Grey Nation Down

I'm playing on the title of a 1970s disaster film, Gray Lady Down, about a nuclear submarine that collides with a freighter and sinks to beyond where it can be rescued. But what I really mean is that Latvia is more and more a gray nation -- in terms of aging, the weather, the unique gray light of November -- and it is down in several senses, depressed economically, depressed psychologically, and headed for stagnation -- a state of, for the foreseeable future, permanent down.

I don't mean to disparage the gray of age, but this is an aging nation and probably was even before the economic crisis. Now the gray scale is being cranked up by the emigration of the young, among other things, because they see the growing hopelessness of the old and gray. Those are the ones with no option, the ones whose entitlements can be cut with relative impunity and probably will be cut. A family in Ireland or Great Britain can at least financially support its gray generation which will get little or nothing for years of social taxes paid. Indeed, Latvia if not now, then soon will be a country with a high negative return on taxation. Instead of getting some kind of services for taxes (the schools work, the police come, there is health care), Latvians will be paying more for less and subsidizing out of pocket what their higher taxes no longer support.

One need only to look at Latvia's foreign trade statistics (despite fanfares about approaching balanced trade, the current account and all that) to see that this is a country in economic depression. Almost all imports (a sign of the health of the domestic economy) are down by huge double digit figures. The same for exports . Imports of manufactured goods in September were down by 53.3 % from the year earlier, imports of clothing (textile and textile articles) down by 37 %.

Exports rose for such seasonal and world-market affected categories as foodstuffs (mainly grain), but even here, the fish and pharmaceutical exports that had been rising were off again. The country, according to some statistics, is maintaining a good trade surplus in manufactured goods, but at a depressed level and only because imports in these categories have collapsed. As indicators of domestic purchasing power, the trade statistics show that, like a wounded submarine, Latvia is plummeting to the bottom and will probably stay there for the next decade. The 2011 budget, which has to pass the Saeima probably weeks after next year's general election, MUST cut at least another LVL 500 million if there are no surprises. This year, according to how one counts, LVL 500 million were cut, but the international lenders objected, and another 50 plus millions had to go. So with tax revenues mechanically depressed (down) because of salary cuts. So for all we know, the new, very likely populist and inexperienced new government that will be clunkered together in the fall of 2010 will face demands to cut, perhaps, LVL 600 million. Who knows?

All of this is quite justifiable grounds for down as in depression. OK, there is probably nothing to gain from wallowing in this emotion, neither is there reason for euphoria because of occasional statistical blips. Emigration -- both foreign (as in leaving the country) or internal (refusing to cooperate with a failed system) is certainly not an irrational step and it is at least some kind of action, rather than passive acceptance of the consequences of an prolonged economic stagnation exacerbated by gross misgovernance.

Foreign direct investment plummets in Latvia

Foreign direct investment (FDI) in Latvia totaled LVL 16.5 million in Q1 2009 , down almost 94 % from LVL 260.8 million in Q1 2008, but up from a decline of LVL 95 million Q4 2008, according to Bank of Latvia statistics available through the Central Statistical Bureau.

Looking at the Bank of Latvia's quarterly balance of payments bulletin, these seem to be net FDI figures, balancing an inflow of "equity and other capital" of LVL 149.9 million in Q1 2009 (up from LVL 143.9 million a year earlier) against losses by "direct investment companies" of LVL 133.4 million.

A bit confusing, maybe the real economists reading this can comment. To me it looks like FDI is falling, although investment inflow (according to Bank of Latvia) is slightly up. Netting against losses, it seems we are talking about some kind of a burn rate here, but then, the net for Q4 was negative. Is that better? Or simply a case of getting less, thereby burning proportionally less?

