Essay: The global crisis and EU financial and economic crisis, its influence on Latvia

The financial crisis that hit the global economy since the summer of 2007 is without precedent in post-war economic history. Although its size and extent are exceptional, the crisis has many features in common with similar financial-stress driven recession episodes in the past. The crisis was preceded by long period of rapid credit growth, low risk premiums, abundant availability of liquidity, strong leveraging, soaring asset prices and the development of bubbles in the real estate sector. The current crisis has demonstrated the importance of a coordinated framework for crisis management. It should contain the following building blocks: a) Crisis prevention to prevent a repeat in the future. This should be mapped onto a collective judgment as to what the principal causes of the crisis were and how changes in macroeconomic, regulatory and supervisory policy frameworks could help prevent their recurrence. Policies to boost potential economic growth and competitiveness could also bolster the resilience to future crises. b) Crisis control and mitigation to minimise the damage by preventing systemic defaults or by containing the output loss and easing the social hardship stemming from recession. Its main objective is thus to stabilise the financial system and the real economy in the short run. It must be coordinated across the EU in order to strike the right balance between national preoccupations and spillover effects affecting other Member States. c) Crisis resolution to bring crises to a lasting close, and at the lowest possible cost for the taxpayer while containing systemic risk and securing consumer protection. This requires reversing temporary support measures as well action to restore economies to sustainable growth and fiscal paths. Inter alia, this includes policies to restore banks' balance sheets, the restructuring of the sector and an orderly policy 'exit'. An orderly exit strategy from expansionary macroeconomic policies is also an essential part of crisis resolution. The beginnings of such a framework are emerging, building on existing institutions and legislation, and complemented by new initiatives. But of course policy makers in Europe have

had no choice but to employ the existing mechanisms and procedures. A framework for financial crisis prevention appeared, with hindsight, to be underdeveloped otherwise the crisis would most likely not have happened. The same held true to some extent for the EU framework for crisis control and mitigation, at least at the initial stages of the crisis. Quite naturally, most EU policy efforts to date have been in the pursuit of crisis control and mitigation. But first steps have also been taken to redesign financial regulation and supervision both in Europe and elsewhere with a view to crisis prevention. By contrast, the adoption of crisis resolution policies has not begun in earnest yet. This is now becoming urgent not least because it should underpin the effectiveness of control policies via its impact on confidence. The vulnerability of Eastern Europe Capital flows frozen, financial markets in eastern Europe dried up, capital retreats to home markets Devaluation of national currencies (for CEE NMS up to 20-25%), Tensions in countries with pegged exchange rate (Baltic states, Bulgaria) Daily debt financing paralysed, credit ratings of CEE countries downgraded, debt of Ukraine, Latvia, Romania rated as `junk-bonds` At the peak of the crisis (March 2009) Ukrainian state bankruptcy was priced to a probability of 40% shown by `credit default swap spreads` (CDS); in case of Latvia it was 10% Households and enterprises often indebted in foreign currency with debt burdens due to weaker national currencies and higher banks fees increasing Families in desperate financial situation a burning social problem The banking sector in CEE is 80% in foreign hands and foreign banks were often reluctant to bail out their CEE affiliates The situation is alarming, mostly in the Baltic states

The 20082010 Latvian financial crisis, which stemmed from the global financial crisis of 20082009, is a major ongoing economic and political crisis in Latvia. In 2008, after years of booming economic success, the Latvian economy took one of the sharpest downturns in the world, picking up pace in the last quarter which saw GDP contract by 10.5%. On January 13,

2009, Latvia saw its worst riots since the collapse of the Soviet Union after more than 10,000 people took to protest in the capital, Riga, over the governments handling of the crisis. In February the Latvian government asked the International Monetary Fund and the European Union for an emergency bailout loan of 7.5 billion Euros, while at the same time the government nationalized Parex Bank, the country's second largest bank. On concerns of bankruptcy, Standard & Poors subsequently downgraded Latvia's credit rating to noninvestment grade BB+, or "junk", its worst ever rating. Its rating was put on negative outlook, which indicates a possible further cut. On February 20 the Latvian coalition government headed by Prime Minister Ivars Godmanis collapsed. The Baltic States have been amongst the worst hit by the global financial crisis. In December 2008 the Latvian unemployment rate stood at 7%. By December 2009, the figure had risen to 22.8%. The number of unemployed has more than tripled since the onset of the crisis, giving Latvia the highest rate of unemployment growth in the EU. Early 2009 estimates predicted that the economy would contract by around 12% in 2009, but even those gloomy forecasts turned out to be too optimistic as the economy contracted by nearly 18% in the fourth quarter of 2009, showing little signs of recovery.