Latvia is back in the eye of the storm. A row between the Baltic state and its Nordic neighbors over the country's compliance with an international agreement to cut its spending has again raised fears of a lat devaluation. The Swedish krona tumbled Wednesday and Latvia failed to sell one of three bonds it was auctioning.
Nordic governments are threatening to withhold the latest tranche of a €7.5 billion ($11.03 billion) bailout package unless Latvia cuts spending by 500 million lats ($1.04 billion) in 2010. So far, Latvian Prime Minister Valdis Dombrovskis has only offered to cut LVL325 million.
Meanwhile, Mr. Dombrovskis has raised the stakes by threatening a new law limiting Latvian homeowners' mortgage liabilities to the value of their homes rather than the value of their loans. That has raised fears he is preparing the way for a devaluation. Most Latvian mortgages are denominated in foreign currency and house prices have fallen 70% from their peak, according to Danske Bank. Devaluation would saddle homeowners with soaring debts, but Mr. Dombrovskis's proposal would transfer much of the risk to Nordic banks that are the main lenders to the Latvian mortgage market.
This mortgage plan may simply be a bargaining chip in budget negotiations with the European Union, International Monetary Fund and Nordic governments. Mr. Dombrovskis softened his line on the budget Wednesday, saying more cuts could be found if it would avoid a worse outcome. Meanwhile, Latvia's central bank has criticized the government over both its stance on the budget and its mortgage plan, raising pressure on Mr. Dombrovskis to back down. Even so, the row reflects the growing public opposition to the scale of austerity measures needed to bring Latvia's finances into order. Real wages fell 5.3% in the first half of the year, according to Fitch.
The likelihood of a messy outcome has clearly risen. But the risk of contagion to other East European states has receded since the summer. Lithuania pushed ahead Wednesday with a $1.5 billion bond sale. The Swedish banks, too, have raised capital to prepare for losses on Baltic lending. What happens in Latvia may stay in Latvia.
Nordic governments are threatening to withhold the latest tranche of a €7.5 billion ($11.03 billion) bailout package unless Latvia cuts spending by 500 million lats ($1.04 billion) in 2010. So far, Latvian Prime Minister Valdis Dombrovskis has only offered to cut LVL325 million.
Meanwhile, Mr. Dombrovskis has raised the stakes by threatening a new law limiting Latvian homeowners' mortgage liabilities to the value of their homes rather than the value of their loans. That has raised fears he is preparing the way for a devaluation. Most Latvian mortgages are denominated in foreign currency and house prices have fallen 70% from their peak, according to Danske Bank. Devaluation would saddle homeowners with soaring debts, but Mr. Dombrovskis's proposal would transfer much of the risk to Nordic banks that are the main lenders to the Latvian mortgage market.
This mortgage plan may simply be a bargaining chip in budget negotiations with the European Union, International Monetary Fund and Nordic governments. Mr. Dombrovskis softened his line on the budget Wednesday, saying more cuts could be found if it would avoid a worse outcome. Meanwhile, Latvia's central bank has criticized the government over both its stance on the budget and its mortgage plan, raising pressure on Mr. Dombrovskis to back down. Even so, the row reflects the growing public opposition to the scale of austerity measures needed to bring Latvia's finances into order. Real wages fell 5.3% in the first half of the year, according to Fitch.
The likelihood of a messy outcome has clearly risen. But the risk of contagion to other East European states has receded since the summer. Lithuania pushed ahead Wednesday with a $1.5 billion bond sale. The Swedish banks, too, have raised capital to prepare for losses on Baltic lending. What happens in Latvia may stay in Latvia.
