Savage cuts test Latvians to the limit

Latvia’s government has allayed international fears that it was on the verge of having to devalue the currency, according to Valdis Dombrovskis, the prime minister – but it must now assuage domestic fears about deep spending cuts.

“We have calmed down the financial market,” said the 37-year-old premier. “Our main task now is to preserve the social peace.”

Fears that Latvia was on the brink of abandoning its currency peg are receding after coalition leaders agreed 500m lats ($998m, €712m, £606m) of tax increases and spending cuts, designed to cut the budget deficit by 10 per cent of gross domestic product during the next three or four years.

But Mr Dombrovskis, who took over in March after riots helped bring down the government, said his main concern was not whether parliament would pass the budget but how people would react.

“As this is the third round of budget cuts this year, people are becoming weary,” he said. “It’s coming to the limit. We must send society positive signals that there are no more cuts this year.”

Latvia has gone from boom to bust spectacularly. From 2004 to 2007 it experienced annual expansion of more than 10 per cent. But the country ran up Europe’s biggest current account deficit in 2007 as inflation and spiralling wages hit its competitiveness. This year the economy is forecast to contract by 18 per cent.

The government’s determination to maintain the peg and keep open possible euro entry in 2013 compels an agonising economic adjustment.

The decline has been so savage that during the past two weeks Latvia has been rocked by speculation that its €7.5bn economic stabilisation programme was in trouble and that it would be forced to devalue the lat. The speculation affected other east European currencies, the Swedish krona and shares in Swedish banks that dominate Latvia’s market.

As part of the austerity package, the public sector wage bill will be cut by 20 per cent – for the second time this year – while pensions will be reduced by 10 per cent.

“How will we survive?” said Anna Matouk, a Russian-speaking pensioner at a street market in the Riga surburb of Jurmula. She is supporting herself and her unemployed son on a pension of 156 lats a month, turning her fridge off for a few hours each day to save money.

“I haven’t bought anything,” she said tearfully. “I can’t afford to buy anything. The only thing left to do is to die.”

Mr Dombrovskis said the European Commission gave him clear indications on Wednesday the cuts would be enough to release a €1bn loan pledged by December’s International Monetary Fund-led rescue package.

He said the IMF, which froze a €200m tranche in February because of budget delays, had also given “positive indications” – but neither donor would release funds until after the revised 2009 budget was approved by parliament next week.

“The EU ... confirmed if we made the necessary budget adjustment of 500m lats we will continue to receive the international loan,” he said.

The prime minister said the government had funds to last until the autumn anyway: “We must send a strong signal that our [IMF] programme is on track and that we will receive this money.”

Mr Dombrovskis said the recession appeared to be bottoming out. He did not expect to have to make many more cuts next year on top of those already announced.

“Once you are in the hands of international loan providers they tend to go too far,” he said. Donors conceded Latvia need no longer aim for a budget deficit as a percentage of GDP because accelerating economic contraction put it for ever out of reach. “We must stop chasing a moving target. We agreed the size of the [austerity] measures and that should be it for this year.”