LATVIA VOTES FOR PAINFUL FISCAL MEASURES, AWAITS

C O N F I D E N T I A L SECTION 01 OF 03 RIGA 000803

NOFORN
SIPDIS

TREASURY FOR BILL LINDQUIST

E.O. 12958: DECL: 12/16/2018
TAGS: EFIN ECON ETRD PGOV LG
SUBJECT: LATVIA VOTES FOR PAINFUL FISCAL MEASURES, AWAITS
IMF-EU ASSISTANCE, GOVERNMENT REMAINS STABLE - FOR NOW

REF: A. RIGA 729

B. RIGA 724

C. RIGA 723

Classified By: Charge d'Affaires a.i. Bruce Rogers, for Reasons 1.4 (b)
and (d)


1. (C/NF) Summary: To qualify for IMF and EU financial
assistance, Latvia has adopted a modified 2009 budget and an
Economic Stabilization Plan. The measures include deep cuts
to public salaries, state services and ministries' expenses,
and substantial economic restructuring. These moves,
combined with the earlier changes to the original takeover
agreement of Parex Bank, have reportedly met both the IMF's
and EU's conditions. The government hopes to finalize
assistance packages by December 18, with a potential Nordic
bridge loan by December 20 and a December 23 IMF Board vote
planned. The latest information is that the EU could provide
3 billion Euros, the Nordic countries 2 billion, and the IMF
another 1.8 billion. Despite the unpopularity of the
measures among voters, the government is likely stable in the
short term because nobody else wants to take on the
implementation of these tough measures in the coming months.
End summary.

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Slamming on the Fiscal Brakes
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2. (U) In the early morning of December 12, aftera
twenty-hour session of the Saeima (Parliament),Latvia passed
amendments to its 2009 budget and laws to enact the
government's Economic Stabilization Plan. The fiscal changes
and economic restructuring measures were introduced to meet
requirements set forth by the IMF and EU in order for Latvia
to receive urgently needed financial assistance. Given
Latvian insistence (refs A and B) that the national currency,
the Lat, must retain its current peg to the Euro, the
required adjustments to Latvia's fiscal policy are
particularly severe.


3. (U) The 2009 budget was already trimmed-down when passed
in November. The December 12 amendments reduce planned
expenditures by another 8%. With the slowing economy
projected to shrink revenues (which even after increases to
VAT and excises taxes could fall 16% below 2008 revenues),
the projected 2009 budget deficit will grow approximately 3%
of GDP.


4. (U) Key items in the amended budget are a 15% cut in
public sector salaries and a 25% cut in other government
expenses. Subsidy payments from the government (with the
exception of health care programs) will be reduced 25% and
local governments will be called to reduce their budgets by
25%. The budget sets a goal to reduce the number of public
employees by at least 15% from 2008 figures, over the span of
two years.


5. (U) The Latvian economy is projected to shrink by almost
5% of GDP in 2009. To compensate for falling revenues,
increases were passed to the VAT and several excise taxes.
The general VAT rate will increase on January 1 from 18% to
21%. The reduced VAT rate on selected items will increase
from 5% to 10%, and the list of goods and services qualifying
for the reduced rate will be cut. Partially offsetting the
VAT and excise tax increases, the income tax rate will be
reduced from 25% to 23%, and the minimum deductible will be
raised from 80 Lats to 90 Lats (from $146 to $164 USD).

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Economic Restructuring
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6. (U) Other enacted legislation included continuation of
bank deposit guarantees up to 50,000 Euros, permission for
the government to issue loan guarantees for syndicated loans
which fall due in 2009, increased supervision and monitoring
of the financial sector, and the creation of a legislative
framework and procedures for public assistance provided to
troubled financial institutions. Measures to increase
Latvian competitiveness include creation of an export credit
insurance system, the merging of all public utility
commissions, improvements and consolidation of the health
care and education systems, and simplification of bankruptcy
and insolvency procedures. Monetary goals, such as
maintaining the Lat in its 1% band peg to the Euro and
adoption of the Euro by 2012, were also passed.


