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Euro Area Must Take Austerity Pain Now, Dombrovskis Says

Europe’s most indebted nations shouldn’t use their recessions as an excuse to avoid committing to austerity plans if the region is ever to emerge from its debt crisis, Latvian Prime Minister Valdis Dombrovskis said.

“It’s important to do the adjustment, if you see that adjustment is needed, to do it quickly, to frontload it and do the bulk already during the crisis,” Dombrovskis said yesterday in an interview in Stockholm.

Latvia’s economy contracted 18 percent in 2009, more than any other nation in the European Union, after Dombrovskis’ government hung on to power to push through austerity measures mandated by an International Monetary Fund-led bailout. Yet the program proved successful and the Baltic country’s economy rebounded in 2010 to achieve growth in excess of 5 percent last year. Latvia’s budget deficit will narrow to 3.3 percent of the economy this year, from 9.7 percent in 2009, the European Commission estimates.

Deficit reduction goals inside the euro region suffered a setback this week as May 6 elections in France and Greece saw voters embrace anti-austerity candidates. In Greece, the weekend’s election outcome raised speculation Europe’s most indebted nation may exit the currency bloc as anti-bailout parties stole the agenda. In France, Francois Hollande told voters “austerity isn’t inevitable” after he defeated Nicolas Sarkozy to become the first Socialist to win the presidency in 17 years.

‘Never Popular’

“Certainly austerity is never a very popular subject and in this case the question is, are there really alternatives,” Dombrovskis said. “Of course, a country can say we don’t like austerity, but then the question they should ask first is who is going to finance the budget deficits, financial markets aren’t in the mood to finance large deficits right now.”

The debate as to whether governments should prioritize austerity over economic growth as Europe struggles to emerge from its crisis is splitting the region. German Chancellor Angela Merkel yesterday rejected “huge” stimulus programs in her first response to Hollande’s election victory.

“The core of the discussion is whether we again need debt-financed economic programs, or whether we need growth elements that are sustainable and oriented toward the economic strength of certain countries,” Merkel told reporters in Berlin yesterday.

Contracting Economies

The euro region will contract 0.3 percent this year, the European Commission said in February. Greece’s economy will shrink 4.4 percent after contracting 6.8 percent in 2011, it said. At the same time, average debt in the currency bloc will swell to 90.4 percent of gross domestic product, well above the European Union’s 60 percent threshold. Latvia’s debt will reach 45 percent, the commission estimates.

Greece’s New Democracy leader, Antonis Samaras, yesterday said he failed to form a government after the weekend’s election rewarded politicians with anti-bailout agendas. The attempt to forge a government will now pass to Alexis Tsipras, the head of Syriza, the second biggest party, which has vowed to cancel the republic's bailout terms.

Countries that have tried to postpone savings and relied on deficits to finance spending will send their economies into even deeper recessions, Dombrovskis said.

“If the EU is to provide assistance to Greece and other countries they certainly would like to see credible and quick paths to how those countries will restore sustainable finances,” he said. “Nobody is willing to put money in some bottomless place.”

Investment Grade

Latvia’s economy contracted about 25 percent in total in 2008 and 2009, then the deepest recession in the world, after a lending-fueled real-estate boom turned to bust and international credit markets froze. The economy is growing at a “good pace” again and expanded 5.7 percent in the fourth quarter, Dombrovskis said.

Growth in the first quarter will be on the same level, he said, adding he expects expansion this year to “substantially” exceed the government’s official forecast for 2 percent.

Standard & Poor’s on May 2 raised Latvia’s credit rating to BBB-, restoring its investment grade for the first time since 2009. Five-year credit-default swaps on Latvian debt eased to 245 basis points this week from 365 at the end of last year. The country’s default swaps peaked at 1,193 basis points in March 2009.

“If we compare with the financial markets assessment it seems we are still substantially underrated so we would expect further credit rating increases this year,” Dombrovskis said.

The Baltic country in February sold $1 billion of five-year bonds, at a yield of 5.375 percent, according to data compiled by Bloomberg. The international sale was the first by Latvia since it raised $500 million from a 10-year bond in June last year. The country has covered its financing need this year, he said.

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