Latvia – from Baltic Tiger to the sick man of Europe

With the highest unemployment rate in the EU, the capitalist boom time is over for Riga and communism is back is fashion. Tony Paterson reports

The capitalist pig has returned to Riga. Rosy-cheeked, fat and a briefcase full of workers' cash clasped between its trotters, he stares out greedily from a placard opposite the Latvian parliament on the capital's main boulevard. Next to the hoarding, unemployed men in balaclavas and worn anoraks huddle around a fire.

As little as two years ago, any public display of such anti-capitalist, communist-style cliches would have been considered madness in Latvia: after shedding the Soviet yoke nearly two decades ago, the country enjoyed an unprecedented economic boom But the party is now long over.

Latvians like 33-year-old Gints Berneckis have lost their faith in the Western economic model. In common with thousands of others in Latvia, where unemployment is now running at 23 per cent, he was made redundant from his job as a computer salesman last year. "Yes, the capitalist pigs are back and they are walking off with our money and the government is handing it to them," he scoffed.

He has been camped out with fellow demonstrators braving Latvia's worst winter in decades in a small tent city in front of the national parliament since the beginning of the year "Everything is being cut. Social security, education, pensions – and people are leaving en masse," he said.

Berneckis is a member of a growing movement of Latvians driven to protest against their government's handling of a severe economic crisis, which many argue is far worse than that that currently experienced by Greece.

The crisis peaked just two years ago when the Latvian government was forced to take over the country's second largest bank to prevent it from collapsing. Ever since they have teetered on the brink of bankruptcy. In a foretaste of what may be in store for Greece, Latvia applied for and was granted a €7.5bn (£6.66bn) rescue package from the International Monetary Fund and the European Union.

But the conditions imposed under the IMF package have obliged the Riga government to usher in a raft of draconian belt-tightening measures which aim to slash the budget deficit from 12 per cent of gross domestic product to 3 per cent by 2012. Tough spending cuts and tax increases have been the order of the day.

Between 2005 and 2008 Latvian salaries doubled and borrowing grew by about 60 per cent each year. Both developments fuelled a massive economic bubble that earned the country a reputation as the "Baltic Tiger". But in 2008 the bubble burst dramatically. Property prices plummeted and consumer spending collapsed. Huge Swedish investments in building projects dried up and unemployment rose to the highest level ever experienced by an EU member country.

Latvia's economy shrank by nearly 17 per cent during the last quarter after retail sales dropped by a third. Yet the current government maintains that it plans to introduce the euro in 2014. "If it wasn't for the IMF and the EU, Latvia would now be completely bankrupt," said Jens Fischer, a Riga-based political and economic analyst. "But it's not like Greece – the people have seen worse times during the Soviet era and don't complain. There is also a big grey economy which remains unseen but keeps people ticking over."

Even so beggars abound in the carefully restored 14th-century centre of downtown Riga and most of the smart Western shops and fashion stores that set up in the city from the mid 2000s onwards are devoid of customers. In a bid to enhance Riga's trade in "stag night" tourists, the government last week passed a bill to cut value added tax for hotels. The trouble is that it threatens to undermine the terms of the IMF rescue package.

The dire state of the economy has also inflicted its first serious wounds on the Latvian government. Last month, Prime Minister Valdis Dombrovskis was left searching for new political partners after his coalition collapsed following a walkout by the five cabinet members of the influential People's Party. He now runs a minority government.

The MPs walked out in protest after Mr Dombrovskis refused to sign measures aimed at easing the pain of the crisis through delaying tax increases and reducing the number of government ministries. Mr Dombrovskis has since branded the walkout as a "direct and unmistakable attempt to topple the government" ahead of a general election later this year.

The political turmoil has led some financial observers to warn that Latvia now faces a period of ineffective government which may deter badly needed investors. "Political risk and uncertainty are on he rise again," said Violete Klyvenie, a leading analyst of Baltic states economies, "This could disrupt confidence in the Latvian economy and bring renewed pressure to the financial market."

However most analysts think that the stringent IMF conditions leave Latvia's beleaguered government with little choice but to stay its course. "No one wants to bring down the government so it seems like it will stumble on until the election," said Nils Muiznieks, a political scientist at Latvia University. "It is not very pleasant for a country to have the IMF," Mr Dombrovskis said recently as he glanced over his shoulder towards Greece, "But once a country has come so far that it needs a lender of the last resort, it cannot be too pleasant."

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