Latvia will devaluate, adviser Bengt Dennis says

Source: Bloomberg

Bengt Dennis, the former Swedish central bank governor and an adviser to the Latvian government on how to cope with the economic crisis, said the Baltic country will need to devalue its currency.

“No one knows if there will be a devaluation tomorrow or in a few months -the timeframe is always uncertain- but we have moved beyond the question of whether there will be a devaluation and should instead focus on how it will be carried out,” Dennis told Swedish state television SVT last night.

Latvia’s economy shrank an annual 18 percent last quarter, the steepest slump in the European Union, as domestic demand collapsed and property values slumped the most in the world. The government is struggling to cut budget spending so it can continue to receive its international bailout, the terms of which assume an economic contraction of 12 percent this year.

Dennis’s comments last night are “the expert’s personal, individual opinion” and are unrelated to the working group of which he is a member, Latvian Prime Minister Valdis Dombrovskis said in an e-mailed statement today.

The comments on devaluation aren’t “the position of the government of Latvia,” Dombrovskis added. Latvia’s talks with international lenders “are based on the requirement of a stable national currency,” the statement said.

‘Less Costly’

“The announcement by Dombrovskis supported our view that the government remains firmly committed to preserving the currency peg,” said JPMorgan Chase & Co. economist Yarkin Cebeci in an e-mailed note today. “Preserving the peg and taking the necessary fiscal measures is still less costly, both economically and politically, than a devaluation.”

Swedish banks including Swedbank AB and SEB AB, the largest in the Baltics, will suffer from falling asset values if Latvia devalues its currency. The banks have been lending in euros while Latvian borrowers earn wages in lati, meaning a devaluation may undermine locals’ ability to repay their debts.

Swedbank fell 2.6 kronor, or 5.4 percent, to 45.3 kronor in Stockholm trading as of 1:33 p.m. SEB declined 1.2 kronor, or 3.4 percent, to 33.7 kronor while Nordea fell 1.4 kronor, or 2.2 percent, to 61.1 kronor.

SEB has 166 billion kronor ($22 billion) of outstanding loans in the Baltic states of Latvia, Lithuania and Estonia, or 13 percent of its total loan book, while Swedbank has loaned more than 200 billion kronor to the region, the banks say.

Loan Losses

Sweden’s four largest banks will have an estimated 170 billion kronor of loan losses in 2009 and 2010, of which almost 40 percent will stem from the Baltic states, Sweden’s central bank said in a report today. The banks can handle losses exceeding that amount and will be able to cope with losses on bad credit of 300 billion kronor over the next two years in the central bank’s worst-case scenario, Sweden’s Riksbank said.

The Latvian government has committed itself to wage and spending cuts to bolster competitiveness and rebalance the economy while keeping its peg to the euro. Latvia is a member of the pre-euro exchange rate mechanism and defends a 1 percent band around a target rate to the euro.

Devaluation Debate

Justice Minister Mareks Seglins said yesterday the government should debate a devaluation of the lats, the Baltic News Service reported. Seglins wants the central bank and the Finance Ministry to create estimates for possible gains or losses from a change in the value of the currency, Seglins said, according to the Riga-based newswire. “I am not calling for the devaluation of the lats, but there must be a debate,” he said.

Latvia in April appointed a group comprising Nordic and European economists and advisers to help the country cope with the crisis. The group also includes Sirkka Haemaelaeinen, a former Finnish board member of the European Central Bank.

Dennis was governor of Sweden’s Riksbank during the Nordic country’s banking crisis of the early 1990s. In 1992, he raised the repo rate to 500 percent for a few days to defend the the krona. The plan failed and Sweden was forced to abandon the krona’s peg to the European Currency Unit, a basket of currencies of European Community member states. Dennis has also worked for SEB AB, the second-largest bank in the Baltics.

In December Latvia signed a 7.5 billion-euro ($10.7 billion) bailout from a group led by the International Monetary Fund and the European Commission. The bailout is equivalent to about 34 percent of gross domestic product.