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