Identifier
Created
Classification
Origin
09RIGA401
2009-08-03 13:41:00
CONFIDENTIAL
Embassy Riga
Cable title:  

LATVIA CONCLUDES IMF DEAL: DIFFICULTIES REMAIN

Tags:  ECON EFIN PGOV LG 
pdf how-to read a cable
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C O N F I D E N T I A L SECTION 01 OF 02 RIGA 000401 

SIPDIS

DEPT FOR U.S. DEPT OF TREASURY D. WRIGHT

E.O. 12958: DECL: 07/31/2019
TAGS: ECON EFIN PGOV LG
SUBJECT: LATVIA CONCLUDES IMF DEAL: DIFFICULTIES REMAIN

Classified By: Charge d'Affaires, Bruce R. Rogers, for reasons 1.4 b an
d d.

C O N F I D E N T I A L SECTION 01 OF 02 RIGA 000401

SIPDIS

DEPT FOR U.S. DEPT OF TREASURY D. WRIGHT

E.O. 12958: DECL: 07/31/2019
TAGS: ECON EFIN PGOV LG
SUBJECT: LATVIA CONCLUDES IMF DEAL: DIFFICULTIES REMAIN

Classified By: Charge d'Affaires, Bruce R. Rogers, for reasons 1.4 b an
d d.


1. (U) Summary. Latvia concluded an agreement and signed a
new Latter of Intent (LOI) with the International Monetary
Fund (IMF) on July 27 following weeks of tense and
politically sensitive negotiations. The deal will allow
Latvia to access the second tranche of its aid package (USD
285 million). The deal calls for small adjustments to
Latvia's 2009 budget as well as targets and strategies for
deficit reduction in 2010 and 2011. The IMF predicts a
continuing deterioration of Latvia's economic climate over
the next 18 months. While the five coalition political
parties all signed the LOI, there is no guarantee they will
be able to agree on specific spending cuts in the 2010 budget
with parliamentary elections upcoming in 2010 and a divisive
public debate amongst ministers of the coalition already in
full swing. End summary.

Brief Background
--------------


2. (U) Latvia, faced with the largest economic contraction in
the European Union, signed a stand-by agreement with the IMF
in December 2008. This agreement required Latvia to maintain
a budget deficit in 2009 of not more than 5 percent of gross
domestic product (GDP). However, a dramatic worsening of the
economic situation required significant additional budget
austerity measures and forced Latvia to renegotiate its
agreements with the European Commission (EC) and the IMF.


Budget Deficit Deterioration and IMF-EC Divergence
-------------- --------------


3. (C) According to the IMF's lead negotiator, Mark
Griffiths, the IMF and EC are both extremely skeptical that
Latvia will be able to reduce its budget deficit to the
Maastricht Treaty required level of 3 percent of GDP by 2012
or even 2014. This means Latvia's adoption of the Euro may
be indefinitely delayed and pressure on the Lat is likely to
surge occasionally as economic conditions fluctuate.
Unfortunately, Griffiths noted this was one of the few points
of agreement between the EC and the IMF during their
negotiations with the Latvian government.


4. (U) The IMF is calling for a budget deficit of no more

than 13 percent of GDP in 2009 and 12 percent of GDP in 2010.
This is in sharp contrast to the MOU signed between the EC
and the Latvian government, as amended on July 13, which
calls for a budget deficit of no more than 10 percent of GDP
in 2009 and 8.5 percent of GDP in 2010. The reason for this
difference is twofold. First, the IMF and EC are using
different methodologies for calculating the budget deficit.
And, second, they have different economic forecasts for how
the Latvian economy will perform. The IMF is predicting a
larger deterioration in the economy, particularly in 2010,
and is calling for a larger reduction in spending. The EC,
on the other hand, is calling for a smaller reduction in
spending in 2010 based on a more optimistic budget and
economic outlook for 2010.


5. (C) Griffiths acknowledged that the EC had delayed
disbursement of its large tranche of money (EURO 1.2 billion,
disbursed on July 27) pending progress in the IMF's
negotiations. And both the IMF and the EC emphasized the
importance of their coordination in their respective press
releases. However, Griffiths complained that the EC had
signed off on Latvia's budget deficit reduction plan
prematurely and without actually looking at the numbers or
structure of the cuts in the amended 2009 budget. Griffiths
lamented the rushed process for the initial cuts and the
failure of the EC to review the numbers prior to publicly
supporting them.


6. (C) The amended budget cuts adopted at the behest of the
IMF and EC were undertaken in a very short timeframe
immediately following Latvia's municipal and European
Parliamentary elections in June. Latvian politicians admit
that the rushed process produced a poor result with across
the board reductions rather than sustainable structural
reforms. For example, Griffiths emphasized the failure of
the government to adequately account for some degree of
social spending required in a crisis. Unfortunately, the
public and political backlash of the rushed budget process
means it will be more difficult politically for the governing
coalition to push through the necessary cuts to the 2010
budget this fall.


7. (U) It is important to note that Griffiths stressed that
the IMF and EC teams had built trust during the negotiations.

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Griffiths expressed optimism that the IMF and EC would be
more in-sync moving forward, which will be essential since
any signal of divergence could unsettle the markets.

Hard Work Still to Come
--------------


8. (U) Despite the positive outcome of the negotiations,
Latvia's economic problems remain severe. The IMF is
projecting an 18 percent decline in GDP for 2009 and another
four percent decline in 2010. Given the contractionary
nature of the fiscal cuts, the budget outlook for 2010 is
expected to be even worse, requiring an additional USD 1
billion cut in 2010. Second quarter growth will show a steep
decline in economic activity, as exhibited by just published
figures showing a 29 percent year-on-year and 5 percent
month-on-month slide in retail sales in June.


8. (C) This difficult economic situation and the dramatic
fiscal cuts necessitated by Latvia's currency peg to the Euro
have created a tense political environment. The chairwoman
of the ruling New Era party, Solvita Aboltina, told PolEcon
Chief that she was concerned about the 2010 budget process.
Aboltina said that the largest coalition party, the People's
Party, might try to bring down the current coalition by
balking at concluding a budget agreement in the first or
second reading of the budget bill as early as this October.
(Note: The People's Party spooked the markets on July 27 when
it briefly delayed its signing of the LOI after word had
already leaked that a deal was done.) The current government
has only been in power since March of this year, following
the collapse of the previous government after street
demonstrations and its failure to pass its own budget
amendment. However, Aboltina said she thought it was more
likely that the People's Party will talk tough but refrain
from such a divisive move until closer to the parliamentary
elections next fall in an attempt to avoid blame for the
tough economic consequences of the budget reductions.


9. (C) While the IMF deal provides reason to hope that the
governing coalition will cooperate on making the necessary
budget cuts to stave off economic collapse. Based on the
already acrimonious and very public political debate between
members and even ministers of the governing coalition, the
IMF deal is no guarantee that Latvia is out of the woods.


10. (U) Please direct any specific questions regarding this
issue to Pol/Econ Chief, Hagen Maroney, at
maroneyhd@state.gov.
ROGERS