RIGA - The agreement Latvia's ruling coalition signed with the IMF July 27, releasing a 200 million euro loan to help stabilize a slumping economy, only buys time before worries return regarding the country's finances and the strength of the currency peg, warn analysts, reports news agencies Leta-Reuters.
Tough terms were imposed by the IMF, including more budget cuts totaling 500 million lats (714 million euros) next year, a possible progressive income tax and raised VAT if the cuts do not reduce the budget deficit to the required level.
The agreement is supposed to calm nerves over the financing of state spending through the end of 2011, but economists say a budget deficit of 10 percent of GDP this year, and 8.5 percent next, are moving targets. The risk is still that the recession worsens from its already expected GDP drop of 18 percent this year.
Danske Bank's chief analyst Lars Christensen says that "It is likely the IMF deal is already based on too optimistic expectations."
"If the Latvian program collapses, which is still a risk, all three currency boards in the region would probably collapse," says Capital Economics economist Neil Shearing, referring to currency pegs in Lithuania and Estonia.
"The recession across the region will be deep and protracted, but we already knew that. The key is whether political and public commitment to adjustment via the real economy is deep enough to prevent the pegs from going. I am increasingly skeptical," Shearing added.
From the Stockholm School of Economics in Riga, professor of economics Morten Hansen said Latvia had no choice but to follow the economic program agreed with the IMF and EU, but that people should not underestimate Latvia's determination to keep its currency peg. "To make it easier to fulfill this package, a strong coalition would be nice, but it is evident that this is not what Latvia has," he said.
Lithuania's need for an international bailout depends on neighboring Latvia's economic performance and its own banking industry, not on its collapsing output, say the Danske Bank and Capital Economics analysts, reports Bloomberg. The economy, which plunged in an initial reading of 22.4 percent last quarter, isn't in 'urgent' need yet of assistance from the IMF, said Christensen.
"There's a little bit more room for waiting to go to the IMF," he said, adding that "Lithuania is not in the same place as Latvia. I'm not sure it's seen as different in Frankfurt or London, but there's a difference in degree of the crisis here."
Latvia turned to the European Commission and IMF for a 7.5 billion euro stabilization loan in December. A loan agreement with the IMF, signed on July 27, released the first loan payment. That followed a 1.2 billion euro transfer by the European Commission, which helped quell concern about a devaluation of the lat.
Sixty percent of the 1.1 billion lat first installment loan, from the European Commission and the IMF, has been spent repaying state debt, reports Latvian Commercial Banks Association representative Oskars Kupse. Approximately 25 percent was spent on covering the hole in the state budget, and 15 percent for repaying Parex bank's syndicated loan.
From the second installment of 1.2 billion euros, 600 million euros was deposited at the Bank of Latvia as a reserve for the Latvian financial sector. This money can only be used for specific goals and only with the European Commission's permission.
