VZCZCXRO2674
PP RUEHIK
DE RUEHRA #0569/01 3341222
ZNR UUUUU ZZH
P 301222Z NOV 09
FM AMEMBASSY RIGA
TO RUEHC/SECSTATE WASHDC PRIORITY 6160
INFO RUEATRS/DEPTTREAS WASHDC
RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 02 RIGA 000569 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN LG
SUBJECT: LATVIA SET TO PASS BUDGET, CONSIDERING PAREX SPLIT AND SALE 
 
RIGA 00000569  001.2 OF 002 
 
 
 
¶1.   (SBU) Summary:  The cabinet of ministers has approved a budget 
for 2010 that includes 500 million Lats (USD 1 billion) in fiscal 
consolidation demanded by international lenders.  The second and 
final reading of the budget in the Saeima (Parliament) will take 
place on December 1, and the budget is expected to pass.  The 
disposition of Parex Bank now stands as the primary economic hurdle 
facing the GOL, which was forced to take a majority interest in the 
bank in 2008 to prevent a major financial catastrophe.  A break-up 
of the bank between performing and non-performing elements (a "good 
bank/bad bank" split) has been approved in principle by the cabinet, 
but questions remain on the best ownership structure to get Parex 
off the GOL books while limiting political damage to those involved 
in the initial takeover.   It is now broadly agreed that a 
devaluation of the lat is highly unlikely.   (Note: Finance Minister 
Repse will  lead a team to New York on December 2 for meetings with 
bankers on the possible sale of Latvian Government bonds.  He is not 
seeking meetings with USG or IMF officials, according to Ministry 
officials.)  End Summary. 
 
¶2.  (SBU) On November 23, Deputy Assistant Secretary of Treasury for 
Europe and Eurasia Christopher Smart visited a number of leading 
figures shaping the GOL budget and banking system, including 
Minister of Finance Einars Repse, IMF Chief of Mission Mark 
Griffiths, Bank of Latvia Governor Ilmars Rimsevics, Parex Bank CEO 
Nils Melngailis, Latvian Mortgage and Land Bank CEO Normans Panko, 
and bank regulator Irena Krumane.  Interlocutors were guardedly 
optimistic as a government that had only months ago seemed shaky 
seems poised to deliver a budget that will meet international 
obligations.  Meetings regarding the future of state-owned banks 
were more downbeat - although there has been progress, there are 
still serious disagreements on how to deal with both Parex and the 
Latvian Mortgage and Land Bank (LHZB). 
 
The 2010 Budget 
--------------- 
 
¶3.  (SBU) The Minister of Finance and IMF representatives detailed 
elements of the budget agreement that is expected to be approved by 
Parliament on December 1.  The final budget includes a rate hike 
from 23 to 26 percent in the personal income tax, a small, but 
progressive real estate tax, and increased taxes on capital gains, 
cars and natural gas.  The budget is based on the IMF's projection 
of a 4 percent decline in GDP in 2010.  IMF Chief of Mission 
Griffiths expressed reservations about the temporary nature of 
spending cuts, noting the GOL set many provisions to sunset in 2012, 
sidestepping the need for coherent structural reform. 
 
¶4.  (SBU) Minister of Finance Repse appeared confident that the 
budget would be approved by parliament.  While he acknowledged 
concerns about the temporary spending cuts, he asserted that the 
cuts could easily be extended.  Recognizing the challenge of making 
further adjustments in the 2011 budget given Parliamentary elections 
in October, Repse said taxes were high enough already, and hoped for 
gradual expenditure reductions including structural reform in areas 
like health care.  Bank of Latvia Governor Ilmars Rimsevics was 
vocal in expressing disappointment about the lack of structural 
reforms in education, health care, and public administration.  He 
predicted a more modest decline of 1.5-2.0% of GDP in 2010. 
 
Parex to Center Stage 
--------------------- 
 
¶5.  (U) With completion of the 2010 budget, focus now turns to Parex 
Bank.  Although some observers (including Rimsevics) think the 
entirety of Parex could hold positive value, the consensus is that 
to get it off the books, the GOL will have to recognize a loss.  The 
Parex takeover remains poorly understood by the public and a source 
of a lot of public anger, with a two billion-dollar exposure to the 
Latvian taxpayer.  As a result, some politicians are adamant that 
the GOL not recognize a loss at all.  Furthermore, due to ongoing 
criminal investigations into the Parex takeover, some officials may 
be concerned that a significant loss could increase the risks of 
personal prosecution. 
 
