Finance & Business World

Latvia’s Cabinet will seek to persuade European Union Monetary Affairs Commissioner Joaquin Almunia it can adhere to the fiscal terms of its bailout after lenders criticized the government for dragging its feet.

Almunia met with Prime Minister Valdis Dombrovskis at 9:30 a.m. in the capital Riga, a day after the ruling coalition said it will try to find 320 million lati ($668 million) in spending cuts and 180 million lati in tax increases in a bid to meet the demands the International Monetary Fund, the EU and Sweden attached to a 7.5 billion-euro ($11.1 billion) loan.

Yesterday’s Cabinet talks followed criticism from lenders that the Baltic state hasn’t shown enough commitment to its loan terms, which call for budget cuts of 500 million lati a year until 2012. Latvia tried to persuade donors to sign off on 325 million lati in budget cuts, prompting Swedish Premier Fredrik Reinfeldt to tell Latvia it “must correct” its deficit. The EU has called for better coordination in the country’s talks.

“Since the start of the crisis last year, communication about Latvia has often unsettled the markets,” said Kenneth Orchard, a senior analyst at Moody’s Investors Service in London. “There has been a constant effort by the European Commission and the IMF to coordinate communication. It’s going to be an ongoing saga at least until after” general elections a year from now.

Euro Peg

Latvia, which like neighboring Lithuania and Estonia pegs its currency to the euro as part of the exchange-rate mechanism 2, is suffering the EU’s second-deepest recession behind Lithuania after a lending boom spurred a property bubble that burst when the credit crisis descended on the region.

“As long as the economy remains weak, I can’t see this getting any easier,” Orchard said.

Gross domestic product contracted 18.7 percent in the second quarter, compared with a 20.2 percent slump in Lithuania and a 16.1 percent decline in Estonia.

Riga’s OMX Index was little changed at 313.09 today at 2:18 p.m. Riga time. The yield on Latvia’s 5.5 percent government bond due March 2018 rose 6 basis points today to 7.299 percent. The lats was little changed at 0.7095 per euro.

Almunia said that now is a “critical moment” in Latvia’s program since there are some signs of economic stabilization, according to a press release from the Latvian Commercial Bank Association which met with him today. Almunia said it is necessary for Latvia to be timely in adopting its 2010 budget, according to the press release. Almunia will hold a press conference today at 3:30 p.m. Riga time.

Drag On

Coalition talks may drag on even after Almunia’s visit quick pay day loan. The country’s biggest coalition party, the People’s Party, has said it may not support the Finance Ministry’s proposed cuts.

“Almunia is not the god, the lord,” Vents Krauklis, the party’s deputy faction leader said, according to the Leta newswire. The party last night said its chairman, Mareks Seglins will step down on Nov. 21, and may be replaced by Andris Skele, a three-time former premier. Skele said the party should support Dombrovskis’ government as long as it has the confidence of the president and the Parliament, according to the statement.

Danske Bank A/S said Skele’s previous support for a lats devaluation “could unnerve markets yet again,” in a client note today. Skele in August suggested widening the trading corridor of the lats band. He also called for a budget deficit of 3 percent of gross domestic product in 2010, and to quickly sell Parex Banka, the lender the state took over in November.

Hurting Sweden

Dombrovskis and Finance Minister Einars Repse are members of the New Era Party. Repse is due to present the proposed budget to Parliament on Oct. 23. Lawmakers will vote on the budget a month later.

The region’s economic decline is hurting Swedish lenders with Stockholm-based Swedbank AB and SEB AB the biggest banks in the Baltics. Dombrovskis has tried to contain the domestic fallout of the stipulated austerity measures, also needed to maintain the euro peg, and last week proposed capping mortgage holders’ liability.

That led to speculation, which the government has sought to quell, that the country may be preparing the ground for a lats devaluation by limiting the domestic losses such a move would incur.

Sweden’s krona slipped as much as 0.6 percent against the euro today to trade at 10.3633 at 1:20 p.m. in Stockholm. Swedbank lost 2.3 percent to 64.75 kronor and was down 0.2 percent at 46 kronor.

Austerity Measures

Even as austerity measures exacerbate the nation’s recession, Latvia has no choice but to push through the IMF and EU-ordered budget cuts or risk spiraling debt levels that would undermine its chances of adopting the euro, Orchard said.

“If they start slipping, then the debt-to-GDP ratio could go to 80 percent or 90 percent and that may not be sustainable,” Orchard said.

The country targets euro adoption, which requires member states to have budget deficits no wider than 3 percent of GDP and debt levels within 60 percent of GDP, in 2014. The government estimates that the country’s budget shortfall next year will be equivalent to 8.5 percent of GDP.

Source