RIGA — Despite a new agreement with international lenders, Latvia’s economic depression could actually worsen under a number of scenarios — including a new round of political instability, botched economic policies and structural reforms, or a protraction of the global financial crisis.
Politicians have tirelessly repeated in recent days that the worse for Latvia is behind — e.g., Prime Minister Valdis Dombrovskis said this week that the bottom was reached in the third quarter last year — yet independent voices claim that the situation could either take a turn for the worse or the economy could stagnate indefinitely.
In its most recent Baltic economic review, which was released Thursday, Swedbank wrote, “Insufficient progress on structural reforms in both the public and private sectors runs a risk of post-recession stagnation, with very weak convergence in living standards to the rest of the EU.”
The bank pointed to Portugal, which has stagnated for more than a decade, as an example. Swedbank forecast that Latvia’s gross domestic product collapsed 18 percent last year and will shed another 3 percent this year.
Mark Weisbrot, co-director of the Washington-based Center for Economic and Policy Research, wrote Friday in UK newspaper The Guardian that by choosing a policy of internal deflation over currency devaluation, Latvia was only prolonging its anguish.
“It makes no sense to continue to shrink the Latvian economy, with no end in sight to the recession, simply to maintain the pegged exchange rate,” he wrote. “Maintaining the fixed, overvalued exchange rate also creates enormous uncertainty that undermines investment and causes capital to leave the country.”
The IMF, Weisbrot pointed out, has predicted that some €1.5 billion will leave Latvia this year. The lost investment and capital flight are extraordinarily crucial, as Bank of Latvia chief Ilmars Rimševics reiterated at a press briefing on Thursday, particularly in light of the highly likely scenario that Estonia will introduce the euro next year.
“In the future, every investor or producer, while choosing to invest his money…will be more familiar with an environment where the euro has already been introduced, where there will be no risks with different interest rates,” the central banker said.
In this light, Latvia’s potential recovery could be slowed by Estonia’s success. Also, there are the perennial political risks.
Local media continually speculate on the imminent fall of the current government. Friday’s edition of the Neatkarīgā Rīta Avīzes daily, for instance, cited a source in the People’s Party as saying that Dombrovskis had to go and the party was prepared to work with an outside, non-aligned prime minister.
But even if the government were to survive until the October elections, there was no guarantee that the next Cabinet would be able to put together a coherent budget for 2011 — without which there would be no assurance of IMF and EU bailout funds. And without that assurance, investors will simply avoid Latvia.
“Because of fears that prior to October 2010 next year’s budget won’t be prepared, and also because of uncertainty about the further budget consolidation, there will be speculation that the simplest and quickest solution won’t be cutting costs, but raising taxes,” said Rimševics. “This could have a profound effect on the further development of Latvia’s economy.”
Indeed, Latvia’s January stock market rally was the weakest of the three OMX Baltic exchanges and has already leveled off and begun to dissipate.
Unemployment remains major problem
Baiba Paševica, head of Latvia’s employment agency, told Latvian Television on Friday that the worse case scenario held that there would be some 250,000 jobless in the Baltic state. The optimistic scenario foresees 150,000 unemployed. The latest statistics show that at the end of December there were 179,000 unemployed, and analysts agree that the number will grow, although how rapidly no one can say.
Swedbank predicts that the average “job seekers’ rate” will reach its peak in mid-2010, or about 23 percent. From there it will “start to diminish gradually afterwards, first due to emigration and rising inactivity, and then due to slow job creation.”
According to Latvian data, unemployment is currently 16 percent, while EU data, which uses a different methodology, maintains that the jobless rate is 22.4 percent – the highest in the 27-member EU.