¶6.  (SBU) Rather than leave the bad assets on the government books, 
the GOL has chosen to establish a complex structure to try to sell 
the assets without taking an immediate loss. The GOL has approved in 
principle a plan to split Parex into a good bank (or perhaps two 
good banks) and a bad bank, or Asset Management Company (AMC).  The 
GOL is currently insisting that Parex find simultaneous buyers for 
both parts to avoid getting stuck with only the bad assets. 
Rimsevics is an advocate of this approach, and Repse recommended a 
task force on Parex disposition with Rimsevics as the chair. 
 
¶7. (SBU) Parex CEO Melngailis said that some non-conventional 
structures were being considered in order to create a good bank and 
bad bank without recognizing a loss.  Foremost among them would be a 
structure with the good bank as a subsidiary of the AMC.  Melngailis 
recognized that this would be an unorthodox move, but said they had 
 
RIGA 00000569  002.2 OF 002 
 
 
no choice but to "hide the hole" for political reasons.  He sought 
USG assistance in convincing the GOL to recognize their losses now. 
 
¶8.  (SBU) Melngailis suggested a subordinated ownership structure 
for the AMC with private investors getting first cut at the profits, 
IFC and EBRD second cut, and the GOL last, essentially underwriting 
any losses.  Krumane claimed that there are several EU buyers 
interested in the "good bank."  She said that the IFC is doing due 
diligence on the AMC, but the EBRD has still not confirmed any 
interest. 
 
¶9.  (SBU) Hanging over all of this is a 300 million euro ($447 m) 
syndicated loan payment due in February that Melngailis reports 
Parex will not be able to cover.  He suggests they may need GOL 
assistance to provide half the payment.  Krumane indicated that a 
portion of the IMF payments that has been earmarked for assistance 
to state-owned banks could be used for this purpose if necessary. 
 
LHZB - less of an issue? 
------------------------ 
 
¶10.  (SBU) The Latvian Mortgage and Land Bank (LHZB) is fully 
state-owned, and has a syndicated loan payment due in December. 
Both LHZB Chairman Panko and Krumane report that LHZB has sufficient 
cash to cover the loan.  Enthusiasm for mixing the bad assets of 
LHZB and Parex in a single bad bank or AMC is waning.  However, LHZB 
is still in a fairly tenuous situation, surviving on bilateral loans 
from the Nordic Investment Bank and European Investment Bank.  A 
negative turn, such as a decline in Latvia's credit rating, could 
spell significant problems for LHZB -- and the GOL.  Krumane claimed 
there is a buyer who has expressed interest in buying LHZB as is. 
 
Devaluation Off the Table 
------------------------- 
 
¶11.  (SBU) Rimsevics, who has steadfastly opposed devaluation, was 
happy to report that it was no longer an issue.  He noted with 
pleasure that even Andris Skele, the head of the largest party in 
the governing coalition and a vocal proponent of devaluation, had 
declared it too late to devalue at the People's Party congress two 
days earlier.  Griffiths was less certain - although he seemed to be 
approaching it more as an intellectual exercise than a policy 
proposal.  He noted that despite the current account surplus, many 
forms of analysis still showed the Lat as overvalued, which would 
continue act as a drag on any incipient recovery. 
 
¶12.  Comment:  Completion of the 2010 budget is a positive step, but 
focus should remain on carrying through with serious structural 
reforms to prime Latvia for a steady recovery.  The 2011 budget will 
require another 500 million lat consolidation, and will be 
complicated by next October's election.   Before the election, 
nobody will want to make politically painful decisions, and after 
elections, the new government will be forced to work quickly to 
complete the budget before the end of the fiscal year.  On Parex, 
our financially savvy interlocutors seem to recognize that losses 
are unavoidable, but the governing and political class has yet to 
come to terms with that reality.  The sooner they do, the better. 
 
 
GARBER