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Latvia Sobers Up As the Party Ends
The Washington Diplomat / May 2009

By Larry Luxner

Only yesterday, it seems, Latvia was Europe's fastest-rising star — a former Soviet republic that had transformed itself from an impoverished Baltic backwater into a high-tech haven with more cellphones than citizens.

But Latvia grew too fast for its own good.

These days, it's one of the continent's worst basket cases — and somewhat of a liability for the 27-member European Union, which admitted Latvia as a full member exactly five years ago this month.

"In a way, we have become victims of our own success," said Riga's envoy here, Andrejs Pildegovics, in an unusually frank interview with The Washington Diplomat.

Our meeting took place Apr. 1, following violent protests in early February that brought down the center-right government of Prime Minister Ivars Godmanis — making Latvia's government the second in Europe to collapse, after Iceland, in the wake of global financial chaos. Valdis Dombrovskis, who leads the coalition that replaced Godmanis, must now deal with Latvia's gravest economic crisis since independence — a looming disaster that also threatens prospects for recovery in the other two Baltic republics, Lithuania and Estonia (see related story).

"This crisis is unprecedented in scope and scale, and we don't know if we've seen the bottom yet," Pildegovics warned. "Some economists are forecasting a contraction of 10 to 12 percent in 2009. It's not impossible. This year is going to be very tough for many households."

On Apr. 9, London-based ratings agency Fitch downgraded all three Baltic states, citing their worsening economic situation. Fitch cut Estonia's long-term foreign currency issuer default rating to BBB+, from A-, Latvia's to BB+ from BBB-, and Lithuania's to BBB from BBB+. But it raised particular alarm about Latvia.

"The downgrade of Latvia's ratings," said Fitch, "reflects the deterioration in the prospects for the Latvian economy and elevated risk of policy slippage" since Riga secured a $10 billion bailout from the IMF, the EU and other lenders in December.

Under conditions of the rescue package, the Dombrovskis government must dramatically slash spending. The new government has already made deep cuts, asking ministers to put together proposals for further cuts amounting to 20, 30 and 40 percent of planned spending. But the IMF has complained that it still must do more to bring down public spending, postponing a payment of 200 euro recently because of a lack of progress.

Among other things, the government has promised not to run a deficit exceeding 5 percent of gross domestic product for 2009.

But Dombrovskis warned in mid-April that unless it receives the promised cash from the IMF, the EU and other lenders, his country could face bankruptcy by the end of June. And if Latvia falls, so will a string of Western European countries from Austria to Switzerland that hold Eastern Europe's massive debts.

The crisis has indeed pitted struggling Eastern neighbors against their wealthier Western counterparts, who are reluctant to bail out countries that gorged on credit. But not long ago, the Baltics were the darlings of Western Europe.

Latvia, about the size of West Virginia, is home to only 2.2 million people, 10 percent fewer than when it re-emerged as an independent country in 1991 following the breakup of the Soviet Union. That makes it much more populous than Estonia (with 1.3 million people), but not as populous as Lithuania (with 3.5 million people).

"Over the last 18 years, we had regained freedom and independence, and we saw a very profound transition from a Soviet-style, centrally planned economy run from Moscow into a modern, free-market, European-style economy," said Pildegovics. "It was a remarkable transition. When the USSR imploded in 1990, we inherited the legacy of this bankrupt economic system. We turned the page and started a new chapter in our history."

At the time of the collapse, Latvia, Lithuania and Estonia shared a reputation as "the happiest barracks in the Soviet Union," he joked. But the Baltics paid a heavy price for independence, with GDP immediately falling by 40 percent and unemployment jumping to 20 percent as Latvia's lifeline to Moscow was cut.

The country's low birth rate wasn't enough to compensate for the mass emigration of ethnic Russians — who suddenly felt like foreigners in their own land — and Latvia's population began dropping.

Pildegovics, 37, was only 19 years old when Latvia — an ancient land that first declared independence in 1918 following World War I — regained its sovereignty and embraced both democracy and free-market reforms with unbridled enthusiasm.

A specialist in Chinese history who studied at the University of St. Petersburg, the Beijing Foreign Languages Institute and Stanford University, Pildegovics served as foreign-policy adviser to former President Vaira Vike-Freiberga during her 2000-07 term of office. He's been at his current post since July 2007.

"In many respects, we telescoped our development from a bankrupt socialist system into a 21st-century economy, and it was a real success story," he told The Diplomat."We joined the Shengen [passport-free] zone. In May 2004, we were admitted to the EU. We normalized relations with Russia, and we joined NATO, so security is not an issue anymore. We hosted the NATO summit in Riga in 2006 to showcase the Baltics and demonstrate that our membership in NATO is irreversible."

Latvia's entry into the EU was a "blessing which triggered a completely new ball game," said Pildegovics. "People had mobility. Latvians could suddenly work everywhere in the EU. If you're an IT specialist, you could easily earn twice as much in Ireland as in Latvia, so the government raised salaries to keep the smartest people from leaving the country. And excessive spending contributed to the rise in inflation."

The country's GDP grew by an astonishing 11.9 percent in 2006 and 10.2 percent in 2007. It became a mecca for the high-tech, IT and the banking and service sectors; as such, Latvia was one of the first nations to achieve a telephone penetration rate exceeding 100 mobile lines per 100 people, and it quickly surpassed the United States in per-capita broadband Internet access.

Yet as investors flocked to Latvia, the economy started showing signs of strain.

