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.
Acknowledging these deficiencies, Latvia has made significant effort and progress in increasing their oversight and regulatory mechanisms. Recent reports by the Council of Europe’s money laundering watchdog, Moneyval, noticed marked improvement in the country. But Latvia still suffers from significant corruption issues—including disturbing reports that Russia’s foreign-intelligence service, the SVR, is increasingly active in the country (e-mails have surfaced purportedly showing the SVR’s involvement in the campaign of Nils Ušakovs, the current mayor of Riga). Additionally, the small size of the country’s Financial Intelligence Unit, responsible for overseeing the countries anti-money-laundering efforts, leads to difficult questions over its ability to implement the necessary safeguards.
But Latvia’s attractiveness for the influx of Russian deposits goes beyond the welcoming financial and legal environment. Differentiating Latvia from Luxembourg and Switzerland are the close ethnic and linguistic ties between Russia and Latvia. Ethnic Russians account for 25 percent of the population (the highest proportion among the Baltic States), and a further 37 percent speak Russian as their first tongue. The ethnic composition of the country provides familiar environs for oligarchs, criminals and launderers to not only send their money but spend it as well. The common ethnic bonds affords a degree of comfort to those wishing to spirit their ill-gotten gains out of Russia and into Latvia’s stable legal and political environment—sorely lacking in Russia, where your business dealings and bank accounts are monitored as assurance of your loyalty to the Kremlin.
In addition to the stable legal environment, launderers and corrupt officials are looking to place their assets in a more stable banking environment that allows easy and unfiltered access to their money. Russia has a 7 percent inflation rate and is debating its own quantitative-easing program, which could raise inflation even higher, threatening the value of their wealth. Plus, what good is the ability to spirit ones profits from prying eyes if it cannot be spent? The ability to send one’s children to the finest schools on the continent and to vacation in Monaco are the aspirations of many wealthy Russians, and Latvia’s access to the continent will ease their ability to enjoy such luxuries.
This desire to access capital across Europe has led to Latvia increasing in attractiveness as an entry point to Europe, especially since Luxembourg and Switzerland are increasingly wary of suspicious or opaque sources of deposits—not to mention Cyprus’ recent implosion (Several large Swiss banks—such as UBS—have seen large fines levied for their lax anti-money-laundering standards and are being lobbied to ease their banking-secrecy laws).
Latvia has made significant strides in its effort to join the eurozone and to allay fears of following Cyprus’ trajectory. But while the regulations may be in place to nominally prevent such events, the enforcement and application of such laws remains to be seen. Whether or not Latvia can chart its own course and become a productive member of the Euro is not certain—although it certainly can benefit from the mistakes and travails of other member countries. The only certainty is that money is fleeing Russia, and a lot of it is heading Latvia’s way.