EU looks to reassure markets over Latvia

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Latvia expects to access the next tranche of its €7.5bn (£4.5bn) economic rescue loan soon and will not need to devalue its lat currency, Prime Minister Valdis Dombrovskis said on yesterday.

EU Economic and Monetary Affairs Commissioner Joaquin Almunia backed him up, saying the end of Latvia's currency peg to the euro, fears of which have rattled financial markets, would create "very serious difficulty".

Mr Dombrovskis said the Baltic country, whose economy is due to shrink by a fifth this year, should get fresh international aid after sharp budget cuts agreed this week that will further reduce the minimum wage, raise taxes and cut state salaries.

"If our programme remains on track, we will keep the peg. The government is committed to the stability programme based on the lat," he told Reuters in an interview. Mr Dombrovskis, speaking in Brussels, said he was confident of receiving the second tranche worth €1.2bn from the aid package agreed in December, and said a third tranche could come in late 2009 or early 2010.

Mr Almunia said continued spending cuts, which will only increase the pain of the crisis for ordinary Latvians, were needed to ensure payouts from the emergency package backed by Brussels and the International Monetary Fund.

"The end of the lat (currency peg) would create, if it happens, very serious difficulty and we want to avoid, at any price, this situation," he told a news conference.

The Latvian lat currency, which the central bank has intervened to protect in its corridor against the euro, was being quoted in Riga at its highest rate since May 2008, at 0.6965/75 per euro.

However, traders said there was virtually no trade in the currency or interbank market, where rates had topped 100 per cent due to lack of lats after the central bank interventions. The central bank keeps the euro between 0.6958 and 0.7098.

Amid the tough market conditions, the Treasury managed to sell 15m lats of one-month debt at an auction, a week after a failed sale of 50m lats panicked markets. In Sweden, whose banks are exposed to the crisis in Latvia, the crown rose and shares in Swedbank and SEB rose sharply on relief after the country's financial supervisor said the banks could withstand "extreme pressures".

At the same time, the Swedish central bank tapped the European Central Bank for a loan to ensure financial stability.

There are few signs of discord in the Latvian capital, where property prices shot up and then fell sharply when the global credit crisis took hold, as happened in Ireland and Spain.

But concerns are increasing conditions may deteriorate in the EU country of 2.3 million people as its economy shrinks by around 20 per cent this year and unemployment benefits start to run out.

A peaceful protest in January descended into a riot, though conditions have since returned to calm.

Sweden's central bank, fearing a meltdown in Latvia could hurt Swedish banks that pumped money into the Baltic region during the boom, on Wednesday said it was tapping the European Central Bank for a financial stability loan.

Though the immediate worry about devaluation has eased in financial markets, several economists have raised questions about how feasible it will be for Latvia to cut a total of 1.5bn lats – 10 per cent of GDP – over three years.

The Fitch ratings agency cited a "significant and rising risk" Latvia would still have to devalue its currency in spite of the 500m lats in cuts that the government agreed with its social partners such as employers and unions this week.

Commerzbank's analyst Barbara Nestor said the "draconian fiscal cuts" should help it avoid devaluing.

"The policy response is much too delayed but we see it as positive and substantial,"she said in a research note.

The planned cuts have caused controversy in Latvia too, but the President Valdis Zatlers rebuked criticism from a local economist that the reductions amounted to "economic murder".

"It would be murder if we did nothing, if the government waited until the situation sorted itself out, if we do not get the next loan from the IMF," Zatlers told LNT television.

Many shop windows in Riga's Old Town – a UNESCO World Heritage site – feature "for rent" signs and many are deserted. Though people continue to dine and socialise in the city's beer gardens and patios, bar operators say revenues are down.

"People are coming to the club but they do not drink as much as before the crisis. We are minimum 20 per cent down," said Martins Adukonis, manager of the once-bustling Essential Club.

The Latvian National Opera has filled about 90 per cent of seats for its annual opera festival now under way, according to its international relations director Jochen Breiholz.

"This year we are not quite sold out," he said.