Latvia: the Next Cyprus?
Earlier this month, EU finance ministers gave their approval for Latvia to become the eighteenth member of the Euro in January 2014. It seems counterintuitive that the country of two million people would want to enter the perpetually distressed and recession-stricken economic zone. But for Latvia it has a variety of benefits, not the least of which would be to allow its impressive financial sector easy and unfiltered access to the rest of the continent. The hope is that by embracing the euro and committing itself to the necessary structural preconditions for acceptance, that Latvia will see economic growth and avoid events like the massive drop in GDP it experienced after the 2008 global economic crisis.
Latvia joining the euro, taken by itself, would seem at the very least uninteresting to most observers and politicians sitting in Brussels and Washington D.C. But there is a more worrisome aspect that troubles those very same politicians and portends an economic crisis on the scale of Cyprus if it is not carefully addressed. That nefarious aspect is the country being used as an entry point for illicit Russian money seeking to enter the EU.
The concern over Latvia entering the EU is in part due to the striking similarities between the Cyprus and Latvia. Like Cyprus, Latvia has an oversized financial sector compared to its population, which it has made the centerpiece of its economy. Both countries have strikingly low corporate tax rates, with Latvia at 15 percent and Cyprus at 12.5 percent (the Euro average is 23.5 percent). Additionally, a majority of the services in these nations cater to foreign clients, particularly Russian clients—or from former Soviet states in Central Asia—hoping to escape the capricious and unstable legal and economic situations inside of their country. (More often they are simply hoping to move their money from the watchful eye of Rosfinmonitoring—Putin’s personal financial-intelligence-collection unit). But making Latvia even more dependent on Russian money is the fact that nonresidents account for 48.9 percent of deposits, compared to 43 percent in Switzerland (the perennial tax-cheat haven) and 37 percent in Cyprus. Since 2010 nonresident deposits have increased 32 percent (According to the Latvian central bank, foreign direct investment from Russia has increased from 268.6 million euros in 2010 to 356 million euros today). These statistics are especially troubling considering that in 2008 one of Latvia’s largest banks, Parex, was forced to seek a government bailout due to worried investors withdrawing over $120 million in November alone. Situations like Parex forced Latvia to seek a bailout.
These worrisome statistics have not gone unnoticed, and Latvia has spent a fair amount of time and effort defending itself and its banking system, especially from comparisons to Cyprus. Aivis Ronis, Latvia’s former foreign minister and ambassador to the U.S. and NATO, said in Bloomberg of the scrutiny being placed on Latvia, “We welcome the bright light shined by the euro: It represents yet another chance to prove that Latvia, now the EU’s fastest-growing economy, is a stable place for Western investment, and a nation that is proud to help build Europe’s future.”
It is true that large nonresident deposits by itself are not enough to condemn Latvia to the unenviable path of Cyprus and Greece; especially considering that Latvia’s bank balance sheets total 128 percent of GDP compared to the Euro-wide average of 359 percent. But Latvia has also had a checkered history in relation to money laundering and financial sector oversight. Six banks are suspected of laundering corrupt proceeds related to the $230 million tax fraud that Sergei Magnitsky uncovered (and for which he was recently posthumously convicted). Latvian regulators recently fined, but refused to name, one of the banks €191,000 ($249,000) for its role in laundering the proceeds. Additionally, two Latvian banks acquired the unseemly distinction of being singled out by the Treasury Department for their lax money-laundering standards. Further, the State Department, in its most recent International Narcotics Control Strategy Report, estimates approximately 30 percent of the Latvian economy is made up of so-called “shadow” (untaxed) elements.