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Thursday, May 28, 2009


baltic collapse repercussions

ed harrison passes on what may be an indication from danske bank (following on an earlier note) that the eastern european crisis is reaching a critical stage.

The event risk has risen sharply in the Baltic markets and we advise utmost caution. Yesterday, the Swedish central bank Riksbanken said it will increase its currency reserve by SEK 100 bn through a loan from the Swedish debt agency. Investors seem to believe that this is a buffer to deal with potential problems arising from the Baltic crisis.

edward hugh of fistful of euros:

The krona fell for a third day after the Riksbank announced the loan, and declined more than any of the 16 most-traded currencies against the dollar and the euro. Stefan Ingves, central bank governor, said in the statement that the financial crisis may be “prolonged”. Since the start of the financial crisis, Sweden has spent 100 billion kronor on swap agreements with Iceland, Estonia and Latvia and on dollar injections into Swedend’s financial system.

Swedish banks have claims in Latvia, Lithuania and Estonia amounting to about $75 billion, according to ING Groep NV, with SEB, Swedbank and Nordea accounting for 53 percent of Latvia’s lending market. Sweden’s central bank raised the amount of euros available for the Latvian central bank to swap for lats to 500 million euros ($670 million) at the start of May. Latvia’s central bank first entered the swap agreement with both its Swedish and Danish counterparts to borrow as much as 500 million euros for lats last December. The Riksbank was to provide 375 million euros and the Danish central bank the remainder.

Latvia has already spent over 500 million euros buying lats this year to support the currency.

the economist revisited east europe recently, noting the strident austerity budget now being put in place in the baltic states.

The biggest worry now is the Baltic three, which are seeing the sharpest falls in GDP. Estonia’s first-quarter figures showed a year-on-year decline of 15.6%. The fall in Latvia was a stunning 18% and in Lithuania 12.6%. Monetary policy cannot counteract this, since all three are pegged to the euro. And fiscal policy offers no respite. Politicians are pushing through spending cuts, not only to reassure external lenders, but also to meet the Maastricht deficit target of 3% of GDP so as to adopt the euro soon (by 2011, Estonia hopes).

“The crisis is even good if it makes the state more efficient,” says Andrus Ansip, the Estonian prime minister, who is cutting overall public spending by nearly 12%. He has slashed a fifth of the posts in his own chancellery, he says proudly. “Inefficient” spending will be cut; budgets vital for future growth will be preserved, he insists.

Devaluation is still largely taboo in the Baltics. The national currencies are not just economic symbols of solidity, but political ones too. Instead, they hope to regain competitiveness through wage cuts and greater efficiency. Such an “internal devaluation” is possible in theory, but it is unusual (and painful) in practice. It may work: Latvia now has a current-account surplus as its exports rise. Outsiders are awed by the Balts’ determination, though sceptical that the sacrifice will pay off.

with IMF-mandated regressive "efficient" fiscal policy only adding to the conflagration which is the paradox of thrift enjoined by the public, private and foreign sectors simultaneously, i will be amazed if the baltics can avoid a breakdown of civil order, giving up their euro pegs and abandoning the misconceived limitations of the maastricht treaty. claus vitesen thinks likewise.

... [I]nternational economics 101 tells us, the only way you can correct with a fixed exchange rate and an open external account is through deflation and a very sharp drainage of domestic capacity. And so it has come to pass that particularly in Latvia who has come under the receivership of the IMF the scew has been turned, (and turned and turned) and now the question is how much more can the public and the goverment take. In a recent article in the NYT the situation is well described as the Latvian government scrambles to meet ends on the IMF’s pre-condition to continue funding the bailout programme.

One very significant indication that things are near its breaking point came when Central Bank Governor Ilmars Rimsevics launched the idea that, since the liquidity in Lati is being drained in order to keep the peg and because the cuts needed to abide by the IMF rules are immense, public employees might be submitted to receive their pay in “vouchers” in stead of actual Lati. As Edward points out, this is straight out of the vaults of the Argentian crisis’ annals. This is one of the things you get with a peg maintained too tightly during a deflationary crisis. It deprives you from liquidity. Now, in some sense this all about the next installment of IMF funds of course and whether Latvia will (can) make the needed budget cuts to please the fund to such an extent that they will continue to slip the bailout checks in the mail.

and while depegging might be what they have to do, the result will be a dagger struck at the heart of already-deeply-wounded european banking.

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