Latvian IMF lesson for the Caribbean

There may be lessons for Caribbean countries in negotiations between Latvia and the International Monetary Fund (IMF) for a rescue programme totalling about US$10.4 billion.

Latvia is a relatively small member country of the European Union (EU). Its population of 2.3 million is roughly the same as the Caribbean’s Jamaica. Until 1991 it was a member of the Union of Soviet Socialist Republics (USSR) dominated by Russia. With the break-up of the USSR, Latvia regained its independent status and elected to join the EU in 2004.{{more}}

Between 2000 and 2007, Latvia enjoyed one of the highest GDP growth rates in the EU, but this collapsed in late 2008, exacerbated by the global economic crisis and shortage of credit. The economy dramatically fell in the first quarter of 2009 by 18%, the biggest fall experienced by any EU country.

Since last year, the Latvian government has been engaged in negotiations with both the EU and the IMF on the $10.4 billion bailout programme.

Anxious to help an EU member state, and mindful that Latvia has pegged its currency to the Euro – the official currency of most of the EU members – the EU Commissioner for Economic and Monetary Affairs Joaquin Almunia has announced the release of $1.6 billion as a rescue loan payment but only after extracting budget cuts worth $1 billion from the Latvian government.

In the event, the EU loan is only 10 percent of Latvia’s needs, and it is the IMF to which the government is looking for the greater part of its borrowing.

The going has not been good. And, despite the rhetoric about more flexibility in fiscal and monetary policies in light of the present and ongoing global financial crisis, the IMF is still pushing tight fiscal policy, cuts in government spending and very low inflation as conditions for its lending.

Before Latvia, Romania faced similar problems with the IMF. It is reported that the IMF mission chief for Romania said that in exchange for $17.5 billion, there were requirements to bring down budget deficits below 3% of GDP, restructure wages policies, recalibrate pension schemes and reduce inflation.

In this regard, the much vaunted increase in IMF resources up to $750 billion after the G20 meeting in London last April could mean little. It seems that what remains vital is the need for reform of IMF terms for lending, or, as the Third World Network has suggested, “additional resources to the IMF would give it the means by which to discipline crisis-hot countries the wrong way, worsening the crisis for them”.

Going back to Latvia specifically, the government announced that the IMF has imposed fresh conditions for it to qualify for rescue funds. Other reports also indicate, as this commentary is being written, that Latvia has been given a deadline by the IMF to agree its conditions, or the negotiations will end.

The Prime Minister, Valdis Dombrovskis, said the negotiations had turned contentious, largely over how quickly to cut the country’s budget deficit. The government wants to reduce the budget deficit, which could hit 10 percent of GDP this year, to 3 percent by 2012, but the IMF wants a faster rate of reduction. Following riots in its Capital City, the Latvian government is naturally unwilling to accept the IMF proposals, lest discontent in the country results in further upheavals.

The IMF also wanted Latvia to devalue its currency, arguing that the present link to the Euro is unsustainable. A devalued currency, they say, would make Latvian exports cheaper. But it would also make imports more costly and push-up the cost of living. Fortunately for Latvia, the IMF appears to be persuaded by the EU to back-off from a requirement for devaluation at this time.

Nonetheless, Latvia is not out of the woods. The Prime Minister has said that IMF backing for its whole programme is necessary even if the government raises the money it needs from other sources. The major areas of contention appear to be: budget deficit levels, further tax rises and reducing spending in key areas like education, welfare and health, even though Latvia has already made cuts that included reductions in public sector salaries and a 10 percent reduction in pensions.

Several Caribbean countries are now considering engagement with the IMF to help their ailing economies.

A few of them have already entered special arrangements that are not rescue programmes. For instance, St Vincent and the Grenadines has an arrangement under the Exogenous Shocks Facility (ESF) which has a higher degree of flexibility and does not include structural conditions but does require a low inflation rate.

Dominica has also received $5.1 million from the IMF under the same ESF. The government had to commit to aim for annual primary surpluses of at least 3% of GDP so as to reduce public debt. It also had to agree to finance capital largely with external concessional resources – a hard task indeed at a time when concessionary financing is drying-up.

Jamaica is presently talking with the IMF about a possible Standby Agreement for Foreign Exchange Balance of Payment Support. The details of the sort of programme that Jamaica is seeking and the terms that the IMF has put on the table are not known as this commentary is being written. But the Finance Minister Audley Shaw has said that “there is no need for the great concern for conditionalites that will be oppressive; that will be destructive to the social sector; that will be destructive to the financial sector. Not at all”.

Jamaica has enough experience with the IMF and enough people who have worked within the IMF to negotiate the best terms possible. But, it is as well for all Caribbean countries to keep their eyes focused on the Latvian experience to which the IMF would be much more sympathetic because of the EU’s lobbying and the place of its key member states on the Executive Board. So far, the IMF does not appear to have relaxed its tough conditionalites.

It is also necessary for the Caribbean to join with others for meaningful reform of the IMF’s lending terms. The existing terms could make hard-hit economies worse rather than better. The forthcoming Commonwealth Finance Ministers meeting is a good place to advance the arguments for urgent reform.

Sir Ronald Saunders is a business consultant and former Caribbean diplomat.
(responses to: ronaldsanders29@msn.com)