The following blog entry has been republished here courtesy of Failed State Latvia?.

I have not been following the seemingly shambolic (tax this, no, tax that, no, tax nothing, axe nearly everything) development of the 2010 Latvian budget in great detail.

But it now seems that the main problem with the international lenders (the European Union/EU, the International Monetary Fund/IMF, the Nordic countries, etc.) is that there appears to be no common definition of benchmarks.

There is the absolute number of LVL 500 million (that’s more than USD 1 billion for those who want it in “real money”) and the other figure of an 8.5 % budget deficit as a proportion of Latvia’s GDP.

One is a fixed figure, the other is changeable (not in nominal terms, but in the underlying factors). LVL 500 million is 500 million. 8.5 % is 8.5 % of a figure that has already fallen by 18 % and will probably fall again in 2010.

What was USD 8.50 out of a hundred dollar bill isn’t USD 8.50 out of USD 82 or maybe USD 70 further down the line.
So what is the crucial figure? In terms of keeping government borrowing down as a percentage of total GDP, it is the percentage that counts and all (most?) of the other figures adjust accordingly.

This is one way that you can interpret the Latvian government’s proposal to cut the budget in absolute figures by only LVL 225 million, or maybe LVL 275 million, or maybe LVL 335 million. Which is it? But forget that, the important thing is that one of the “whiches” is an amount that brings the budget deficit close to 8.5 % and, in a sum of spending cuts and revenue increases, actually adds up to, or has the same effect as 500 million. Got it?

Swedish finance minister Anders Borg didn’t, nor perhaps did the EU. Borg was speaking on behalf of the EU when he chided Latvia for not cutting LVL 500 million straight up from state expenditures, punkt, slut! as the Swedes would say.

But maybe the EU really didn’t mean 500 million, whatever it takes, but rather, whatever gets Latvia to 8.5 % without effectively stopping the core functions of the state, including education, pensions and health care.

A long IMF country report dated August 7 but made public only a few days ago in early October doesn’t paint a very hopeful picture of Latvia’s ability to live up to the IMF’s conditions.

It uses words like “daunting”, “challenging”, etc., seeming to say between the lines that Latvia lacks the political will and administrative capacity to get its act together.

It also hints that the country might have been better off devaluing the LVL early on, as the unbendingly strong lat is named as one of the “challenges” in several parts of the report.

Anyway, to devalue at this point would merely worsen the effects of a very harsh internal devaluation (wage cuts of 30 % and more) and replace falling prices with import price inflation.

If the LVL is floated, there is talk that it would be very volatile and fall between 30 and 50 %, maybe to recover close to its current theoretical but unused band of plus or minus 15% of the “fixed” rate against the euro.

With some non-Swedish foreign papers interpreting the story of Borg’s alleged confidential talks with Swedish banks as “warning of Latvia’s collapse”, it is a wonder that there has not been any pressure on the LVL as yet (Oct 7).

The Swedish Finance Minister is in the challenging position of having to speak for the EU (it is the Sweden presiding) when the EU position (500 million or 8.5 %) is a bit ambiguous, and of avoiding a situation where Latvia actually cracks and hundreds of billions of SEK (as loans by Swedish bank subsidiaries in EUR) are put at great risk or lost.

As the rather harsh dialogue between Latvia and “the Borg” (not the Star Trek hive mind, but the Swedish FM with his dual role) continues, it is obvious that the basic problem is a failure to formulate the issue, which Latvia has tried to belatedly do, arguing that it is meeting the 8.5% target and should not be beaten with the 500 million cudgel.

But it may be too late, and Latvia has created an almost irrevocable image of being an unreliable, vacillating and politically disorganized partner for its international lenders.

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