Analytics, Economics, Financial Services, Latvia

Latvian authorities' plan is to save the country's currency and economy by internal devaluation, which has caused residents' wages and therefore purchasing capacity to drop steeply. "By ratcheting down state wages and prodding companies to do the same, policy makers are betting the resulting plunge in consumer demand will curb inflation, bring it back in line with the euro countries, whose currency Latvia is trying to join," Bloomberg reports.

Latvia's inflation rate may turn to 1 percent deflation in October, according to the median survey of six economists. That would be the first annual deflation since the country split from the Soviet Union, cites Bloomberg LETA.

Latvia's strategy is criticized by economists including Nouriel Roubini, the economist who predicted the global economic crisis. The New York University professor said in the "Financial Times" on June 10 that Latvia's policy was a "self-defeating strategy" and that the country would have to devalue, as Argentina did in 2002.

However, Prime Minister Valdis Dombrovskis and Central Bank Governor Ilmars Rimsevics are resisting pressure to drop the lats out of its 2 percent trading band with the euro because a devaluation would throw Latvia off the path to joining the common currency.

Dombrovskis told Saeima yesterday that a devaluation would mean the country "would lose the light at the end of the tunnel. We would not be able to implement the exit strategy: to join the euro zone in 2014."

"Devaluation would mean reducing the actual incomes of each and every resident of the state," said the premier, adding: "It would further aggravate borrowers' problems, because 85% of loans are in euros. Latvia is a very small and open economy. It means that the possible improvement in competitiveness would be very brief and insignificant, because the prices for imported energy resources and components would increase at the same time."

Several analysts also point out that devaluing the lat would deal a heavy blow to Western banks active in Latvia because about 90% of loans in the country are denominated in euros.

A 30% lats devaluation would put 44% of all loans into arrears over 90 days, the central bank said October 1.