Business, Finance & Economics

For richer, now poorer


SEJA, Latvia —For Latvians, the party is officially over. The life they had gotten a taste of — that of life in western Europe, with new cars, nice restaurants, and boutique shopping — is in jeopardy.

This ex-Soviet Baltic state faces bankruptcy by June if it does not cut more money from its national budget and reach another deal with international lenders, prime minister designate Valdis Dombrovskis warned this week.

But Latvia has already slashed its budget to the bone. As part of a 7.5 billion euro ($9.5 billion) International Monetary Fund-led bailout package agreed on late last year, the country adopted an extreme austerity program. The government’s budget must be kept within 5 percent of gross domestic product (GDP). Public sector salaries have been cut by 15 percent, and then another 10 percent. Government ministries have seen their outlays drastically reduced. Even a traditional Victory Day celebration with neighboring Estonia has been cancelled for lack of funds.

Now Dombrovskis says that even this will not be enough. He was named to lead a four-party center right coalition after the previous prime minister, Ivars Godmanis, resigned on February 20, in part over public outrage to the austerity measures. Dombrovskis and the new coalition have been left little choice but to follow the same path however.

Revenues have been lower than anticipated, while spending has been higher. The deficit ceiling should be raised to 7 percent of GDP, the prime minister said, while the next tranche of the bailout cannot be delayed. Even so the government will have to slash some 280 million lats, or $506 million, from the budget.

“We need an agreement with the IMF and with the European Commission,” Dombrovskis said on national radio, as quoted by Reuters.

“The social impact [of the cuts] will of course be very unpleasant — but even more unpleasant would be not getting any more international financing, and the treasury runs out of money in June,” he cautioned.

What all this means for the country’s 2.26 million inhabitants, and towns like Seja, a sleepy farming community of some 2,500 inhabitants and 40 kilometers from the capital Riga, is anybody’s guess, however.

According to Guntis Liepins, chairman of Seja’s town council, the central government has already slashed his budget by 40 percent this year. “But there’s no guarantee that we will receive the remaining 60 percent,” he adds.

Because of the cuts, the town’s school may be in danger of closing. Liepins just completed a 100,000 lat gymnasium and sport center on the school’s grounds before the crisis hit — a project of pride that was built on credit. Now he wonders where they will find the money to pay off the loans.

“I feel like a hostage between the government and the people, says Liepins, a barrel-chested man with a bushy moustache. “There’s no money, but at the same time, they don’t tell us what to do.”

The scene is being mirrored across this nation, wedged between Estonia and Lithuania on the Baltic Sea, which with its neighbors became a European Union and NATO member in 2004. Just two years ago Latvia boasted one of the fastest growing economies in the world. Today it is one of the fastest shrinking.

Schools and hospitals are being closed or reduced to save money. Meanwhile, local industry is shutting down. And thanks to the freedom to travel brought by EU membership, untold numbers of young Latvians moved abroad in search of higher wages. Now with economies worsening throughout the 27-member EU, they may be coming home, but to no work, which will further boost unemployment payments.

Just who is to blame for Latvia’s predicament is open to debate. Some observers say that the crisis is simply a result of Latvia’s EU accession, which opened the economy to foreign investment, and, equally crucial, cheap loans.

Others believe that Latvian officials bear a large portion of responsibility: the economy was under-regulated (driving up the credit market), the government spent far beyond its means, and when the economy overheated, officials refused to put the brakes, thereby missing the chance for a “soft landing.” Then when the international economic downturn hit with a vengeance, the leadership was slow to react.

Still some, like Katinka Barysh, deputy director for the Centre for European Reform, a think tank, argue that the tradition EU growth model has also been called into question. In a recent briefing note she says that Eastern European nations are now suffering in part because they opened their economies up to foreign banks (which have now frozen credit lines) and based their growth on exporting to foreign markets (which are now rapidly drying up).

But other analysts, like Anders Aslund, senior fellow at the Peterson Institute for International Economics and an expert on the region, believe that Latvia’s economic policy has been for the most part blameless except for one critical decision, which is now having lasting repercussions: pegging the country’s currency, the lat, to the euro in hopes of fast accession to the euro zone. This has overpriced the lat in comparison to other currencies.

“Few countries have made so few mistakes,” Aslund said in a recent telephone interview, adding that it was better for Latvia “to take the blow immediately, rather than have a long steady slide.”

Town council chairman Liepins, who classifies himself as “opposition” though he belongs to no political party, is less sanguine however. “I’ve never seen such a bardak (mess),” he says.

“Where we are going, nobody knows."


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More on the economic crisis in eastern Europe:

How the Baltics melted down

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EU leaders hold extra economic summit