Latvia; Starving themselves to recovery - wheres the upside?

* Ever tried starving yourselves to better health? I wouldn´t recommend it.

Still, that is what the Latvian government in essence wants their population to do. While I can appreciate the Latvian government standing their ground, as an expression of determination, I dont really see the logical analysis behind as to why.

There used to be an "exitplan"; joining the Euro in a couple of years. Well, that is all fine, but then what? Live happily ever after on EU subsidies? Counting on global happy days? Counting on improved competitiveness alá extreme?

Clearly Latvia is not ready for the Euro, and by now, the likelyhood of them meeting the Maastricht criteria is extremely unlikely (but not impossible). The exitplan is very unlikely/gone.

In practise, Latvia is already in default. IMF and the EU is the heart-lung machine currently preventing it. Latvia is applying the right strategy at the wrong time. This should have been done during the good days. Not now.



* How long will the current government last?

The Latvian government has declared an agreement with their coalitionpartners and opposition that they will cut the statebudget by 500 mio Lvl per year for the next three years.

This will then have to pass the parliament, the Saema and sold to the population. The snag is that a big chunk of the cuts will hit social spending. I doubt this will be well received by a population already under pressure. With deflation running at full speed, it should not be long before the soon to be extinct private sector layoffs leads to social unrest and the fall of the current government.

Then the game will finally be up. Unfortunately, the Latvian population will then be more debt burdened (due to the IMF loans) and with potentially nothing left of the loan. Spend on defending the present FX regime and then forced to devalue. Now, thats silly. Why not take an even bigger IMF loan, float the currency and use the means to soften the blow?

That scenario would at least provide the Latvian economy with an impetus to become dynamic again, attracting investments, providing new jobs, lower the unemployment rate, generate higher GDP, etc in the process.


* Downward spiral
Latvia is currently continuing in their downward spiral of lower growth, lower taxrevenues, higher unemployment, higher social costs, etc ,etc. The responsibility now lies heavily with the current primeminister and his government.


* The IMF and the EU

My impression is that the IMF wants to see a devaluation but the EU does not. The EU seems to have a bigger say than the IMF in this case. No devaluation. I do wonder, apart from an extreme unwillingness to deleverage, whats the plan and analysis at the EU camp?

Whats the EU exitplan?
Scrapping the Maastricht criteria? Fingers crossed for a swift turn upwards in the economic cycle? What about the fact that the GDP drop could accelerate downwards swiftly in Latvias downward spiral? When does the budgetsaving demands stop? What about unemployment? Does the EU have any plan at all with this apart from avoiding contagion? Is the EU ready to sacrifice the Latvian people over it? I guess the answer is yes.
Shame on the EU then.



* The current Latvian FX regime is over.

Even if there is no IMF or EU demand for change of the currency regime in conjunction with the IMF loan, the current Latvian FX regime will most likely be over before the end of the year. At least if they want to remain a democracy. That is the bottomline.




* The IMF working on a plan B?

The market has been a little bit hot headed recently, expecting imminent devaluation. This does not seem to happen. Still, I believe the IMF especially, might be working on an alternative plan to come to grips with the current situation as they realise the current situation is nonsustainable. Unless the IMF and the EU provides Latvia with a very lax GDP budget deficit target, they should realise Latvia will miss it once again.

Disclosure; I am long Eur/Lvl FX Forwards.


* New positions and position changes
- Took profit on my long Eur/Sek
- Sold half my long SAS stock at flat as it went lower.
- Bought Eur put/Usd Call
- Bought Gbp put/Usd Call
- Bought Usd/Zar



As usual, good luck.





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