What’s the Matter with Latvia?
Once an investor darling, Latvia’s booming, double-digit growth earlier this decade was accompanied by massive imbalances – a current-account deficit approaching 25% of GDP (among the world’s widest) and an external debt load that peaked at over 140% of GDP. The correction in these imbalances would have been challenging under any circumstances, but the global financial crisis and consequent drying up of capital inflows have raised the likelihood of a full-blown balance of payments crisis. Latvia’s currency, the Lat (LVL), is pegged to the euro within a ±1% fluctuation band, and such pegs do not tend to survive harsh economic adjustments like that now underway. In countries with flexible exchange rates, domestic demand does not have to bear the full brunt of correction in external imbalances as currency depreciation can shoulder some of the burden. Latvia’s economy is currently on life support. Although agreement was reached in December on a € 7.5 billion (US$ 10.4 billion) IMF and EU-l
