Latvia

There’s a lot of bickering going on about Latvia.
The IMF is playing hard ball versus the ECB.
From Den Danske Bank we learn:

While Mr. Kampars might be right on his assessment of the IMF staff, it is certainly unhelpful for further negotiations (if there are to be any) to bad mouth the institution that is supposed to give Latvia a loan. In our view it increasingly looks like the IMF will not pay out the next instalment on Latvia’s loan. This not only has ramifications for Latvia, but should also be a reminder to investors that the IMF is not just a “money machine” that automatically.

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Latvia - again

In May something strange happened but it went by barely unnoticed by the rest of this planet. Regional leaders in Asia agreed on a 120 billion USD emergency fund to counter the crisis. This fund was set up by the Asian Development Bank with his 67-members, in fact bypassing the IMF. Don’t forget that the IMF is de facto an United States driven institution, but that the US is also an important member of the ADB.
In the mean time we hear that the talks between Latvia and the IMF are not progressing at all. The IMF tries to play hardball.
While the EU is much more cooperative in finding solutions for the Latvian problem.
From the FT:

Although the Latvian Parliament did approve the announced budget cuts on Tuesday this week, the IMF response posted on its official website was rather lukewarm, suggesting that the measures were still not enough for the IMF to feel comfortable enough to continue the support of the Latvian peg with its own money.
Typically, the EU disbursements have followed those of the IMF in the sense that the EU left the IMF in charge of “managing” the programmes (ie, undertaking the economic assessments) and then would disburse its funds following the completion of IMF reviews. For example, this has been the practice in Romania and Hungary. Now it seems that in Latvia this IMF-EU cooperation could break down, with the IMF declining to conclude its review even though the EU wants to make its own disbursement.

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This must be Europe...

From Europe, with love:

ECB's 1-year money: The highlight was of course the huge 1-year provision of money at 1% by the ECB, which has set in motion a decline in money market rates that I suspect will broadly equate what would have happened if they had cut their policy rate to 0.5%. Bending to the evidence that the ECB prefers to provide the last bit of monetary easing via liquidity provisions rather than rate cuts, Goldman changed their forecast for policy rates to “unchanged” at 1% for the next 12 months.

On the policy side: The Spanish government approved a EUR 9bn fund to bail out needy banks, while the Germans are focusing on their fiscal exit strategy via a rule-bound fiscal consolidation that’ll limit the cyclically adjusted deficit to 0.35% from 2016.
Latvia help: In a stunning move, the European Commission announced last Friday that it'll disburse a EUR1.2bn loan tranche to Latvia in the next few weeks as the revised memorandum of understanding between the EC and Latvian government is finalised. This should be positive for CDS spreads for the Baltic states and Sweden, and also (at least temporarily) dampen a potential source of volatility in the CEE region.

Thanks Goldman….

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We're all brothers/sisters

Are the Russians different from the Americans? No, comrad. As long finance is concerned there is not that much difference if we observe the course of the S&P500 and the CEE ETF, which is investing in Eastern European and Russian stocks.

It’s summer. Fish are jumping in our harbor (literally). Time to close down the week and going for walk to my local (read: pub) for a good pint of Guinness and a jolly sing-along.
Adios to everybody and enjoy the weekend.

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The Latvian pressure cooker

The Latvian pressure cooker is still on the stove.
We know the story: Latvia, the former Eastern European tiger, pegged his currency to the euro in order to speed up growth a little. Than the financial crisis came and Latvia found itself badly caught out. Credit was needed but the attempt to issue 100 million LAT-denominated bonds resulted in no takers. In normal times and countires you devalue the currency. But that will cause trouble in Europe. For starters: Swedish banks lent heavily to Latvia and once the devaluation cascade starts, these banks will be forced to take big losses. Than there is the fact that nobody knows what will happen to neighbor countries and farther south once the currency peg will be broken up.
The Swedish Central Bank borrowed this morning 3 bln EUR from the ECB. The Riksbanken has already a swap agreement in place with the ECB of 10 bln EUR. Now why do they do this?

Now, let’s have a closer look to European banks. Total lending to emerging markets is now some 4.7 trln USD. 74% of that came from European banks. The Netherlands and Austria are the countries lending more than 50% of their GDP to these emerging countries.

