RIGA - An ongoing discussion on the strength of Latvia's currency has created political turmoil and become something of a national obsession, with speculation over an imminent devaluation putting the government and the Central Bank on the defensive.
The rumors started after an editorial by Morten Hansen, an economics lecturer at the Stockholm School of Economics, appeared in the Diena daily (the article repeats many of the arguments Hansen made in an earlier article printed in The Baltic Times, #541 's ed.) on Feb. 12.
Hansen argued that Latvia's malign spiral of high inflation and soaring wages is depriving the economy of the ability to compete and that down the road leaders may have to consider devaluing the lat to give exporters a boost.
"A devaluation of the lat may still be a distant prospect 's and it may certainly not happen 's but policy makers should be nervous by the simple fact that discussion of a possible devaluation has re-emerged," Hansen wrote in The Baltic Times.
Once reprinted in Diena, Latvia's largest daily, the article resonated like an incendiary bomb. Immediately Latvians, many of whom have bitter memories of the 1995 banking crisis, fear a financial crisis, and some even turned to the government through e-mails and SMSs to learn what would become of the lat.
The offices of both Prime Minister Aigars Kalvitis and Central Bank Chairman Ilmars Rimsevics have reportedly been inundated by questions from ordinary Latvians across the country who are distraught by rumors that the lat may be devalued.
Kalvitis dismissed the rumors, claiming they were spread deliberately by speculators out to make "easy money." Rimsevics, for his part, said the lat was stable, and he pointed out the bank had sufficient reserves to maintain the lat's strength.
According to one report, the government has turned to the Constitutional Protection Bureau asking for a probe into persons undermining the Latvian economy.
Consumers' fears are understandable. Thousands of Latvians have borrowed in euros and dollars, but since nearly all receive wages in lats, a devaluation means they would have to work more hours to pay back their loans.
The fallout of a devaluation would indeed be great, which is why governments often (to their great misfortune) choose to defend the currency to the last.
Still, inflation in Latvia is alarmingly high 's 7.1 percent as of end-January 's and unlikely to recede this year. The gap between rising wages and productivity increased significantly last year, which essentially means Latvian firms will have to charge more for the same product in order to keep a steady rate of returns. The result: a sharp drop in the Baltic state's competitiveness.
In the meantime, consumers are spending like mad and banks are all too willing to lend money. So Latvia now boasts the largest current account deficit in Europe 's 24.2 percent of GDP in the third quarter 2006.
Importantly, the government, which has limited leverage at its disposal, seems unwilling to address these inherent contradictions. Ministers are riding the high horse of the EU's fastest growing economy 's 11.9 percent in the fourth quarter 's and seem to think the rough edges will correct themselves. (See editorial on page 15.)
And from here arises the significance of Hansen's hypothesis.
"The growth in wages and prices is really excessive," Hansen told The Baltic Times, "and the economy is incapable of maintaining that growth." He stressed that there was "not much willingness to change the situation" in government circles.
As far as reaction to his article, Hansen said it was "over the top."
"I never imagined that it would have created such panic," he said. But he defended the article. "I'm an economist, and I pointed to some things that could happen in the not-too-distant future."
The devaluation theory, the economist stressed, is not new, and if Latvian media and government officials had taken the time to read what is being written about the economy in international publications and financial institutions, they could have spared themselves a lot of grief now.
