With his country reeling and on the verge of becoming the next Iceland or Argentina, two countries whose economies collapsed and needed international bail-outs, Latvian Prime Minister Valdis Dombrovskis came to Brussels to meet European Commission President Jose Manuel Barroso to show it will meet tough requirements set by the European Union and the International Monetary Fund needed to get another 1.2 billion Euro in aid, part of a 7.5 billion Euro rescue package that had been cobbled together to save the once-tiger of the Baltics. Before he did, he met with New Europe for an interview to explain what the government was doing, but the problem is complex. 

After a consumption-driven boom that began in 2000 and caused red-hot property values that created an artificial bubble, it began to burst for Latvia late in 2008 as the worldwide recession gripped the country, sending real estate worth plummeting and necessitating the need the EU-IMF bailout, with Sweden joining because its banks had invested heavily in the country and the Baltics and had a lot to lose.

But the aid was tied to Latvia instituting harsh reforms with deep cuts in social spending to try to stem the near-collapse of the GDP, which fell 18 percent in the first quarter, and when the IMF said the pace of reforms was too slow, it withheld the 1.2 billion Euro aid which Latvia now wants released. That prompted Dombrovskis, a physicist who was a former Member of the European Parliament and a member of the budgets committee, to come to Brussels to meet Barroso to push for release of the aid money and show Latvia is proceeding with tough measures that would reduce the budget deficit of 9.2 percent – far above the IMF’s standards and the EU’s benchmark of three percent needed to join the Eurozone – to seven to eight percent by slashing spending by 500 million lats (USD 1.01 billion, or 715.34 million Euro) this year.

That proposal goes to the Latvian parliament on June 17, but there has been social unrest, and riots in January as people took to the streets to protest the fall in their standard of living in a country where 28 percent of the population is Russian, and where the previous generation remembers living under state-run cradle-to-the-grave Communism, leading to fears that going to privitisation (some 68 percent of the GDP is generated by private businesses) has working class citizens fearing the capitalism is a gilded coffin for their dreams. Without the next round money, the lat could be deeply devalued, panicking investors and starting a stampede in Eastern Europe and Sweden, whose banks are so closely linked to the rise-and-fall of the Baltics and Latvia. The boon was consumptiondriven and underwritten by soaring private debt, the same scenario that started the domino effect of collapse and recession with the sub-prime mortgage debacle that began in the US, with the same financial underpinnings, which coincided with a hands-off laissez-faire approach by government, which left financial institutions barely regulated and free to start what amounted to a run on the banks and on the coffers of countries.

President Valdis Zatlers said it would be “murder” if the country doesn’t adopt the reforms required by the EU and IMF because that would signal the end of international aid, bring down the country and cause a chilling ripple effect throughout the region, playing further into the hands of Eurosceptics. The signs of implosion are popping up in the graceful Art Nouveau blocks of downtown Riga, the capital. Dozens of shops have been abandoned. Restaurants and beauty salons are empty. Streets are quieter as cars repossessed from bankrupt Latvians are sold to foreign buyers at discount prices. Teachers face a drop in their salaries to the minimum wage level of 199 Euro a month – itself cut from 256 Euro – and police salaries for some officers have been cut 30 percent, a lure for corruption to supplement pay in an atmosphere in which public workers believe they have been abandoned by the government. Analysts say Latvia, like Baltic neighbors Estonia and Lithuania, is paying the price of a lending binge fueled by over-exuberance in the boom years after the three — formerly part of the Soviet Union, which fell apart in 1991 — joined the EU in 2004. Enticed by cheap, easy-toget loans, Latvians snapped up consumer goods, automobiles, and real estate. Salaries rose quickly and inflation soared to nearly 18 percent. The bubble burst at the worst possible time, right before the global downturn set in.

In the interview, Dombrovskis elucidated.

First of all, we are talking about an agreed macroeconomic stabilisation package where the total amount of 7.5 billion Euros, of which the EU is contributing the largest share. Suddenly we appreciate the efforts of the Commission and also some EU member states are taking to assemble this international loan package and as we saw from today, there are also positive signals from the commission that they will be able to continue with disbursement.

