Latvia's currency - the lats- is on the verge of being devalued as the nation's economic collapse threatens to break its peg to the Euro. The Baltic nation's GDP contracted 18% annualized in the first quarter, and pressure is building to allow the lats to fall to stimulate the export sector.
A Latvian devaluation could spread panic in Eastern Europe as investors flee nations that may debase the value of their holdings. In addition to fellow Baltics Lithuania and Estonia - Poland, Hungary, and Bulgaria could be next. It is unknown how far this could spread, but it should be noted that the 1997 Asian financial crisis began when Thailand was forced to abandon its peg to the dollar.
Most immediately concerned is Sweden's financial sector, which invested mightily in the Baltic economies during the boom times. The iShares MSCI Sweeden Index Fund (NYSEARCA:EWD), the US traded ETF that tracks Sweden's broad market is down 8% on the week on the backs of steep declines in Sweeden's big financial names, which make up about a fifth of the index. The SPDR Emerging Europe Fund (NYSEARCA:GUR) and the Market Vectors Russia (NYSEARCA:RSX) are off by similar measures on contagion fears. Broader European funds such as the iShares MSCI EMU Index Fund (NYSEARCA:EZU) are off about 5%, despite the American markets being up on the week.
Observers are urging the IMF and the EU to come to Latvia's rescue, but the two institutions are demanding stiff terms. Latvia yesterday cut its budget by 10% of total GDP to meet IMF bailout requirements, but it is uncertain of even this will be enough to stave off a fierce devaluation and the regional panic that may result.