Highlights
– Latvian economy expected to worsen in 2009
– European Union countries unlikely to offer significant help to Latvia in near-term
– Latvia likely to remain heavily reliant on the International Monetary Fund
Prime Minister Ivars Godmanis’ center-right coalition government resigned on February 20, 2009. President Valdis Zatlers accepted the resignation and immediately began talks with party leaders to form a new coalition.
On February 26, 2009 Valdis Dombrovskis was named the Prime Minister-designate. Dombrovskis is a former economist and member of the opposition New Era party. He comes to power at a time when Latvia is suffering from a severe economic crisis. A statement made by Dombrovskis, “ The country is on the verge of collapse unless immediate action is taken,” is indicative of Latvia’s near-term dire economic outlook.
Latvia was recently considered a European Union (EU) “tiger economy” because of its 12 percent growth rate. 2009 is likely to set the country back, As the economic crisis worsens in the country, we expect further social unrest. The likelihood of the unrest turning violent is high, especially in Riga and other urban centers. We note that the government collapse and severe instability in Latvia may be indicative of what is in store for several Eastern European and Balkan countries, regions that are facing severe economic turmoil and several governments on the verge of collapse.
Growing Discontent
Latvia’s center-right coalition government under Prime Minister Ivars Godmanis was the victim of the country’s growing economic and political turmoil. This is the second European government to collapse, following Iceland, from international economic turmoil.
Gross domestic product shrank by 10.5 percent in January 2009. By the end of 2009 Latvia’s economy is projected to shrink by at least 12 percent, negating years of growth. Unemployment has risen, while those who do have jobs have had their salaries slashed. The construction, real estate, and farming sectors are, which have suffered the worst, are expected to endure greater strife in 2009.
Public discontent is on the rise and trust in the government has plummeted to record lows. In January 2009, nearly 10,000 people gathered for a peaceful demonstration that turned violent as scores of protesters began battling police officers and ransacking stores. In February 2009, farmers blockaded Riga with tractors and forced the resignation of the agricultural minister Martins Roze. The large-scale and often bold demonstrations are likely to continue, especially as the economy worsens and the political situation becomes unstable.
Combating the Crisis
The Prime Minister-designate recently met with the International Monetary Fund (IMF) in an attempt to secure emergency funds. The IMF is mandating spending cuts before Latvia can receive the US$9.6 billion IMF-led bailout. This requirement goes against the Kensian economics being pursued in Western Europe, Japan and the United States to tackle the economic crisis in these countries. Latvia has received about 1.5 billion Euros. The next installment of 200 million Euros is due after the budget is amended.
After raising taxes and lowering wages, two policies that remain unpopular, the government must lower expenditure by US$1.3 billion, which is equivalent to about 5 percent of the gross domestic product (GDP). Ultimately, economic growth for Latvia may come from boosting exports. This poses as a problem because the Latvian currency is overvalued. Devaluing the currency is likely to be politically unpopular, and Dombrovskis may be reluctant to propose such a measure at a time when he is trying to form a government. In addition to potentially devaluing the currency, other politically risky measures, such as lay-offs and wage cuts, may need to be implemented to stave off further economic turmoil. The latter two will certainly be unpopular with the populace and result in rising anger toward Dombrovskis and hamper his attempts to create a government.
The Growing Trend
Latvia has been among the countries hardest hit in Eastern Europe, but it will certainly not be the last. Other countries, such as Estonia and the Ukraine, are facing similar problems.
While Latvia has been plagued by the global financial crisis, some of the government’s recent policies have contributed to the overall downfall of the economy. The government pursued a policy of strengthening the national currency to meet the Euro, largely as an attempt to accelerate admission into the Euro zone. This action resulted in the currency being overvalued and increasing inflation.
Western European countries are unlikely to offer significant amounts of financial support to Latvia and other Eastern European countries in the near to medium-term, as most are dealing with their own domestic problems. We are likely to see more Eastern European, Baltic, and Balkan states turn to the IMF for support. By turning to the IMF, these countries will be forced to restructure their economies and implement policies that are not always popular amongst the people, resulting in public discontent and political instability.
Latvia will follow the requirements of the IMF support, leading to public discontent with a Dombrovskis government. The rising social discontent is likely to result in increased demonstrations throughout the country, particularly in Riga.
