Swingeing cuts in Latvian government spending helped to boost the shares of banks in Sweden yesterday as investors took comfort from the prospect that the Baltic state may avoid a damaging currency devaluation.
The Latvian Government reached agreement with its coalition partners to cut the state budget by Lats500 million (£620 million). The budget deal raised hopes that the debt-burdened country would secure a further tranche of a rescue loan from the International Monetary Fund (IMF) and the European Union, thereby avoiding a downward spiral of devaluation and default.
The budget agreement lifted the gloom in Stockholm, where Sweden’s leading banks have been waiting nervously for the outcome of negotiations. Huge investments in the Baltic economies by Swedish financial institutions have left them heavily exposed to countries’ recent economic collapse. Shares in SEB rose 12 per cent yesterday while Swedbank, which owns Hansapank, the Baltic region’s largest bank, gained almost 8 per cent.
Latvia’s currency rose against the euro in reaction to the budget agreement, but the market optimism was not enough to quell scepticism at Standard & Poor’s, the rating agency that put Latvia’s credit rating on watch for a further downgrade. The country is already at junk level owing to its huge borrowings in foreign currency and the rapid downward spiral of the economy, which is expected to shrink by 18 per cent this year.
The IMF and EU have promised Latvia €7.5 billion (£6.5 billion) in aid, but the money is conditional on harsh economic reforms. The retrenchment follows years of rapid wage and house price inflation, a bubble economy that was financed with external borrowings, mainly in euros.
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The contraction of Latvia’s economy led to speculation that it would be forced to sever the link between the lat and the euro. The Latvian central bank has spent almost €1 billion this year supporting the peg.