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UNCLAS LONDON 001321 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON XH UK
SUBJECT: UK ANALYST SEES LATVIAN DEVALUATION AS UNAVOIDABLE 
 
¶1. (U) Summary: The Royal Bank of Scotland (RBS) foresees the 
devaluation of the Latvian currency as inevitable.  RBS' Head 
of Central and Eastern Europe Middle East and Africa 
Research, Timothy Ash, told us on June 3 there is no way back 
for Latvia on the currency front.  Ash maintained a move to 
devalue sooner vice later is better, particularly in an 
environment where the market is relatively risk-positive. 
RBS, house view is the current situation may provide an 
opportunity to use Latvia as a test case for the region 
getting off fixed exchange rate regimes. End Summary. 
 
¶2. (U) Ash views the current Latvian central bank bleeding of 
foreign exchange reserves as unsustainable.  In his June 2 
Market Strategy report, he notes the Bank of Latvia has 
already intervened in recent weeks to defend the lat 
currency, and the resulting contraction in the monetary base 
has worsened domestic demand and public finances in the 
process.  Though the current account is in surplus now, the 
budget deficit has spiraled out of control as revenues have 
collapsed.  The original IMF program targeted a budget 
deficit of 4.9 percent of GDP, but the government appears to 
be now targeting a deficit of 9 percent of GDP, while 
European Commission (EC) forecasts warn of a deficit of 11 
percent of GDP.  If Latvia sustains its ratio of general 
government debt to GDP in excess of 50 percent into 2010, 
financing the debt will be difficult given that external and 
domestic markets appear closed to Latvia which leaves the 
country reliant on official financing, Ash stated in the 
Market Strategy report. In fact, on June 3 the Latvian 
treasury failed to sell any of its debt securities at an 
auction adding to the pressure to devalue. 
 
¶3. (U) Ash acknowledges the mere fact that members of the 
current government have put out "feelers" over the options on 
the exchange rate regime front is a major worry, as it could 
spook depositors in the banking sector. While devaluation is 
not without costs, it would clear the air.  Ash saw the 
decision to stabilize Latvian banks using IMF/EU funds as 
putting a "finger in a dyke" in the effort to prevent a 
domino-effect to other fixed exchange rate regimes in the 
region and to protect Western European, largely Swedish, 
banks.  In hindsight, Ash finds that with the current pace of 
real GDP contraction and mounting fiscal problems in Latvia, 
a devaluation could not be much worse than the slow death 
being wreaked on the Latvian economy by fixed exchange rate 
orthodoxy.  He foresees a potentially embarrassing scenario 
for Sweden if markets perceive Latvia,s real economy has 
been sacrificed for the stability of Swedish banks. 
 
Visit London's Classified Website: 
http://www.intelink.sgov.gov/wiki/Portal:Unit ed_Kingdom 
 
LeBaron