In order to do that you have to convince the EU and the IMF that you are making significant cuts - slash salaries, reduce the minimum wage, all of which would hurt working people. Where is that 7.5 billion Euro going, if it’s not going to them?

First of all, we must understand the macroeconomic background. In previous years, even though we had double digit growth the previous government did not even balance a budget so right now we have to make extremely huge fiscal adjustments somewhere on the scale of more than 10 percent of GDP. And in order to do this we need to make major adjustments and in the next year we will have significant budget deficits with the aim of a budget deficit below three percent by 2011 and 2012.

You are at 9.2 percent. The IMF wants you to go to five percent. You are asking more for seven percent. Which goal do you think you can reach and by when?

Well the problem is that now that we’ve agreed to not chase a deficit figure because that’s what we had been doing for the last half of the year. When the programme was launched the recession assumption was five percent. In March,when I took over the government, it was 12 percent recession, now it is 18 percent, so we’ve agreed to stop chasing this moving target. Instead we have agreed on an amount of measures we need to deliver for this year. If we deliver these measures, we can continue receiving the international loan package.

Is it fair for the EU to put such harsh requirements on you? The EU benchmark is three percent of the deficit. Italy, France and Greece can’t meet that. Why should Latvia?

Our problem is that we are not able to finance our budget deficit from international financial markets. In this term we are dependent on the conditions set by international loan providers. The terms are quite harsh but we do not have much of an option but to meet those terms.

Do you think it’s fair that they put these conditions on you? They gave much more than 7.5 billion Euro to the banks and required nothing of them. The banks won’t even lend them money

You cannot compare the international loan package with a bank rescue. One of the reasons that we had to turn to the international package, we had to rescue our largest independent commercial bank. The problem with the bank is on one hand a system building bank, and if you let those banks fail, it may have a domino effect to other banks to enterprises which had accounts in those banks and the consequences for the economy may be even much worse so from this point of view it is quite understandable that you rescue those banks which are important for the financial system. Another question is do you need to rescue the bankers.

How are you going to prevent the riots you had in January if indeed the social cuts are instituted, you get what you want from the EU and the IMF, but the working class people’s standard of living falls?

Now we are working quite intensively with social partners, with trade unions, with employer’s confederation, with local government to actually reach an agreement on how we are moving with this 500 million lats package.

That’s 715 million Euro. That’s a lot of money to cut from a budget

It is quite a significant cut. It is 20 percent of what remains of our budget for the second half of this year. Suddenly if you subtract some expenditures which are not subject to reduction like interest payments, payments to international organisations like social funds that we are trying to secure as much as we can, then it is very severe cuts to what is left and it is on top of two rounds of budget cuts for this year’s budget already.

Is there any fear you are destroying Latvia in order to save it?

Measures are of course very serious; there is no doubt about this. But, a real alternative currently is just worse.

What is the alternative?

One alternative is to do nothing and not to receive the international loan package. In this case we would just go bankrupt.

Do you feel you’re being preached to? The Swedish Finance Minister said you have to meet the reforms that the IMF and the EU want, but isn’t he really interested in saving the interests of Swedish banks that invested heavily in Latvia?

Well, Swedish banks are quite heavily exposed to Latvia. We are part of the problem and we had a overheat and way too easy credit and now they have their own interests to preserve stability but this happens to be our interest to preserve stability in our country.

Some economists want you to devalue the lat, they think it will help people The banks don’t. They fear it will cause panic among investors and a ripple effect throughout the Baltics and eastern Europe. So what do you do, you’re kind of between a rock and a hard place aren’t you?

With devaluation, we do not see this as an option it is not clear how this will help people. The purchasing power of the people will deteriorate even faster than with the budget cuts that we are doing. The experience in many countries is that devaluation tends to get out of control, plus it is not even solving the budget deficit problem.

Valdis Dombrovskis is the Prime Minister of Latvia

Why should the EU help Latvia?