Latvia recovers by doing right by its creditors

From Jonathan Auerbach of Auerbach Grayson, another interesting report from the field:

Last June, a NY Times financial section headline stated ‘DESPITE DEVALUATION FEAR, LATVIA STANDS BY CURRENCY’.  This was followed by dire predictions that Latvia, probably hit harder by the ongoing economic morass than any country in the EU, would devalue and thereby begin a domino toppling that would bring down Swedish banks (who were heavily loaned in the Baltics) and thereafter spread through Europe like a virus. In fact at the time the SKR and the Swedish banks (Swedbank had a short-term market price drop of almost 40%) were all under pressure. We decided to organize a quick visit to the Baltics and see first-hand if Latvian devaluation was indeed an option. Alex Doncov and I with several clients met for a week with the likes of the Latvian and Lithuanian Central Banks and Finance Ministries as well as with the Minister of Finance of Estonia. Our conclusion, which we sent to you in early July, stated unequivocally that, based on our many first-hand local meetings it, was clear that Latvia would not devalue, and we thus made a strong case for clients to buy what were clearly cheap Swedish financial institutions (not to mention a couple of Baltic names).

Are you with me so far? Ok, let’s fast forward to last Friday, when we hosted a lunch here in NY for Karlis Bauze, Head of Monetary Policy, Bank of Latvia. We like to have interesting people for our ad hoc lunches and typically have 9-10 acceptances. Well, 25 people came to hear Karlis. Interestingly enough, he started his talk by asking. ‘How many of you think we shall still devalue?  At least 1/3 of the audience raised their hands. Karlis then embarked on a well documented (I have copies) ‘The Case of Latvia’ giving an unvarnished portrayal of how they got there (and a familiar litany to the U.S. audience, like credit growth, consumerism, bank competition for market share, and of course the real estate bubble.).  He then addressed why this little text-book country is already seeing light at the end of the tunnel, making difficult decisions of fiscal consolidation that essentially makes them all poorer (he has taken a 25% pay cut mandated for his staff), but has already resulted in a current account surplus for the first time in 14 years. Bottom line: You don’t need a lesson in economics –the Latvian story is not going to precipitate a crisis — they are not going to devalue and they are a poster child of why global recovery in many ways will surprise EM investors with its resiliency.