Latvia has cut spending so much that even the International Monetary Fund says it’s gone too far. Now the Baltic nation has paid off its 2008 bailout loan before any other nation, depriving the lender of any say-so over its policies.
A drop in the guaranteed minimum income, which aids the country’s poorest, took effect Jan. 1, two weeks after Latvia paid off the IMF’s chunk of a $9.9 billion rescue loan. The fund, better known for making deficit-cutting a condition of its lending, says the changes risk denting the social safety net.
Latvia’s recovery from a slump that erased almost a fifth of economic output has split world opinion. Nobel prize-winning economist Paul Krugman has criticized its austerity measures even as European leaders call them an example for the continent. While backing fiscal rigor, IMF opposition to the nature of some of the cuts has often put it at odds with the government.
“Now that the IMF monitoring has gone, the government has got its way,” Alf Vanags, director of the Baltic International Center for Economic Policy Studies in Riga, said by phone. “The IMF has upheld this issue and argued against the policies that basically go against poor people and unemployed people, in a way quite surprisingly, because that’s not their reputation.”
The cuts in social spending risk widening the European Union’s worst inequality, stoking the fastest emigration in a decade and denting economic growth that’s forecast at 5 percent in 2012, the IMF has said.
The government’s benefit-reduction policies, in addition to shrinking a public-works program, are designed to push Latvians into employment, according to Finance Minister Andris Vilks, who favors bigger payouts to those who are genuinely in need.
“There’s an increasing number of people who really don’t want to work,” he said in an interview in Riga, the capital. Some municipalities are reporting “people coming with very good cars and saying they are very poor, please give me money.”
The government’s IMF rescue was needed in the wake of Lehman Brothers Holdings Inc.’s 2008 demise as gross domestic product plunged more than in any other nation in the 27-member EU the following year.
Even with the impact of the cuts, the economy is predicted to have grown at the fastest pace in the bloc last year. Latvia’s budget deficit is set to narrow to 1.4 percent of GDP in 2013 from about 9.8 percent in 2009.
Bond investors have rewarded the government policies that brought public finances back under control and maintained the path toward planned 2014 euro adoption. The yield on state debt due 2018 plummeted to a record-low 1.7 percent Dec. 17 from a high of 12 percent on March 18, 2009. The bond trades at 108.5 basis points higher than its German equivalent.
Latvia on Dec. 5 sold its biggest bond since returning to the market after recession, raising $1.25 billion that will be used to repay the IMF in full almost three years ahead of schedule.
Standard & Poor’s and Fitch Ratings raised the country’s credit ratings to the second-lowest investment grade in November. Moody’s Investors Service, which rates it one level lower, said repaying the IMF early is “credit positive.”
Latvia’s benchmark OMX Riga equity index has risen 6.8 percent over the past 12 months, compared with a 13.8 percent advance for the Stoxx Europe 600 Index.
Some Latvians remain optimistic. About 35 percent of respondents said this year will be better than 2012, the highest figure in six years, according to a survey of 1,003 people by pollster SKDS published last month. It had a margin of error of three percentage points.
While the IMF welcomed the early loan repayment, it has repeatedly rebuked the government for policies including a drop in the threshold above which salaries are liable for income tax and a reduction in the guaranteed minimum income.
“Our position was that the government should continue co-financing the minimum benefit, at least until mid-next year,” Silvija Simfa, a health and social adviser to the Latvian Association of Local and Regional Governments, said by phone. “We can’t consider the crisis ended because social indicators haven’t reached pre-crisis levels.”
Inequality in Latvia is already the highest in the EU, ahead of Bulgaria and neighboring Lithuania, according to Eurostat. About 110,000 people have emigrated since 2009 on a net basis as unemployment tripled, according to data compiled by Mihails Hazans, a labor economist at the University of Latvia.
About 31 percent of Latvians were classified as severely materially deprived in 2011, the EU’s second-highest level behind Bulgaria, compared with about 19 percent in 2008, according to Eurostat.
“Inequality is obviously undesirable in its own right,” Shekhar Aiyar, the IMF’s mission chief to Latvia, said in a phone interview. “But it also appears, especially for middle-income countries, that there’s a relationship between inequality and growth. In particular, societies that are more unequal tend to grow more slowly over the medium-to-long term.”
GDP will advance 3.7 percent in 2013, the Finance Ministry forecasts. While unemployment has receded from a 2010 peak of 20.5 percent, at 13.5 percent it remains above the EU average and is more than double the pre-crisis level of 6.5 percent.
EU President Herman Van Rompuy has called Latvia’s recovery an “inspiration” for other European nations. Krugman wrote on his blog in in October that with GDP still 15 percent below the pre-crisis peak, the rebound “isn’t cause to break out the champagne.”
The World Bank is publishing a report on overhauling benefits in February. Latvia ignored IMF advice to wait for its findings before embarking on its own revamp.
“No policy maker wants some referee coming in and saying ‘you just did it wrong,’” Lars Christensen, an analyst at Danske Bank A/S in Copenhagen, said by phone.