How Latvia Avoided Meltdown

In June, as the government struggled to pass a supplementary budget to rein in the deficit and the country's currency came under sustained pressure, Latvia seemed to be hanging by its fingernails over a bottomless economic abyss. You could almost hear the voiceovers: "Oh, no! This looks like the end!!!"

Three months later Latvia's perilous journey through Crisis Ravine is still far from over, yet the extreme suspense of early summer has given way to a nervous sense of uncertainty. No longer dangling over a precipice, the country is walking along its edge. Moving forward, but wary that the ground may give way under its feet.

Some elements of stability have started to appear in the economic situation. At the beginning of July, after the Latvian parliament passed the necessary budget cuts, the European Commission approved the second tranche of its aid program. These 1.2 billion euros give the government a significant budgetary cushion and have stopped speculation in the financial markets that Latvia is on the verge of devaluing the lat.

At the beginning of September the board of the International Monetary Fund approved changes in its agreement with Latvia, significantly relaxing the limits put on the budget deficit for 2009. While the December agreement with the IMF had permitted a maximum budget deficit of 5 percent of gross domestic product, the new deal lets Latvia run a deficit of up to 13 percent. (The agreement with the EU caps the deficit at 10 percent, but the difference is due to different methods of calculating the shortfall.)

There are also some encouraging "green shoots" in the economy. After a sharp fall at the end of 2008, exports have started to recover. Surprisingly, the transit trade has held up remarkably well, with Latvian ports handling roughly the same amount of cargo as a year ago. As a result, the current account balance, the broadest measure of a country's income from international trade, has been consistently positive since the beginning of the year and climbing fast, from a 4 million lat (5.7 million euro) surplus in January to a 259 million lat (369 million euro) surplus in June.

Considering that this crucial macroeconomic indicator had been in the red since the middle of the 1990s and that only two years ago, in July 2007, the current account balance fell to a record deficit of 385 million lats, the turnaround has been astounding.

In June Latvia also recorded its first monthly trade surplus in goods and services in more than 15 years. The country finally seems to be reaching the point where it can finance its imports with the money it earns from its exports rather than from the money it borrows from foreign banks.

Of course, these numbers are largely the result of the collapse in imports following the onset of the recession, which looks to bring Latvian GDP down by around 18 percent this year. The number of people without work has been rising steadily and according to Eurostat Latvia now has the second highest unemployment rate in the European Union, after Spain. A recent survey indicated that close to 70 percent of companies have cut wages this year. And the pain is far from over. Most observers believe that the economy will only start growing again some time next year. In the meantime the government has to put together a budget for 2010 that, in accordance with the revised agreement with the European Union, must contain an additional 500 million lats, or about 4 percent of GDP, in budget cuts.


That is not going to be easy. Parliamentary elections are coming up in October 2010. The People's Party, the largest party in the ruling coalition, is already sending signals that it may be preparing to leave the government in order to distance itself from the politically unpopular decisions coming in November when parliament will have to vote on next year's budget.

At present it seems that even if the People's Party decides to go into opposition, the government of Prime Minister Valdis Dombrovskis will still be able to get enough votes to pass a budget in line with its commitments to the EU and the IMF. Nevertheless, the closer the parliamentary vote, the more people will be biting their nails, because all the elements are in place for a nerve-wracking autumn.

History gives us some perspective. Getting through by the skin of their teeth is an old Latvian tradition, dating back to the War of Independence in 1919. It has been updated lately by the country's Houdini-like escape from the clutches of the USSR in 1991, its ability to not only survive the implosion of the economy at the beginning of the 1990s (much tougher than what is happening today) but also to defy the naysayers and join the European Union and NATO in 2004. Of course, that is no guarantee of success in the future, but it does give the country a track record of beating the odds (while raising everybody's blood pressure in the process).

So as the budget discussion heats up, there are sure to be new hair-raising twists and stomach-churning turns in the plot. People's Party jumps off the ship of state! Budget proposal tied to the tracks as a train full of opposition politicians hurtles toward it at full speed!!! Could this be the end?!