We read this morning

IMF director Dominique Strauss-Khan said that Mexico, Colombia and Poland face challenging financing deficits that if not corrected soon, could put them at risk of defaulting. The external financing needs of Mexico and Colombia have been met for 2009. In this regard, the comments of Strauss- Khan seem strange and could add noise to the markets. . . .
The comments of IMF’s Strauss- Khan are particularly inopportune but should not be taken seriously. The IMF hasn’t published a formal press release confirming the fund’s view. Mexico is still investment grade and it is very unlikely that any of the three major rating agencies decide to lower it to junk.
Mauro Leos from Moodys said a couple of weeks ago that “it was far fetched to believe that Mexico would lose its invest grade category any time soon”. The view of the rating agencies has been that Mexico needs to pass structural reforms to avoid a downgrade. Shelly Shetty from Fitch commented recently that Mexico would need a plan “B” in case Congress fails to approve a fiscal reform after the July elections in order avoid a downgrade. This amounts to sort of running in order to stand still.
But the prospects for comprehensive fiscal reform are very slim. In fact, the two major political parties: the centre left PAN and centre-left PRI have both said that they are not at all interested in passing a fiscal reform package. While no party is expected to publicly say that it favors increasing taxes particularly before the congressional elections of July, the political climate does not support the passing of any reform.
Mexico will be downgraded by one notch on the back of deteriorating fiscal revenues as the economy contracts to between -5.5% and -7.5% this year. Still the comments of Strauss- Khan add noise to the market. . . .

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Don't cry for me, Latvia

We still look to the problems in Latvia. A lot of people assume that the crisis will be small and manageable. Nothing special.
We fear that – as what happened in 1998 – there is a lot of potential that this crsis can spread very quickly over Eastern Europe and that the EU will react too slow to prevent this. The financial version of the swine flu.
Here is an excerpt from an article of Anatole Kaletsky from last week. Anatole is writing for The Times.

Europe is now in the middle of a perfect storm - a confluence of three separate, but interconnected economic crises which threaten far greater devastation than Britain or America have suffered from the credit crunch: the collapse of German industry and employment, the impending bankruptcy of Central European homeowners and businesses; and the threat of government debt defaults from loss of monetary control by the Irish Republic, Greece and Portugal, for instance on the eurozone periphery.
Latvia, partly because it has followed an Argentine-style policy of “fixing” its exchange rate and encouraging its citizens to borrow in euros and Swiss francs, is now in the front line of the battle between governments and financial markets - and a humiliating devaluation looks increasingly likely. Last weekend a former Swedish finance ministry official brought in by the Government as an adviser admitted that devaluation was no longer a matter of “if” but of “when and how”. If Latvia does devalue, then the two other Baltic states will almost certainly be forced to follow and the panic will probably move to Romania and Hungary. Beyond that, the contagion is likely to spread to the weakest members of the eurozone - Ireland, Greece, Portugal and probably Austria.
If the crisis expands, other EU governments - and especially Germany’s - will face an existential question. Do they commit hundreds of billions of euros to guarantee the debts of fellow EU countries? Or do they allow government defaults and devaluations that may ultimately break up the single currency and further cripple German industry, as well as the country’s domestic banks?

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The rigibor

The Lat is the currency of Latvia, the tiny Baltic country in huge difficulties. The authorities try to defend the peg of the local currency. Against the rest of the speculating universe.
We heard of reports stating that the government will come up with another plan in order to secure the lat.
In the mean time are local interest rates – better known as the Rigibor – soaring. Overnight rates are around 20% now.

Defending a currency is costly, because you do this through intervention and it’s a very tricky thing to do once the hunting season is open.

Estonia and Bulgaria are other countries having their local currency pegged to the euro. But they are out the eurozone. Now, is it an advantage to be in the eurozone?
Ask the Irish: they were downgraded today because assets of banks are fast deteriorating. That’s the second time in less than 3 months.
Will the Irish government default on its debt? Prices of insurance against a default – the so called Credit Default Swaps (or CDS) – went up and up and up this morning. The will need the Irish luck...

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Eastern Europe

If the Latvia is the start, how far will the rot spread? For Europeans banks?

The exposure of Western Europeans banks on East European countries was charted a while ago by Zero Hedge.


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