Latvia) keep “sitting on the money” and don’t lend it to the public to foster business activity. This is a problem, and not uniquely Latvian. Do you agree or disagree?

Yes, I truly argue that some of burden of devaluation should be borne by the lenders although your point is well taken; banks are in much better position to absorb the costs of devaluation than the general public is. To be fair – we should not be extreme not to create, as your correctly put it, not to create an extreme asset-liability mismatch. Bank bankruptcies are the last thing we need. A very sensible approach would be, in my opinion, to give people who hold loans in EUR but receive salaries in lats some sort of “adjustment period”, i.e., let the people pay back the loans, converting lats to EUR at the current fixed exchange rate for a certain period of time, say, 3 years, to let the economy and labor market recover. To be fair, without a pre-payment option otherwise speculation would arise and everyone had incentives to prepay their loans – that option should be eliminate from the start. If such a provision does not exist, I am afraid, we will see even larger emigration of our labor force to Ireland so they can get paid in EUR and able to pay back their loans. This situation, again, can lead to another possible rise in wages due to the shortage in labor force and we may end up in similar situation than we are right now. What is your take on this?

I appreciate the discussion.

latvian.economist@gmail.com

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ppp » Re: latvian_economist 28.02.2009 15:55

Emm, I am, of course, flattered and stuff, but I am not Mr. Hansen...and Mr. Hansen is not me, he has nothing to do with what ppp says, just to be clear. Sorry...

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latvian_economist 01.03.2009 03:17

I understand. In Latvia Security Police (Drosibas Policija) is working hard to suppress the freedom of expression with regards to the economic matters. The whole world is laughing at Latvia how stupid we sometimes are and how lightweight our politicians actually are. Did you see the article in The Economist? -


It is very sad that even academics cannot freely express their opinions. We call ourselves a democracy - but are we actually? This crisis have shown that Latvia has a lot to do learn....and maybe some time we will have actually smart and well-educated politicians not some jokers like Slakteris and Godmanis who don't understand what the word "devaluation" means......probably the most poorly governed country in Eastern Europe, and our Central Bank is a joke as well....idiots.