A decisive week for Latvia

 

`Let´s hope for the miracle save´

That was the response from a high-level official at the Swedish Central Bank in December 2008 when former IMF senior economist Torbjörn Becker questioned the policy towards Latvia. The comment was made public last week, when the Supreme Administrative Court gave me access to some of the official Swedish documents regarding Latvia´s economy.

Not as friendly as it seems. Swedish Prime Minister Fredrik Reinfeldt and Latvian Prime Minister Valdis Dombrovkis. Photo: Gunnar Seijbold/Swedish Government Offices

Not as friendly as it seems. Swedish Prime Minister Fredrik Reinfeldt and Latvian Prime Minister Valdis Dombrovkis. Photo: Gunnar Seijbold/Swedish Government Offices

Torbjörn Becker, Director of the Stockholm Institute of Transition Economics, had sent an e-mail first to Christoph Rosenberg at the IMF, then to the Swedish Central Bank (Riksbanken). In his e-mail, Becker criticized the painful defense of Latvia´s fixed exchange rate with argument he and others have later used in the public debate (although with somewhat more diplomatic language):

`It seems that (the IMF statement on Latvia) mostly is a way of defending the honour of their politicians and central bank, as well as protecting the Swedish banks, when nothing is done about the currency in a situation when every normal person understands that an overvalued currency does not help the necessary adjustment of the current account balance. Now they will instead get a meltdown of the real economy, if there is not a miracle save of the world economy´ (my translation).

No one seems to have listened. The laconical response was: `Let´s hope for the miracle save´.

Swedish Finance Minister Anders Borg had already decided to support the Latvian government´s efforts to preserve the exchange rate of the currency, lats. According to several sources, one reason was the heavy losses Swedish banks would suffer if there was a devaluation in Latvia (although Anders Borg denies this).

The rescue package put together almost a year ago is now close to failure. Developments next week will be crucial.

Tomorrow, the Latvian government is supposed to agree further reinforcements of the budget with 175 million lats. At the latest ECOFIN meeting, Anders Borg threatened Latvia with serious consequences unless the budget target was achieved. After some friction between the Latvian and Swedish government, the aim is now to have a budget decision ready when EU Commissioner Joaquín Almunia visits Riga on Tuesday.

Whether all parties in government can agree to further budget cuts and a property tax remains to be seen. Drastic reductions of social welfare and public salaries are already taking a heavy toll. Latvian Prime Minister Valdis Dombrovskis is right in saying that further budget cuts would hurt the economic recovery and increase social unrest.

Still, Latvia will be forced to close even more schools and hospitals, because of the rigid policy of the EU and the IMF.

I have written extensively earlier about Sweden and the crisis in Latvia, and many others (including the Financial Times) have criticized the approach by international lenders.

The question now is whether the Swedish EU Presidency will continue along a path that could led to economic collapse in Latvia and dangerous political instability in a strategic part of the European Union.

Do all EU governments believe in miracles or is there still some strategic thinking left?

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