Latvia Will Seek Agreement to Appease Bailout Donors

By Ott Ummelas and Aaron Eglitis

Oct. 12 (Bloomberg) -- Latvia will seek to strike a last- minute agreement on budget cuts today to satisfy bailout terms in the latest round of brinkmanship that has tested the patience of the country’s international loan donors.

Prime Minister Valdis Dombrovskis has signaled his Cabinet will agree on an additional 175 million lati ($362 million) in cuts at a meeting today to satisfy the International Monetary Fund, the European Union and Sweden. Coalition members are due to meet at 12 noon in Riga. European Union Monetary Affairs Commissioner Joaquin Almunia will visit Riga tomorrow.

“They’re in the clear for the time being, but similar temporary disagreements will likely recur,” said Richard Segal, a fixed-income desk strategist at Knight Libertas U.K. “There is a history of Latvian politicians becoming complacent and trying to sneak in lower budget cuts, which the EU and IMF notice at the last minute. I wouldn’t rule this out in future.”

The IMF, the EU and Sweden agreed to give Latvia a 7.5 billion-euro ($11 billion) loan in December and urged the government to adopt tougher austerity measures. Swedish PrimeMinister Fredrik Reinfeldt, who holds the EU presidency, on Oct. 5 said Latvia “must correct” its deficit while Riksbank Governor Stefan Ingves has said the country risks being “left in the cold.”

‘Fruitful’

International admonitions grew more strident in tone after Latvia said it could achieve a targeted 8.5 percent deficit of gross domestic product in 2010 by cutting 325 million lati off the budget, 175 million lati less than the IMF, the EU and Sweden had demanded.

Latvian coalition parties are ready to discuss a tax on real estate, which Parliament voted against sending to committee stage on Sept. 17, the Diena newspaper reported today. All coalition parties agreed to introduce the tax when they signed agreements with the EU and IMF.

Sweden’s banks are the biggest in the Baltic states. Stockholm-based Swedbank AB, the region’s biggest lender, rose 7.5 percent to 68.25 kronor in Stockholm as of 10:53 a.m. in Stockholm. SEB AB rose 2 percent to 46.1 kronor. The krona slipped 0.1 percent against the euro.

The yield on Latvia’s 5.5 percent government bond due March 2018 rose 6 basis points today to 7.31 percent. The OMX Riga stock index fell 2.7 percent as of 11:31 a.m. trading today, and the lats was little changed at 0.7095 per euro. Credit default swap spreads on Latvian five-year debt rose to 594 basis points from 587 on Friday, according to CMA DataVision prices in London.

‘Fruitful’

The IMF on Oct. 9 said it concluded a visit to Latvia that included “fruitful” discussions about the loan program. An IMF staff team visited Latvia as part of a technical mission in consultation with the European Commission and plans to return in November, together with the EU, for a review of the program, it said in a statement.

Finance Minister Einars Repse said if the bailout program is suspended, Latvia will be forced to balance its budget next year and “live hand to mouth.”

In the event of a suspension, Moody’s Investor’s Service will cut the Baltic country’s credit rating, and the country may have to repay part of its loan early, depleting its reserves, Repse said in an interview on national television broadcast last night.

Billionaire George Soros called on the EU to ease its budget-cut demands to slash budget spending in an interview with Swedish public radio on Oct. 10.

‘Wrong Kind’

“The pressure for them to reduce government spending when the problem is in the private sector is a wrong kind of policy that ought to be avoided,” said Soros. “I think the European Union countries are in a position and ought to help Latvia more than they are currently doing,” he said. Soros said he had no currency positions in the Baltics.

Less severe loan terms might have saved both sides some pain, Knight’s Segal said, adding that Latvia, which pegs the lats to the euro, and its creditors would benefit from making agreements more flexible, with policy requirements contingent on economic developments.

Dombrovskis is trying to limit the pain the budget cuts are inflicting on the economy through legislative changes. The premier on Oct. 6 asked his civil servants to investigate the option of capping mortgage holders’ liability, a move perceived by some investors as a first step toward shielding the internal economy from a devaluation.

Little Impact

According to Segal, the proposal “would not have as much of an impact as a lot of people seem to think.”

Swedish lenders would suffer the deepest blow from the plan, which would swell loan losses. The krona dropped as much as 1.5 percent against the euro on Oct. 7, after investors learned the news. Stockholm-based Swedbank AB, the region’s biggest bank, lost 2.4 percent the same day.

Investors need to take loan losses at Swedbank and SEB AB, the second-biggest Baltic lender, into account when assessing the potential harm the mortgage proposal may inflict, Segal said.

“The impact of any plan on the future value of the Swedish banks in Latvia has to be compared with what they have already written down and I think a lot of commentators have overlooked that,” he said.

Swedbank’s gross provisions for Latvian loans were 4.5 billion kronor in the first half, or 12.77 percent of total lending, the bank said on July 17. SEB, which doesn’t provide country-specific figures for the region, said net credit losses in the Baltics for the same period were 4.93 percent. That compares with Swedbank’s 7.36 percent loss ratio for the region.

‘Bottom Occurred’

“Clearly the bottom of the economic cycle has occurred, we couldn’t have said this three or four months ago and therefore I’m pretty sure that a compromise will happen sooner or later,” Segal said.

The $34 billion Latvian economy “probably bottomed out during the second and third quarter,” Dombrovskis said on Oct. 2, citing Economy Ministry forecasts. Fitch Ratings on Oct. 6 forecast a 4 percent output contraction next year after an 18 percent slump in 2009. Swedbank expects Latvia’s GDP to shrink 2 percent next year, it said on Sept. 29.

To contact the reporters on this story: Ott Ummelas in Tallinn at oummelas@bloomberg.net