Political Risk in the Baltics

Background:

Baltic governments have come under increasing pressure amid a severe downturn in economic activity. As economic growth contracts and tax revenue plummets, the governments of Latvia and Lithuania are struggling to keep their budget deficits in check.The goal is to bring down the deficits under 3% of GDP—the budget deficit limit for euro adoption—in order to enter the eurozone as soon as possible. Given the scale of economic downturns in these countries, the current eurozone entry target dates are widely seen as overly optimistic.

Estonia—the best positioned of the three—successfully kept its 2009 budget deficit under 3% of GDP, and in July 2010, received the green light for its 2011 eurozone entry date.

In all three countries spending cuts are stirring public discontent, particularly in an environment of rising unemployment, and risk sparking splits within governing coalitions. In early 2009, the coalition governments in Latvia and Lithuania lost their parliamentary majorities.

Baltic governments are fragile and the risk of early elections is high. Government changes could bring economic policy shifts and fiscal loosening, which might push euro adoption targets even farther into the future.

Latvia, after the privatization process of the 1990s and the under-regulated banking boom of the 2000s, became a viable haven for Russian offshore capital. From this emerged the powerful oligarchs which eventually set up new parties and entered politics. Since then politics in Latvia has been perceived as broadly divided into the centre-right local parties, the oligarchs and the Russians. After the oligarchs won elections in 2006, they took control of the country’s security services leading to popular ““umbrella revolution” in 2007, which eventually brought the government down. Since then Latvia has been one of the worst hit in the 2009 crisis and the oligarchs have been relegated to less authoritative powers. After two of the three oligarch parties lost elections in 2010, only the Reform Party and the Union of Greens and Farmers (ZSS) remained at the heart of politics. The Latvian Russians in the form of Harmony Center have had the youthful Nils Usakovs as their leader since 2009. Latvian party Unity with the ZSS set up a coalition government in 2010 as dealing with the Russians was seen as a greater task than dealing with oligarchs. Dombrovskis was reappointed as Prime Minister for handling the 2009 crisis effectively. But in 2011, President Zatlers called a referendum as his second term was almost lost in vote in Parliament. 94.3% of the population voted in favor of dissolving the existing government and Zatlers formed the “Reform Party” in the hopes of changing the nation’s politics in favor of the right- centered. The latest September 2011 polls have given the centre-right the chance to govern alone- if Zatlers’ Reform Party (with 21% of total votes), Unity (19%) and the Latvian nationalists (14%) can get along. Final results will come out in two weeks.