Balts Shouldn’t Devalue But Cut Spending Drastically, Analysts & Central Bank Official Tell BMI Alumni

14.7.2009

 

Currency crises in the three Baltic nations can be solved better by radical government budget cuts, however painful, than by devaluations, which might provoke economic chaos, a leading Latvian professor, a Lithuanian central bank official and a top financial analyst said at a discussion with corporate executives organised by the BMI Alumni Association.

 

Raimondas Kuodis, director the Lithuanian central bank’s Economics Department, Morten Hansen, head of Economics at Stockholm School of Economics in Riga, and financial analyst Stasys Jakeliūnas took part in the debate with business leaders in Vilnius last night. Dramatic economic downturns in Latvia, Lithuania and Estonia have put pressure on their currencies and call for reasoned discussion of possible devaluations, an issue that was previously taboo, participants said.

 

“I don’t think credible devaluation, moving from one fixed exchange rate to another without panic and collapse of the currencies, is possible,” Prof. Hansen told the gathering. He recommended “ruthless”, “draconian” budget cuts in keeping with those the IMF and European Union are demanding of Latvia, as the only way to calm markets.

 

The Baltic central banks and governments have repeatedly rejected devaluation as a policy option, even against the recommendations of some well-known international experts. Among others, Bengt Dennis, the former Swedish central bank governor and an adviser to the Latvian government, and Kenneth Rogoff, a Harvard University professor and former chief economist at the IMF, have said Latvia needs to devalue.

 

“My position regarding devaluation is no, no and no. We have to suffer through this period and not add another problem,” Bank of Lithuania’s Kuodis said. “I believe that a substantial devaluation would lead to the bankruptcy of many, including the government, and thus a major contraction of domestic demand,” he added.

 

Kuodis noted he had a long conversation with Kenneth Rogoff about two weeks ago: “He understood the arguments about the currency composition of the balance sheets of the households, firms and the government, and the state of competitiveness of our exporters. These details are hard to appreciate when you’re far away from the local situation.”

 

Stasys Jakeliūnas cited a recent headline in the Economist, “choosing economic torture over chaos”, as a very precise evaluation of the current Baltic situation. He examined the various channels by which a devaluation in any one Baltic country could lead to the same in the other two, including trade relations, borrowing costs, possible runs on the region’s banks and, above all, self-fulfilling negative market expectations.

 

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