Why not to devalue the Lat

  • 2009-06-15
  • In cooperation with The Latvian Institute
The following is a factsheet released from the Latvian Institute:

Latvia's economic situation has become a subject of global debate, as economists weigh in from
every side with opinions on what should be done next. On Friday, June 12, CNN's 'Quest Means
Business' devoted ten minutes to Latvia's fiscal choices and featured an extensive interview with
Prime Minister Valdis Dombrovskis. The Prime Minister once again reiterated Latvia's firm
position on maintaining the currency peg to the euro.

A week earlier, the Governor of the Bank of Latvia, Ilmars Rimsevics reiterated that the
responsibility over the exchange rate of the lats rests solely with the independent central bank,
which is implementing a fixed exchange rate strategy.

According to the Bank, "the stability of the lat will be maintained until the moment it is replaced with the euro, concluding the current program of macroeconomic stabilization that has been agreed with the international lenders, the International Monetary Fund and the European Commission."

Many economic commentators who claim to favor the devaluation of the lat, have failed to
notice that Latvia has had a current accounts surplus since January 2009.
 Support for Latvia's policy was expressed on June 15, by Dr. Anders Aslund in the 'Financial Times', when he wrote, "Latvia is a very open and flexible market economy. It has already cut public wages by 20 per cent and can cut them by another 10-20 per cent, so it needs no devaluation for cost control. Competitiveness has already been restored. The current account is in surplus since
On June 5, Governor of the Bank of Latvia Ilmars Rimsevics stated the following:
"The Bank of Latvia will not conduct any experiments with the lats. A number of experts both in
Latvia and abroad tend to mention devaluation as a solution, which it is not: devaluation would
bring losses to the Latvian economy and would push its recovery to a more distant future.

• As a result of rising housing expenses and retail prices caused by more expensive imports,
the population of Latvia, particularly the low-income segments that receive social support
payments, would lose a substantial part of their income.
• As consumption decreases, enterprises go bankrupt and unemployment is on the rise,
budget income will decrease putting social payments at risk.
• In Latvia, 85% of mortgage loans and 87.5% loans for business activities have been
granted in euro. Consequently, loan payments would become notably more expensive and
solvency of many private persons and businesses would become doubtful. Any
bankruptcy would mean additional increases in unemployment, putting ever more
families in a difficult situation and social budget under increased strain.
• Latvian exports would gain nearly nothing from devaluation, for imported
equipment and raw materials necessary for production, including for export, exceed total
exports. Other EU member states and countries outside the EU have also failed to show
any gains from the drop in their exchange rates: in the course of one year, exports have
decreased 12% in the UK, 18%in the Czech Republic, 16% in Hungary, 25% in Russia;
Poland and Ukraine have also posted decreases. No anticipated increases in exports have
materialized after the drops in these exchange rates even though several months have
passed since. The root of the problem currently lies with the foreign demand and the
export structure of each particular country.
• Servicing the country's foreign debt would become substantially more expensive.
• Under conditions of widespread lack of confidence, devaluation, and thus inflation, in all
likelihood could no longer be controlled thereby undermining any basis for investor
confidence and recovery of the economy.
For the above reasons, determined actions of the government in amending the budget to
meet the conditions set by the international lenders for receiving the loan, are of vital importance.
If we do not receive the international loan, the budget would have to be trimmed even more,
affecting those social groups whose income levels have been agreed to remain at the current
level. Any chance to use measures to stimulate the economy, which are necessary for Latvia to
get out of the deep economic hole would thus be lost.

The Latvian Institute, established by the State of Latvia, is an organization providing information to the public about society, culture and history.