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Busy Two Weeks
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7. (C) The measures complete a difficult two-week effort by
the government to meet guidelines set by the IMF-EU mission.
The process accelerated on December 2 when the government
bowed to the IMF's specific condition that it take over the
remaining shares in Parex Bank from the bank's two previous
owners and remove them from the bank's Board. The government
is reportedly pursuing arrangements to take over the
remaining 15% stake held by minor shareholders, though terms
and details have not been specified by the Finance Ministry.
While the IMF had most urgently sought to remove the former
majority owners from Parex, full nationalization was
recommended by the IMF (ref C) during November talks, and
press reports indicate that the EU is also conditioning its
possible aid on full government ownership of the bank.


8. (C) Discussions between Latvia and the IMF had stalled in
the last week of November on both the Parex ownership issue
and on the lack of clarity of the government's plans to
implement economic restructuring without devaluing of the
Lat. A Bank of Latvia contact informed us that the IMF team
was not (apart from the Parex ownership issue) dictating
specific fiscal or restructuring points to the GOL, but was
using a "show us what you got" approach. As late as November
26, Ambassador Larson was told by both the Prime Minister and
Transportation Minister that they would not agree to the
Fund's suggestions on Parex, and would walk away from IMF
money if changing the original take-over deal were a
condition. While we do not know all the factors that changed
the government's position, the Finance Minister told the
Ambassador on December 4 that the Treasury was critically
short of money. The urgency of obtaining outside funding is
likely to have outweighed the government's commitment to the
original Parex arrangement, as well as removing any thoughts
of walking away from IMF funding. To date, the government
has injected almost 500 million Lats ($910 million USD) into
Parex, and the new Parex Board Chairman has said publicly
that he will seek roughly another $660 million USD from the
government when it receives IMF-EU aid.

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Finalizing IMF and EU Deals
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9. (C/NF) Bank of Latvia Governor Rimsevics has told us that
the IMF team had previously offered providing Latvia with
1000% of its quota (amounting to 1.5 billion Euros),but in
Stockholm on December 10, had lowered that figure to 450% of
quota (675 million Euros). However, on December 16, the head
of the Bank of Latvia's external relations department, Juris
Kravalis (strictly protect),told us the IMF was "happy and
impressed" with the Latvian measures, and that the amount
recommended by the IMF negotiating team to the IMF Board
would likely be closer to the original quota multiple. While
he said that assistance figures will not be set until the IMF
Letter of Intent is signed, talks are looking at roughly 1.8
billion Euros coming from the IMF, 3 billion Euros from the
EU, 2 billion Euros from the Nordic Countries, and an
unspecified amount coming from other neighbors or
institutions (of which he noted roughly 300 million Euros
from the World Bank and 50 million Euros from Estonia).
Kravalis said that the IMF Letter of Intent is scheduled to
be completed by December 17 or 18, with a vote by the IMF
Board on December 23. Financing could be received, he said,
within a few working days after the Board's vote, possibly by
the end of the year. He hoped that a bridge loan,
potentially from Sweden or jointly by the Nordic countries,
could be made by December 20.

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Comment
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10. (C) While there has been much criticism by the public of
the austerity measures in the budget amendments, there
appears to be a general consensus in financial circles that
there is no alternative course, given the need for IMF-EU
support. Unpopular as these measures are, it appears that no
alternative political grouping wants to pick up the
government's mess, and there is no immediate threat to the
coalition or PM. President Zatlers has expressed his support
for PM Godmanis' handling of the situation, and an attempted
no-confidence vote in Finance Minister Slakteris failed.
Godmanis also benefits from the common interpretation that
the financial crisis stems from his predecessor's

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economy-stoking policies, not from his decisions, thus
potentially saving him from the voters' wrath.
ROGERS