* Time to let go
Having said that, so far I have underestimated the reaction time of the Latvian authorities. However, this is a macroeconomic nobrainer. It is so obvious that even the Swedish banks, having successfully managed to lobby the Swedish financeminister Mr Anders Borg into pushing for a non float in conjunction with the Latvian IMF deal, might now realise that there will be more value to be had from a quick devaluation rather than from a slow and painful kryptonite deflation meltdown. Which might sound counterintuitive at a first glance.
Unfortunately, I have very low expectations of any bank management flipping towards a pro devaluation stance, simply because that would mean them loosing their jobs. This too, will happen anyway. With this in mind, "they" are most likely willing to continue this very efficient capital destruction together with the Latvian politicians. Besides, I am also doubtful whether they will grasp the crystal clear macro aspect of it, sorry.
*Consequenses of continuing on the fixed currency regime path
To put it very plain and simple;
No float = houses with no inhabitants. No jobs domestically means moving abroad. Further lowering the asset value for the bank. Expect this to increase the NPL;s and thus, the creditlosses. The Latvian agricultural sector development pretty much sets the pattern for the manufacturing and service industry as a whole; The domestic agricultural market has already almost ceased to exist for domestic farmers. Foreign produce is simply so much chaper that the population at large buys imported produce. This pattern will be similar across the board. No business, no employment.
I expect the currentaccount gap to remain widely negative. This also limits the longevity of the fixed currency regime sharply since Latvia will be extremely dependent on foreign financing in the form of straight forward loans. At the moment, the only source to foreign loan financing is the IMF, the EIB, the World bank and any other bilateral agreement potentially available. Read; Sweden.
The marketplace is essentially closed for refinancing. With the massive upcoming financing needs for countries globally due to mainly but not only, banks bad assets and the nonmark to market approach of those assets on the balance sheets, the organisations mentioned above will come under heavy pressure to be able to get financing available from sponsor countries (biggest contributor; the USA).
Thus, such a situation will call for prioritisation and "efficient" use of capital. In that context, financing a country´s current account deficit in order for it to keep a "doomed" fixed currency regime is as much a waste of capital as it gets. Besides, the ECB will not let them into the Euro anyway, and if they did, then what? A non float will risk social upheaval and chaos.
Just drop it.
*Consequences of floating the currency
The float; Quick and sharp contraction due to massive loanlosses from households and businesses. A sharply weaker currency. However, the inflationthreat should be subdued if any other countries with sharply lowered currencies are anything to go by in this deflationary environment.
Reconstruction and a restart with a chance to export again. People will actually be able to have jobs, thus being able to pay something to the banks. Businesses will actually be able to have some kind of business activity, being able to pay something to the banks. This is all better than the much lower outcomes under a fixed currency regime scenario.
The main advantage is, however that the future prospects will be so much better for the country compared to the "fixed exchange" route. Another massive advantage, will be that any debt that Latvia takes on will have a prospect of getting repaid as well as avoiding throwing borrowed money straight into the current account gap for very little or no value whatsoever. Increasing the debt burden and burning up the money borrowed - in a deflationary environment,,,,, is a quick way of sinking a country. Stop that process.
Just drop it.
I am long Eur/Lvl.
To sum it up;
At present there does not seem to be a workable gameplan in place. There are definitely constructive solutions to be had. In my book, none of them involve a continuation of the fixed currency regime. All of them involve a float or a devaluation of some sort, preferrably combined with external financing in order to tackle the initial blow, restructure and move on forward. From there the Baltic countries could yet again continue their development forward. Perhaps I am missing something here but in that case I am yet to discover it.
* What about the SEK?
The SEK is currently very much undervalued from a fundamental perspective. However, this is of little assistance in determining the price in the shortterm.
The Swedish Riksbank is currently using the SEK for quantitative easing purposes, ie talking down the currency. On top of that, the market is using the SEK as a Baltic proxy. Further, the Swedish banks have likely continued refinancing and capital injection needs for their Baltic subsidiaries given the deteriorating Baltic situation. Until the Baltic states float their currencies I expect the SEK to remain fundamentally weak. Once that has happened, the SEK should be able to regain some ground.
I am long Eur/Sek, targeting 11.60.
* NOK - time to reevaluate?
NOK must be one of the few currencies out there that could be regarded as a "safe haven" in this environment. The reason being their pension fund and ongoing stimulus packages. Any fiscalstimulus activities not being covered by regular inflow to the pensionfund will becovered by sales of foreign assets in the pensionfund, leading to NOK purchases by the state. I am long Nok/Sek, targeting 1.30.
As always, good luck
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