What can Latvia teach the eurozone?

17th September 2012

Friday saw an interesting development which touched on a subject relevant to the economic pain being suffered in Greece and Portugal right now. This came from the announcement below by the International Monetary Fund:

"Latvia today made an early repayment of obligations to the International Monetary Fund (IMF) amounting to SDR 178.448 million (€211.1 million).

The early repayment is about 18 percent of the SDR 982.24 million (€ 1.16 billion) that Latvia borrowed from the IMF under the Stand-By Arrangement (SBA)"

Latvia matters because she is something of a forerunner to the Euro austerity plans applied to Greece, Ireland and Portugal and probably about to be applied  to Spain. She is if you like a couple of years further down the timeline and so we can hope to learn a few lessons from her experience.

What happened in Latvia?

Back on the 12th of March 2010 I took a look at how Latvia had descended into the economic mire and below is the timetable I wrote about then.

1. Accession to the European Union in 2004.

2. A debt fuelled spending spree by consumers combined with loose government fiscal policy and a housing market bubble (my article of yesterday is again relevant here of how a housing bubble can contribute to a fiscal crisis).

3. The economy peaked at a growth rate of 12.2% in 2006

4. This overheated economy found that international markets were abandoning her as inflation for example peaked at just under 18% in 2008 and on February 2009 Standard and Poors downgraded Latvia to junk status (BB+/B). In the 4th quarter of 2008 GDP shrank by 10.5%. Ouch.

So in December 2008 the IMF was called in to help and loans of 7.5 billion Euros were provided.

Analysing what happened next led to me already developing fears about IMF style austerity programmes and therefore what might happen to Greece:

"Now here is the real issue GDP was expected to fall by 5% in 2009 but it actually fell by 12.2%. So my fear of a downward spiral for Greece actually happened for Latvia."

Indeed we could already see that Greece was already on a very hard road which the official forecasts completely ignored -2010 GDP was supposed to rise by 0.3% whereas I suggested a fall of circa 4% was much more likely-. If we look at Latvia's circumstances it was already fairly clear that such forecasts were a fantasy:

"Latvia's experience has much to tell Greece. You see over her austerity programme Latvia's GDP has fallen by some 30%. Latvia has been unlucky in that her austerity programme has come at a time when world economic output was falling but the scale of her adjustment has been so severe that it cannot be ignored"

So as we can now see with the benefit of the following two and a half years that Latvia did provide a map and pattern for the adjustment which has taken place in Greece and looks like it is developing in Portugal. For those wondering how different the Greek economic landscape was back then take a look at some of the numbers below:

"her national debt of 113% of GDP ……..unemployment is 10%"

And believe it or believe it not but she was supposed to hit the Euro area fiscal deficit target of 3% of GDP this year!

What is Latvia's situation now?

This has become something of a political/economic football with many more interested in justifying their own dogma's than actually looking under the bonnet of the engine to see what is actually occurring. Here from Olivier Blanchard of the IMF is the case for success:

"Four years later, Latvia has one of the highest growth rates in Europe, the peg has held, and the fiscal and current accounts are close to balance."

For those wondering about "the peg has held" Latvia has pegged her currency to the Euro which is one of the reasons why her experience is so useful. However Mr.Blanchard also gave an indication of why there are still questions as to whether this adjustment was a success:

"The economic and social cost of adjustment has been substantial.  Output further contracted by 16% in 2009, and is still 15% below its 2007 peak."

And right now?

In the second quarter of this year Latvia continued with her recent rapid -particularly for these times- economic growth as her economy was 4.6% larger than a year before. So a slight slowdown on the first quarter's 5.1% but a rate which many countries would love.

However if we look forwards the official Euro area forecasts are not as optimistic as you might think as Eurostat shows that Latvian economic growth is expected to be 2.2% this year and 3.6% next. So we are left with the view that Latvia has made a sharp -what economists call a V shaped recovery- but this looks as though it will slow maybe sharply.

Continue reading…


More on Mindful Money:

Balancing stability and sovereignty will prove challenging for the Eurozone

What is the debt situation in the UK?

How has the financial landscape changed since 2007?

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