Trading Forex- Latvian Lat.

By: Mike P. Kulej

Over last few weeks a small country in Europe found itself in a center of a financial storm. In a situation closely resembling plight of Iceland last fear, Latvia is suffering an economic crisis harsher than any other country in Europe. Outcome of which could be just as severe and prevent the small country from fully integrating in EU financial system any time soon.
This Baltic state ran into with help unprecedented surge in credit-fueled economic growth that rushed through that region of Europe. All three of those countries were deluged with foreign loans, eager to participate in their red-hot property markets. Estonia and Lithuania noticed dangers of excessive spending much sooner and worked to slow the pace of expansion. Latvia’s leadership, however failed to respond to calls for restraint until it was too late.

Latvian troubles are far from being a local affair. Lion share of any losses would be carried by Sweden’s banks, whose exposure to Baltic region amount to $80bn, or 16% of Swedish GDP. The Krona (SEK) has already suffered on fears of loans default. Things could get worse, because credit losses might reach as high as over 30% of loans for Swedbank and SEB, the two biggest banks in Sweden. The European Central Bank is also worried and has already lent Sweden €3bn to support the banks, with fears that more is needed.

Some of the excessive lending was facilitated by stellar performance of the local currency in preceding years. Latvian Lat has been pegged to Euro, which helped to to be a strong international performer. Riga would like to maintain this status quo, because this will it entry into the single currency zone within the next four years. Any serious pain to the Lat could jeopardize the plan.

Most countries in similar position, hit with financial crisis, opt to devalue their currencies. Government in Riga is trying avoid this route, choosing financial austerity – painful cuts everywhere. And those are meaningful. Pay cuts for public sector workers are scheduled to reach 20% and effect most of the workers in a country of 2.3 million. Retirees and pensioners will suffer 10% reduction.

Currently this plan has the backing of the International Monetary Fund and the European Union. This consortium had pledged about €7.5 Billion in emergency aid, but withheld it pending government concessions. Now that the plan is formulated, this money is being released. This should shore up shaky financial system, as well as restore confidence, if temporarily. Lat remains pegged to a Euro and financial markets are giving Latvia some breathing room.

A lot is riding on this experiment. Outside of the obvious local currency repercussions, scores of countries around the world are watching Latvia with interest. Unlike USA or UK, smaller countries are unable to borrow their way out of crisis. At the same time nobody is willing to make critical yet unpopular budget cuts. This includes public spending, reducing government work force, raising taxes. But Latvia is believed to be first in cutting salaries.

Though steps taken there seems painful, they might not be enough. Under the rescue terms, Riga has pledged to keep its budget deficit to 5% of gross domestic product. But with the economy contracting much faster than then forecast, due to recession, the deficit could reach 12% without drastic action. Even with the latest cuts, it is projected to be 7%, a number outside of the boundaries of agreement.

Latvian government is willing to take this gamble, in hopes to qualify for eurozone membership by the government’s 2013 target date. Until recently there was little doubt about it- country enjoyed fastest growth in the Europe. Now forecast is for economy contracting as much as 18% this year an unpredictable future, which depends largely on health of both EU and Russia.

Should the stabilization plan fail, it could have a domino effect on other economies in the region. Most comparable are Lithuania, Estonia and Bulgaria. These countries also have fixed or “pegged” exchange rates, which would likely collapse in the aftermath. Full integration of any new members into EU would also be delayed. European banks with above average exposure to these countries will once again suffer. This, in turn, could prolong EU’s own recovery.

Article Source:
http://www.goarticles.com/cgi-bin/showa.cgi?C=1862015

About the Author
Mike P. Kulej is a Chief Forex Strategist for Spectrum Forex LLC. He specializes in mechanical trading systems as explained on www.spectrumforex.com. Spectrum Forex LLC offers numerous services to individual traders. He also publishes trading blog under name FXMadness.com where he extensively covers currency crosses . With questions and comments e-mail him at kulej@spectrumforex.com.