Latvian Prime Minister Valdis Dombrovskis said the country faces “bad and really bad scenarios” now that its creditors are insisting on the 500 million lats (€700 million) budget cut. Photo by Aivis Freidenfelds, State Chancellery.

RIGA — Latvian Prime Minister Valdis Dombrovskis has asked the finance ministry to prepare an alternate budget plan in case talks with international creditors break down and Latvia is forced to go it alone during its worst recession on record.

Dombrovskis told Latvian Radio on Wednesday that Latvia will have to choose between “bad and really bad scenarios” now that international lenders such as the European Union and the International Monetary Fund have insisted that the government cut next year’s budget deficit by 500 million lats (€700 million). Even though it pledged to make these cuts last summer, Latvia’s government has only managed to squeeze 325 million lats (€458 million) from the 2010 deficit.

Dombrovskis explained that the bad scenario would be to make the additional cuts and tax increases worth 175 million lats (€246 million), which would deepen the recession, while the really bad scenario would be to ignore lenders’ demands and risk losing the bailout loan. Latvia recently received payments from the EU, IMF and the World Bank, but this money will peter out sometime early next year.

This latter scenario would force Latvia to balance the budget starting next year while stigmatizing the country in the eyes of Europe.

In recent days officials from the IMF, EU and Sweden have warned Latvia of the consequences should it fail to fulfill its pledge to consolidate the budget by 500 million. On Tuesday the EU’s financial chief, Joaquín Almunia, said there would be no compromise on the matter.

Dombrovskis, however, said the 500 million shouldn’t be a “goal in and of itself” and that reviving Latvia’s economy should be the priority for all sides involved in negotiations. He has argued that even with the deficit reduction of 325 million lats Latvia can still make the 8.5 percent deficit, another target defined in the agreement with creditors.

“It’s a good question why we should do this if there’s a possibility to adhere to the budget deficit parameters,” Dombrovskis said.

Still, he doesn’t rule out more budget cuts. “The deadline for submitting the budget to Parliament is Oct. 28,” he said, adding that this date might be postponed so that the government could make additional amendments.

Preparing for devaluation?

Meanwhile, it would appear Latvia is preparing for the worst. In addition to asking for a plan ‘B’ from the Finance Minister, Dombrovskis has ordered the government’s legal experts to draft legislation that would protect Latvian homeowners from default on their mortgages.

According to a government press release, the amendments would prevent banks from evicting homeowners from their only home and restrict banks from collecting more than the amount of the collateral on a defaulted mortgage.

Thus if someone signed onto a €150,000 mortgage, bought a second apartment, and then defaulted, the banks can only confiscate and sell the flat. If the bank can only sell the apartment for, say, €90,000, under Dombrovskis’ initiative it will not have the right to wrestle the remaining €60,000 from the debtor.

Banks are livid at the idea, and warn that it will all but shut down lending at a time when Latvia desperately needs every source of finance.

Experts say that the measure could be a preparation for a currency devaluation, since by protecting homeowners — who have the most to lose from a devaluation — the government removes the biggest obstacle.