The BoL's Q4 report is not very enlightening, it states that FDI for all of 2008 totaled LVL 542.5 million, down 45.3 % from 2007. Whatever it is, it does not somehow look good. Add to that the statistically not very significant but symbolically damaging lowering of the Swedish flag-of-approval in the sale of the media companies Diena and Dienas bizness by media flagship Bonnier Business Press and you have reason to think that Scandinavian investors will shun new investment, if not start a slow retreat from Latvia. After all, the prestigious Bonnier flag still flies (with priority) in Estonia, Lithuania and reputed bandito-land Bulgaria's media scene. And do not Swedish/Scandinavian investors do as do their leading business media (Dagens industri, the mother of all East European business media but its recently abandoned Latvian daughter, as European languages formulate it)?

Cumulative FDI stood at LVL 5.607 billion in Q1 2009 , down from 5.66 billion in Q4 2008 but up from LVL 5.391 billion in Q1 2008 (due to an inflow of FDI during the first three quarters of 2008). Good or bad?

The unavoidable train wreck...

Some fine-tuning details of the plan to cut Latvia's government budget by LVL 500 million have emerged (additional cuts of this size will have to be undertaken in 2010 and 2011), but these do not really change the direction or speed of a country headed for a train wreck.

Supplementary pensions (LVL 0.70 per year worked) will be cut only for those who retired after 1996. Pensions over LVL 500 per month will be limited to that amount, with any sum in excess withheld as a compulsory loan to the government. Teacher's salaries will be cut to the minimum wage per "shift" or teaching load, though it is unclear whether the old minimum of LVL 180 or the new LVL 140 will apply. This, in effect, means the public education system will collapse -- the only question is how fast. Younger teachers interviewed on evening television indicated they would, at the first opportunity, quit their subsistence-paying jobs and emigrate.

An ongoing TV discussion (as I write) is discussing whether any plan or priorities exist as to what to do next -- apparently there is no plan or vision. Also, there appears to be no funding (other than substantial EU structural funds, that are log-jammed somewhere in the bureaucracy) to stimulate the economy at a time when virtually all macroeconomic indicators are in free fall. It appears that we have a situation where the budget deficit is feeding off most efforts to cut the budget deficit by impacting purchasing power, raising unemployment and further deteriorating the remaining shreds of trust in the government.

I think that is the fundamental problem -- no one trusts that the present political elite and the government can solve the problem. It is no surprise that in a telephone vote, more that 5200 callers say it is time to take to the streets (whatever than means -- although the January 13 riots were a hint). There is a near-total breakdown of the social contract -- at least along these lines. The CEO of my workplace, LETA, Una Klapkalne, whose previous work was in government raised this issue at a brainstorming session with Prime Minister Valdis Dombrovskis and other ministers present. She said that whatever plans were drawn up, whatever schemes were sketched, it was all against the background of massive mistrust of the government by society.

Even if the government and the Saeima (parliament) succeed in approving the budget cuts and get the next payments from the International Monetary Fund (IMF), the EU and other lenders, the funds will merely prevent a government default. It will not inject a single santim (1 LVL = 100 santims) into the collapsing real economy.

My scenario -- a temporary boost if the Saeima approves what, at this point, amounts to cutting the carotid artery of the public sector with a resulting impact on the economy, quickly followed by a realization that things will spiral out of control again very soon. The international credit will simply pump more blood into the spurting artery (and, given the inefficiency and corruption of the government and ruling elite, much of the huge sea of billions of "liters" of blood will be sucked by parasites). When this is obvious to the financial markets, pressure on the lat and the "big tail" of the Swedish krona that this little animal can wag -- will increase. The Bank of Latvia, which says it has the entire supply of lats backed by foreign reserves, will come closer and closer to literally buying every lat on the market to keep the peg (effectively Euro-izing the bank accounts of those domestic actors selling lats.) Interbank and domestic interest rates will soar past the present 22 % and short-term funds will rush in to grab some of the shrinking pool of lats (possibly causing a bizarre spectacle of a seemingly strong but actually dead-but-not-fallen-over little mouse Latvian lat alongside a wildly swinging lat-surrogate krona). When the mouse falls dead, it is anybody's guess what happens -- probably freefall for the lat, a frightening dive for the krona and tremors across the Baltic and Eastern Europe.

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)