By Nerijus Adomaitis and Patrick Lannin
Populations in the EU's recession-hit Baltic states look increasingly concerned about the durability of currency pegs that authorities still see as a cornerstone of their attempts to recover in months ahead.
The IMF allowed Latvia to keep its peg in a bailout last year, but doubts among economists are growing over the economic cost of systems which governments and central banks say have helped anchor them through two volatile decades since they left the Soviet Union in 1991.
Popular fears over the peg bubbled up again last weekend in Lithuania, with people rushing to buy euros, dollars and sterling after rumours of a devaluation. Similar panics have been seen in the last two years in Latvia and Estonia.
With recession biting in all three, and currencies across eastern Europe sinking to help economies adjust to a worsening outlook, broader concerns over the sustainability of the pegs are also mounting.
"We are facing huge challenges in the global environment, and I just cannot see the (currency) regimes surviving in the current form," said Timothy Ash, an analyst at the Royal Bank of Scotland in London.
Both Lithuania and Estonia operate fixed-rate currency board pegs to the euro. Latvia allows a fluctuation of its currency of 1 percent around a central rate.
Ash compared the Latvian situation to Argentina, which first tried to defend and then abandoned a currency peg in 2002.
"It is difficult to see them (Latvia) surviving more than 6 months, and if Latvia goes, the focus will be on Lithuania … I will give fifty-fifty Estonia might survive, because it is so small, but Lithuania would probably get rolled over," he said.
In Lithuania, people express the same uncertainty.
"I found out about those rumours on Monday, and though I did not react, I am not very calm given the situation in Lithuania and the world," said teacher Danguole Bylaite-Salavijiene, 35.
"People (changing money) showed a normal reaction as in the past people suffered while the government kept things secret."
SHOCK THERAPY
Some economists say allowing a devaluation would lead to a sharper economic drop, but a faster recovery, and help exports.
But the authorities say any export boost would be minimal, that the confidence blow from a devaluation would outweigh any economic benefit and that thousands of people with foreign currency loans would suffer, hurting banks.
"I think those rumours about devaluation were just nonsense," said Lithuanian Maria Ceronok, 30, who is unemployed.
"I trust the government not to change the rate, what else can I do? Devaluation would be bad for everyone."
Estonia is seen as being in the best position of the three states thanks to budget reserves accumulated during years of consumer-fuelled growth which came to a sudden stop when the Nordic banks which dominate the market shut off the credit taps.
But even here the IMF said in a report this week that the kroon currency was overvalued, though it also saw planned wage cuts restoring competitiveness.
In Latvia, the International Monetary Fund backed the government's wish to keep the peg and opt for a harsh internal devaluation of falling wages, job losses and possible deflation.
But the reluctance of the Fund, which itself raised the idea of devaluation, can be seen in a staff report on the 7.5 billion euro rescue Latvia agreed last year with the IMF and EU.
Though in the end the Fund went along with Latvia's argument a devaluation would do more harm than good, it also pointed out several times the element of risk.
"Correcting currency misalignment without nominal depreciation is extremely difficult, as experience from other currency board and fixed exchange rate countries continues to show," the Fund said in a January report.
POISON, NOT A PANACEA
Latvia's central bank governor Ilmars Rimsevics has angrily rejected devaluation as a "poison" for the economy.
"These pseudo economists who think that (a devaluation) would contribute something should say clearly what those proposals are and why they think that would help Latvia's economy," he said on public television last week.
"If they do not have those calculations then they should not create panic, spread mistrust and start more rumours," he said.
The faith of Baltic policymakers in the pegs has been firmed by watching currency falls in neighbours like Poland and Ukraine produce little benefit in terms of export rises because of the global drop in demand.
Another is that they see a currency devaluation as being something that would simply add to their problems: the public, already worried about job losses and falling wages, would face a more fundamental fear about the value of their own money.
Maybe this is a hangover from the collapse of the Soviet Union, when the Soviet rouble plunged in value and hyper-inflation ate up many people's savings.
Since then, the Balts worked hard to build up confidence in the currencies they re-established after the Soviet collapse.
But Alfs Vanags, director of the Baltic International Centre for Economic Policy Studies, said Latvia was facing such a harsh internal deflation situation with falling prices, wages and unemployment that a devaluation would be less painful.
"I think this is the right time," he said.
To the argument that people with foreign currency loans will suffer from a drop in the local currency and not be able to repay their debts, creating problems for the bank sector, he said people who lose their jobs will also face problems.