"By 2006, it was overheating, and our current-account deficit went as high as 22 percent. Banks were eager to provide loans for 30- to 40-year mortgages, at rates as low as 3 percent. A lot of cheap money was available on the market, and people were investing very aggressively. Money was flowing into the country from all over the EU," said Pildegovics.

"People and companies thought this trend would go on. Remember that for the last 18 years, things were going only up and up, and for the last five-year stretch it was just mushrooming. We had an enormous explosion in economic activity. The wealth nearly doubled. But some economists were cautioning that the situation was not sustainable."

Things came crashing down last year, when liquidity suddenly dried up and banks stopped lending. The government was forced to buy 85 percent of Latvia's second-largest bank, Parex. It also slashed state salaries by 15 percent — a move that extended to all 11 employees of the Latvian Embassy in Washington, including the ambassador.

"Psychologically, it's a very difficult adjustment," Pildegovics admitted. "One of our responsibilities is to objectively explain our own mistakes to the Latvian people."

But that's easier said than done. On Apr. 2, an estimated 10,000 teachers, scientists and other public employees took to the streets of Riga to demand better working conditions and protest against cuts in education spending.

As of press time, some 113,000 people — 10.4 percent of Latvia's workforce — were unemployed, compared to less than 5 percent only five years ago. About 16 percent of those currently without jobs are 20 to 24 years old, many of whom were laid off after Latvia's construction industry slowed down. Of the total number of unemployed Latvians, only 50,000 are getting any unemployment benefits.

"In our case, we had a combination of two crises — one internal, the other external. The previous coalition had a very narrow majority in Parliament, with only 53 out of 100 seats. They had difficulty navigating policy, and of course the external crisis overlapped. Unlike some regional crises of the past, which affected one or two countries, this time it's on a much bigger scale. All of our major trading partners — Russia, Britain, Scandinavia — are facing contractions."

As a result, last quarter, the country's $20 billion economy has shrunk by more than 6 percent. Latvia's currency, the lats, is worth $1.87 and falling; although it's pegged to the euro, many people are calling for full adoption of the euro well before the current target date of 2012.

In fact, an IMF report issued Apr. 5 said crisis-plagued countries in central and eastern Europe should consider scrapping their currencies in favor of the euro even without formally joining the eurozone — a move opposed by many larger and wealthier EU member states like France and Germany. Various economists from Central and Eastern Europe also agree, saying it would only alleviate the immediate pressure without addressing the needed long-term structural changes.

In the meantime, the EU has focused largely on providing funds for IMF loans and boosting financial regulation, stopping short of offering direct bailouts. In mid-April, the European Bank for Reconstruction and Development announced that it would make 200 million euro available for Latvian businesses.

Yet Dombrovskis is warning of serious times ahead, refusing to rule out the possibility that Latvia might need an additional 1 billion euros to stave off financial disaster.

"My mission is to keep the U.S. informed of what steps our government is taking," said Pildegovics. "Washington is not just the seat of the U.S. government, but also headquarters of the International Monetary Fund and the World Bank. And we are in very intense negotiations with the IMF."

Pildegovics says Latvia's embassy in Washington is one of its most important overseas missions. And he made clear that Latvians can earn the trust and support of the United States by helping their American friends out half a world away — in Afghanistan.

"For the Obama administration, Afghanistan is a top priority, and Latvia is a partner in the supply chain for U.S. troops," he said — a fact that is especially important since Kyrgyzstan decided to close a key U.S. base. "We're exploring a new northern route which will bring supplies through Riga, and cargo to Russia, Uzbekistan and Kazakhstan. We think this could be a win-win situation for all parties involed, and it's also a good test case for Russia's willingness to be a part of the Afghanistan endeavor."

Despite the massive problems facing Latvia, Pildegovics insists virtually nobody wants to return the bad old days of communism. "There is no such movement or sentiment of that nature," he asserted. "We have not seen in Latvia any significant rise of extremism, either on the right or the left."

Yet Pildegovics admitted that the long half-century of Soviet occupation "has left a lot of bitterness" in the hearts of the Latvian people. The last of Moscow's 40,000 troops left Latvian soil in August 1998, and only two years ago, Latvia and Russia signed a bilateral treaty, ending the two countries' long-simmering border dispute once and for all.

"We have entered a stage where Russian politicians accept that our membership in NATO is a done deal," he said. "Maybe they're not happy about it, but it's a fact of life. And we absolutely reject Russia's interpretation of Latvia's inclusion in the former USSR" — as did the United States, which never formally recognized the Baltics' forcible annexation by the Soviet Union, continuing to accredit ambassadors in Washington from all three countries during those 50 years.

Pildegovics said that not being honest and open about the past sends the wrong signal to a younger generation of Latvians.

"We are concerned when Russian leaders say the dissolution of the Soviet Union was the biggest tragedy of the 20th century. We are concerned when neighboring states change borders by military means," the ambassador said, referring to the conflict in Georgia last summer. "We are concerned when politicians don't want to discuss issues of the past, or present them in a distorted way. We don't comprehend why it is so difficult to condone Stalin's crimes. The Russian people suffered horribly from this regime, and we don't see any reason why this regime has to be glorified."

Criminal or not, Stalin isn't much on the minds of average Latvians these days as they struggle to make ends meet.

Even so, Pildegovics doesn't seem overly concerned. Or if he is, the ambassador is keeping his worries to himself.

"If we could survive conquest by foreign powers in the Middle Ages, Nazi occupation and Stalin," he quipped, "I'm sure we'll find a way out of this current crisis."

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