Polish, Swedish Officials Urge Action on Latvia

Polish and Swedish officials appealed for swift action to help beleaguered Latvia on Friday to prevent its economic crisis from spilling over into other countries in Europe.

The tiny Baltic state, facing a brutal economic contraction of up to 20 percent this year, is struggling to avoid a currency devaluation that would hammer heavily exposed Swedish banks and reignite worries over East Europe's prospects.

However, a senior IMF official, some economists and ministers from two other countries which like Latvia peg their currencies to the euro all played down the fears of regional contagion, arguing that Riga's predicament was uniquely grim.

Latvia's prime minister, Valdis Dombrovskis, reaffirmed that his government was not planning to devalue the lat. The issue of Latvia's currency peg was not raised in talks on Friday with the IMF and the EU, he said.

"There is a threat that the situation in Latvia may spill over into the region," Dariusz Filar, a member of the Polish central bank's Monetary Policy Council, told reporters on the sidelines of an economic conference in Warsaw.

"This situation is a challenge that requires a reaction on a broader scale than just Latvian, there is a need for more international assistance," he said, without giving details.

Filar's comments knocked regional currencies. Poland's zloty and Hungary's forint traded down about 0.7 percent against the euro in late afternoon trade.

The International Monetary Fund and European Commission say Latvia must make further deep spending cuts before receiving fresh loans. Negotiations with the lenders are now underway.

Pain

Economists say failure to clinch a deal could make devaluation unavoidable, greatly increasing the pain for the many Latvian companies and households holding large debts denominated in foreign currencies.

AP Latvian flag with PM Valdis Dombrovskis

"We need to reach a result in the negotiations and it must happen soon," Swedish Finance Minister Anders Borg said on Friday in Stockholm. "The government's view is that they need to take more measures (in Latvia)."

Speaking at the Warsaw conference, called to mark the 20th anniversary of the fall of communism in Poland, EU Monetary Affairs Commissioner Joaquin Almunia said he expected Latvia's parliament to approve further spending cuts.

"I recognize the difficult situation of Latvia but at the same time I am confident that adequate measures will be adopted," he said.

Devaluing the lat would increase pressure on neighboring Estonia and Lithuania but is unlikely to affect the broader region of central and eastern Europe, JPMorgan analyst Nana Francois said in a note to clients.

"We note that the GDP of the three Baltic countries equates to less than 1 percent of eurozone GDP and around 5 percent of emerging Europe GDP, so the regional impact would be low." Marek Belka, head of the IMF's Europe department, also said he did not expect much regional impact from the situation in Latvia.

Talk of devaluation has been swirling for months in the ex-Soviet republic of two million, which saw its worst riots in January since it regained its independence from Moscow in 1991.

"People are talking about this all the time and some friends of mine have bought foreign money, but I don't see a reason why to do it," Raivis Karlsons, 31, a plumber, told Reuters in Riga.

Estonia's foreign minister and Bulgaria's finance minister both insisted, in separate statements, that their countries were in better fiscal shape than Latvia and that they did not see in the crisis a direct threat to their own currency boards.

Latvia's travails have revived a debate about the value of currency board regimes.

Juergen Stark, a member of the European Central Bank's executive board, said countries with flexible exchange rates such as Poland were better placed to avoid big macroeconomic imbalances and to absorb the effects of an economic slowdown.

No Softening of Rules

Almunia, Stark and European Central Bank head Jean-Claude Trichet, who was also in Warsaw, all made clear there would be no easing of rules for euro zone membership due to the crisis.

"For the governing council of the ECB, what counts are the criteria," said Trichet, referring to tough rules on inflation and budget deficits which most east European states keen to adopt the euro will now have great difficulty meeting.

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Trichet said Poland had built up fewer macroeconomic imbalances, allowing it to weather the global crisis better than many of its peers in ex-communist Europe.

And addressing all euro aspirants, Trichet said: "Only after the elimination of major macroeconomic imbalances and when sufficient convergence has been achieved can countries expect to reap the full benefits of euro area membership."

Poland, the largest ex-communist EU member, wants to join the euro in 2012 but economists say this date is unrealistic.

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