Bank of Latvia governor's bizarre "coupons" idea -- to scare the government?

Bank of Latvia governor Ilmārs Rimšēvics recent suggestion that the Latvian government would have to issue debt "coupons" instead of paying salaries was intended to "scare" the government into pursuing spending cuts so that it can get international loans.

The head of the central bank was essentially saying that the country would have to adopt a dual legal tender system amounting to a murky quasi-devaluation of the lat, but many people saw it as an alarming warning that the ration coupons of the late 1980s would return.

Rimšēvics said that if Latvia doesn't get  funding from the International Monetary Fund (IMF), the government would have no money to pay wages later this year and would have to issue debt paper that he called by the ambiguous Latvian term taloni (the plural of talons, a term most people in Latvia associate with ration coupons issued when certain consumer goods were scarce in the last years of the Communist system in the late 1980s).

There are anecdotal reports that people who misunderstood what was meant by taloni in the present day context have been hoarding salt, flour and the like. During the late 1980s, ration coupons were issued for a number items, including soap, laundry powder, milk for infants etc.

What Rimšēvics meant was that instead of depositing salaries to employee bank accounts (as is the normal practice) state and municipal agencies short of funds would issue IOUs that could be used as legal tender for purchasing goods and services (assuming merchants accepted them or were force to accept by some emergency law or regulation). In effect, Latvia would have a dual currency system with the lat circulating in parallel to lat-denominated debt paper issued in lieu of salaries. Inevitably an exchange rate would arise between "real lats" and taloni. It is difficult to believe that taloni would not be deeply discounted in a free market. Tens of thousands of public sector employees would try to unload their government-printed paper for "real" currency rather than test the local grocery store's or their landlord's readiness to accept taloni as payment.

A simple guess on the value of taloni can be made by comparing them to, say, a two or five year (non-Latvian :) ) treasury bill. If the debt instrument has a maturity value of, say 100 EUR, then it's present value can be calculated (i.e. the sum one would have to put in the bank to have 100 EUR, including accumulated interest, in two or five years). That could be, say, 95 or 90 EUR, but since, unlike the fixed maturity of the treasury bill, no one knows when an insolvent Latvian public sector would recover, the discount would have to  be very deep --anywhere from a substantial double-digit figure to -- worthless. 

 At the same time, confidence in the lat would be undermined and may have been undermined even if the whole mention of taloni was a bluff. It is, nonetheless, a signal that the Bank of Latvia is entertaining the idea of altering the value of the lat. Is it a hint of the devaluation that many serious analysts have been speculating about? The fact that the central bank governor floats wacko ideas about dual legal tender systems is also a sign that probably nobody really knows what to do next. The informal unwritten nod by the IMF to a 7 % of GDP deficit has already been undermined by calculations that even with the drastic spending cuts currently proposed (and likely to wreck the education, health care and law enforcement systems) will create an 11 % deficit.

As things now look, Latvia may well be heading for a double-devaluation in the form of an internal devaluation by drastic public sector salary cuts (and their impact on purchasing power, the domestic private sector and tax revenues) followed later this year by a real devaluation (letting the lat float and printing more of them to cover public sector expenditures and somehow make it through the winter)