SPECTER OF DEVALUATION REAPPEARS - GOVERNMENT BRUSHES IT

UNCLAS RIGA 000314 SIPDIS E.O. 12958: N/A TAGS: EFIN PGOV ECON LG SUBJECT: SPECTER OF DEVALUATION REAPPEARS - GOVERNMENT BRUSHES IT ASIDE REF: LONDON 1321 ¶1. Summary: Comments by prominent local politicians have resuscitated speculation that Latvia will have to devalue its currency, and their concerns gained some traction when Latvia failed to sell any government debt securities on June 3. The Prime Minister, Finance Minister, and Bank of Latvia insist that no devaluation is being considered. Meanwhile, the Bank of Latvia spent 127.6 million Euros in the first three days of June defending the Lat, in addition to 134.5 million Euros in the last week of May, up from only 1.7 million the previous week. The Bank of Latvia argues that the public conjecture about devaluation is forcing defensive moves, but still sees no signs of speculative attack. While the decision on devaluation officially rests solely with the Bank of Latvia, the decision depends as much on opinions in Brussels and Stockholm as in Riga. End Summary. ¶2. Bengt Dennis, former governor of Sweden's Central Bank and current member of a task force studying Latvian economic policy, was quoted in the press saying that devaluation in Latvia was not a question of whether, but of when. In addition, Mareks Seglins, Justice Minister and chairman of the People's Party (the largest faction in the coalition government) declared that the idea of devaluation deserves a more thorough debate, although he has since backed away from those statements. Former PM and People's Party founder Andris Skele and Venstpils mayor Aivars Lembergs (two of what are considered Latvia's three main oligarchs) have been even more direct in advocating devaluation in recent days. The above, combined with the unsuccessful attempt to sell government bonds at auction on June 3, has led to growing speculation in international financial media that a devaluation is inevitable. ¶3. The Prime Minister's foreign policy advisor flatly rejected the suggestion that further discussion of devaluation was warranted. He claimed that Bengt was not accurately quoted and that he is not "an advisor" in the sense that many press reports have suggested - he is only one member of a larger task force studying the economy. PM Dombrovskis has publicly rejected devaluation, claiming confidence that the latest proposed budget cuts will satisfy international lenders, even though the proposed deficit of 9.2% would almost double the agreed-upon target. ¶4. In private conversations, Latvian Bank officials echoed their public statements that they see no need to devalue the Lat. They claim that the current round of defensive maneuvers was necessary because of investors spooked by the baseless speculation of politicians, not because of any change in the fundamentals of the economy. ¶5. Latvian bank analysts have been more sanguine than their foreign counterparts. Peteris Strautins, socioeconomic advisor at SwedBank Latvia, noted that the current account is in surplus and the need for devaluation is actually declining each day. He suggested that many of the statements by Latvian politicians were simply an effort to sow instability by parties that are in a weak position heading into June 6 local government and European Parliament elections. He predicted things will calm down after Saturday's voting. Andris Vilks, Chief Economist at SEB, noted that deposits in Latvian banks have actually increased in the last week as investors respond to higher interest rates for Lat-denominated accounts. He estimated that most of the movement in deposits was due to resident activities rather than speculation by outsiders. ¶6. Comment: While many looking at Latvia's situation would assume that devaluation is a logical step (reftel),the country's small size, heavy dependence on imports and makeup of the export market make it unclear how much it would benefit Latvia. Opinions remain mixed whether devaluation would be a better policy for Latvia's long-term economic health. The current government is attempting to project confidence and certainty in the decision not to devalue - and they seem genuine in their belief in this course of action. There is no question that the Bank of Latvia remains committed to the current peg. However, if the rumors continue to snowball after the election, they risk becoming a self-fulfilling prophecy. While the decision rests with the Bank of Latvia officially, officials in Brussels and Stockholm have as much, if not more, to say on the matter, which comes down to their willingness to fund a defense of the peg if necessary. ROGERS