Latvia central bank supporting currency

Bloomberg

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The central bank purchased lati for the 11th consecutive week after the currency weakened to its trading limit. Latvia, like neighboring Lithuania and Estonia, is a member of the pre-euro exchange rate mechanism and pegs the lats to the single currency. Latvia defends a 1 percent band around a target rate.

Latvia is suffering the deepest recession in the European Union, threatening to upset economic recovery in Sweden, whose banks are the biggest lenders in the Baltic region. Latvia’s government is trying to negotiate a wider budget deficit with the European Commission and the International Monetary Fund, or IMF, to ensure the next payment of its loan. Failing that, Latvia faces bankruptcy, Prime Minister Valdis Dombrovskis has said.

"The level of intervention is frankly staggering and time is clearly running out for the Latvian authorities," Timothy Ash, head of emerging-market economics at Royal Bank of Scotland in London, said in an e-mailed note.

Latvia’s total foreign reserves stand at 2.8 billion euros ($3.9 billion). The country has bought about 643 million lati this year, removing them from circulation and creating a shortage of lati on the local market. The Rigibor, the interbank lending rate, rose to a record 19.6 percent on June 5 because of a shortage of lati.

Dombrovskis, 37, last week pledged to push through budget cuts to put the country back on course to receiving the next tranche of its IMF and European Commission loan. The IMF delayed a 200 million-euro transfer in March after parliament failed to commit to expenditure cuts. Latvia agreed its 7.5 billion-euro ($10.5 billion) bailout from a group led by the IMF and the European Commission in December.

"There is clear concern over contagion risks within the region," Ashley Davies, a currency strategist at UBS in Singapore, wrote in a research report on Monday. "The krona will remain under pressure due to their banks’ loan exposures to the Baltic region."

Sweden’s Swedbank and SEB have together made loans of more than 366 billion kronor in Estonia, Latvia and Lithuania. Loan losses are soaring at the banks, with speculation that Latvia may devalue its currency driving down their share prices and the krona.