DESPIPTE EDVALUATION FEAR , LATVIA STANDS BY CURRETCY

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Despite Devaluation Fear, Latvia Stands by Currency

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By DAVID JOLLY
Published: June 4, 2009

PARIS — Latvia, the European Union member country worst hit by the economic crisis, sought Thursday to convince investors that it would stand by its currency peg as speculation of a devaluation mounted and the country awaited additional aid.
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Ints Kalnins/Reuters

A currency exchange board in Riga, Latvia, showed rates on Thursday. Latvia's currency strained the lower end of the band in which its central bank allows it to trade against the euro.

In December, the European Union, the International Monetary Fund, the World Bank and the Nordic countries backed Latvia's recovery policies with financing worth 7.5 billion euros ($10.6 billion). The I.M.F. agreed to put up 1.7 billion euros of that total, while the European Union offered 3.1 billion euros.

But the disbursal of the latest installment of 1 billion euros has been held up as the Latvian government seeks to carry out painful cuts in public sector wages. European Union and I.M.F. officials are in Riga, the capital, to discuss it.

Fears of a crisis rose Wednesday after Latvia was unable to sell short-term debt and the currency strained the lower end of the band in which the Latvian central bank allows it to trade against the euro. Investors who expected a devaluation would be unlikely to buy debt denominated in the national currency, the lat. One euro currently trades at about 1.41 lats. The band was set in anticipation of the country's joining the euro zone, which is expected in 2012 at the earliest.

NOTE:investors who expected a devalution would be unlikely to buy debt denominated in the national currency, the lat.

"A breakdown in the relationship with the I.M.F. and E.U. would leave Latvia facing a substantial budget and external financing gap," Fitch Ratings said Thursday in a report, adding that "such a situation would be likely to precipitate a devaluation of the lat."

Martins Gravitis, a spokesman for the central bank, said Latvia was committed to the peg "until the lat is replaced by the euro."

Latvia, a Baltic country of 2.2 million people, had a gross domestic product of about $34 billion last year. But output plunged in the first quarter and was expected to contract by about 17 percent for the year.

The government is struggling to reduce its budget deficit, which is estimated at about 9.2 percent of gross domestic product. The I.M.F. had agreed to a revised budget deficit of 7 percent from the original 5 percent, and meeting the current target would not be possible without further budget cuts.

Mr. Gravitis said public sector salaries would have to fall about 30 percent, returning them to 2006-7 levels, to make the budget. The private sector, he said, would find its own equilibrium.

In Washington, Caroline Atkinson, a spokeswoman for the I.M.F., said at a news briefing that the situation in Latvia was "challenging," and that "the authorities have stressed the importance of controlling the government debt and deficits and maintaining the peg."

Prime Minister Valdis Dombrovskis must tread a fine line, balancing international lenders' demands with the knowledge that poverty is increasing and social unrest is rising. Riots in January brought down his predecessor.

Latvians go to the polls this weekend for municipal elections, and officials said political concerns might have affected the timing of the government's new budget announcements.
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Past Coverage

* A Crisis Is Separating Eastern Europe's Strong From Its Weak (February 24, 2009)
* INTERNATIONAL BUSINESS; In Eastern Europe, a Switch to the Euro Comes Slowly (December 6, 2006)
* European Union Eases Rule On Deficits for Six Entrants (May 13, 2004)
* Now, a Latvian Ruble (July 21, 1992)

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