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Nov 20, 2008 | 21:04 GMT

5 mins read

Latvia: Seeking Support from the IMF

ILMARS ZNOTINS/AFP/Getty Images
Summary
Latvia reportedly wants to work with the European Commission and the International Monetary Fund (IMF) to set up a stabilization package in case the economic situation in the country gets worse. The rumors that Riga is considering funding, or at least a standby agreement, with the IMF will do nothing to instill confidence in its Baltic neighbors. The rumors do, however, highlight the growing importance of getting a good place in line to ask the IMF for assistance.
According to unofficial reports out of Latvia, the Baltic country is considering launching an official consultation with the International Monetary Fund (IMF) and the European Commission regarding a possible stabilization package. The Latvian newspaper Diena, citing unnamed government officials, reported Nov. 20 that the IMF consultations might not include a loan, but rather a standby agreement that could be tapped in case the situation in Latvia worsens. As the global financial crisis sweeps through Europe, the region receiving particular attention is the so-called "emerging Europe" — Central Europe, the Baltic states and the Balkans. Of these countries, the Baltics — Latvia, Lithuania and Estonia — are among the most vulnerable to the current crisis. The rumors out of Riga that the government is considering IMF and European Commission funding will not instill confidence in the economies of its neighbors Estonia and Lithuania, which share many of the same problems. The three have had overheated economies in which foreign capital fueled enormous housing booms, a trend now set to be reversed with a considerable crash. As the race for the IMF's cash quickens and the queue begins to grow, being the first in line is becoming ever more important. With the fall of communism in Central Europe and the dissolution of the Soviet Union, a whole new market opened up for Western European — and global — capital. Membership in the European Union removed most of the security and political risk normally associated with the former communist (and some Soviet) states, and capital from the West — especially from Scandinavia, in the Baltic states' case — saturated the region. The Baltics were favored in particular because of the perception that they were small enough that it would not take a lot of money to make a big impact — the states' combined gross domestic product (GDP) is only $87 billion, comparable to Slovakia or Morocco. Their proximity to Scandinavia, Russia and Germany was also seen as strategic, as was their well-educated and multilingual population. Sweden and Finland rushed into the Baltic region with investments, using their knowledge of the region, historical connection and cultural affinity to quickly gain a foothold in the banking and industry sectors. Estonia and Latvia were part of the Swedish Empire for most of the 17th century, and it was only natural — geopolitically speaking — for Stockholm to rush to fill the void left by withdrawing Moscow following the 1991 collapse of the Soviet Union. For Sweden, dumping a lot of capital into the Baltics as quickly as possible was a quick way to reassert dominance over the region. This made sense geopolitically because Stockholm sees the Baltics as a buffer against Moscow's expansion in the Baltic Sea basin, a point of conflict between the two countries in many wars between the 16th and 19th centuries. (click image to enlarge) However, with unchecked credit, the three Baltic states' economies have become too overheated. Their housing sectors, in particular, have exhibited rapid and essentially cancer-like growth. Lithuania and Estonia registered housing price growth rates of 36.4 and 23.8 percent, respectively, from 2002 to 2006, blowing Spain (18.4 percent) and the United Kingdom (14.8 percent) out of the water — and Spain and the United Kingdom are often cited as egregious examples of extreme housing growth. Latvia reached a 40 percent increase in 2005 and an incredible 62 percent in 2006. The collapse of the Baltic housing sector, which actually started in 2007, will contribute to an overall Europe-wide housing malaise. Apart from the housing boom, the associated credit boom also led to an unmanageable increase in consumer lending. Much of this lending was provided in the Baltics by Swedish and Finnish banks. As the credit from Scandinavia flowed, the Baltic states' trade deficits ballooned into the 20 percent of GDP range, and banks became overleveraged to foreign capital. Private debt in Latvia and Estonia exceeded 100 percent of GDP in 2007 (Lithuania was at 78 percent) — astounding numbers considering the three Baltic countries had zero debt at independence from the Soviet Union in 1991. The worry right now is that the global credit crunch will further collapse the housing market and banking in the three countries. Parex Banka, Latvia's second-largest lender, had to be taken over by the government on Nov. 8 and lost $108 million in a bank run just prior to the bailout. Sweden meanwhile announced a 1.5 trillion Swedish krona (US$205 billion) plan to guarantee borrowing by Swedish banks and financial firms, in large part to safeguard against possible contagion from their exposure to the Baltic markets. Ultimately, the Baltic nations will have to consider whether starting negotiations with the IMF early might be a good strategy to keep their place in a line that could become quite long as the crisis sweeps across the globe. Being ahead in the line might be the only way to guarantee that loan terms are favorable — and if the crisis gets even worse, that any loans are given at all.

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