LATVIA-IMF: BANK OF LATVIA BELIEVES IT HAS DODGED

C O N F I D E N T I A L SECTION 01 OF 02 RIGA 000724

SIPDIS

E.O. 12958: DECL: 11/24/2018
TAGS: ECON EFIN ETRD LG
SUBJECT: LATVIA-IMF: BANK OF LATVIA BELIEVES IT HAS DODGED
DEVALUATION BULLET

REF: A. RIGA 714

B. RIGA 723

Classified By: Ambassador Charles Larson, for Reasons 1.4 (b) and (d)


1. (C) Summary. The IMF-EU team has left Riga after a week
of talks, and Bank of Latvia Governor Rimsevics is optimistic
that the GOL has convinced IMF officials not to request a
change in Latvia's currency peg to the Euro, after
government officials demonstrated that Latvia was prepared to
tighten fiscal policy sharply enough to avoid the need for
devaluation. Rimsevics has long been against any talk of
devaluation, and stated that Latvia would "walk away" from an
IMF deal if devaluation of the Lat were a condition. He said
that the total IMF/EU package could total 2 to 4 billon
Euros, though the IMF had offered up to 7 billion Euros in
assistance. The entire package, however, is dependent on the
GOL restructuring the agreement it made to take over failing
Parex Bank. The agreement, if concluded successfully and
cleanly, should allow the government to simultaneously defend
the Lat, stabilize the banking sector, and fund the state
budget. It will come at a tough political cost but should
help restore investor confidence. End summary.


2. (C) In a meeting with the Ambassador on November 24,
Rimsevics detailed the timeline of Latvia's request to the
IMF, noting that they had first approached the EU for help,
and were then directed by the EC to seek IMF assistance. He
said that the IMF (joined by EC, ECB, Swedish government and
Swedish Central Bank officials) came to Riga the week of
November 17 with a tough approach, and while the Fund did not
make a formal request to change the Lat's peg to the Euro, it
was obvious that they wanted a change to the exchange rate
included as a condition to aid. Rimsevics said that the GOL
and IMF held common views on all other conditionality issues
apart from devaluation, which Rimsevics has long noted was a
non-starter (see septel for more explanation of Latvia's
aversion to contemplating devaluation). He said that he
believed that the Latvian side was successful in convincing
the IMF that the government was committed to making deep
enough cuts in next year's budget to shift all the
restructuring pain to fiscal policy and avoid the need to
devalue the Lat. According to him, there is commitment in
the government to trim 350-400 million Lats ($640-730 million
USD) from next year's budget, which would produce a
government budget deficit of 2.5% of GDP. He said that
pursuing a balanced budget would not be politically possible,
as the budget reduction figures would rise to 800 million
Lats ($1.5 billion USD),from a 2009 budget currently planned
for 5.5 billion Lats ($10 billion USD).


3. (C/NF) Given his belief that devaluation is off the table,
he explained that a sticking point had come up during the
talks due to the IMF's discomfort with the Latvian
government's deal to take over Parex Bank. He said the Fund
wanted to ensure that the two previous owners of Parex did
not benefit from the assistance program. Rimsevics said that
the IMF could potentially refuse assistance if their concerns
were not addressed by the GOL, and without outside
assistance, Parex could be closed within a month. We
confirmed the IMF's discomfort with the Parex agreement
during Ambassador Larson's November 25 meeting with the head
of Latvia's bank regulation agency (the FCMC),Irena Krumane.
Krumane (strictly protect) provided Ambassador Larson with a
copy of an IMF memo (ref b) suggesting that the GOL fully
nationalize Parex Bank and that they remove the bank's
previous owners from their management positions and
membership on the Parex Board. The memo notes that their
continued involvement with Parex leaves open the possibility
of further mismanagement or even asset stripping.


4. (C) Rimsevics said that the government would need to press
hard to get the previous owners to voluntarily transfer their
remaining shares in Parex to the government, and if that were
not successful, the government would look into legal and
judicial avenues to obtain the remaining interests of the
previous owners. If the Parex deal could be restructured to
the IMF's satisfaction, he thought that Latvia could receive
a bridge loan from the EU/Sweden in a matter of days, which
would probably entail 1 billion Euros to replenish the
foreign exchange reserves that the Bank of Latvia has spent
since the end of September to support the Lat's peg to the
Euro. The remainder, potentially another 1 to 3 billion
Euros, could be available in 3 to 4 weeks, according to
Rimsevics. He noted that the IMF was willing to provide up
to 7 billion Euros in total, but that Latvia would likely not
request more than 4 billion Euros.


5. (C) Both Rimsevics and Krumane stressed the damage that
would be dome to the reputations of the Latvian banking
sector and Latvian government if the Parex situation is not

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resolved. Rimsevics noted the direct impact a closure would
have on the Latvian Mortgage and Land Bank, which was given
administration of Parex, and to the sales of Latvian T-bills
and other financial paper. Krumane added concerns that
Parex's syndicated loan creditors would call in Parex's
February and June 2009 loan payments, and that without the
IMF/EU assistance, Latvia could not cover those payments, as
the government has already spent 351 million Lats ($640
million USD) on Parex support. Krumane ended her meeting by
saying the Parex restructuring and the painful budget
decisions that will need to be taken in the coming days will
be a crucial moment in Latvian history.


6. (C) Comment: Tough as the terms will likely be, the
government seems to understand that without outside
assistance it cannot simultaneously defend the Lat, save the
banking sector, and fund the state budget. Outside help may
provide it both the funds and the political cover to be able
to do all three. But preserving the Lat is the Holy Grail
for the GOL and initial indications are that the government
has been successful in this regard. If the agreement can be
concluded quickly and cleanly, it should help to restore
investor confidence.
LARSON