FACTBOX-Key political risks to watch in the Baltic states

RIGA, May 26 (BestGrowthStock) – Of the three recession-hit Baltic
states, the political situation in Latvia is the most fragile as
it faces a parliamentary election in October, although Estonia
and Lithuania are also working with minority governments.

The Baltic states suffered the largest drops in output in
the European Union in 2009, led by Latvia’s 18 percent decline.
They hope to gradually come out of recession this year. Estonia
also has its eyes on adopting the euro in 2011. [ID:nLDE64413I]

Latvia’s need to fulfil the terms of its 7.5 billion euro
bailout — led by the International Monetary Fund and European
Commission — including harsh spending cuts and tax rises, led
to the disintegration of its ruling coalition. The People’s
Party, one of the three largest parties which is running low in
opinion polls and seeking to distance itself from the measures,
walked out. [ID:nLDE62G1OQ]

Prime Minister Valdis Dombrovskis intends to stay on as head
of a minority government. Latvia needs to make further budget
cuts, but that will be the job of the next government.
[ID:nLDE63B1ZX][ID:nLDE64O0Z7]

In Lithuania, Prime Minister Andrius Kubilius saw his
parliamentary majority whittled away due to an internal split in
a coalition partner. He needs support from smaller opposition
parties and still has to pass a tough budget for 2011.
[ID:nADO555169]

Estonia also has a minority coalition, but there is wide
support for euro adoption and the government passed austerity
measures to cap the budget deficit.

Following are some factors to watch in the Baltic states.

LATVIA’S ELECTION

Latvians go to the polls on Oct. 2. The result will likely
lead to another multi-party coalition government.

Polls show voters favour the opposition centre-left Harmony
party, which has a broad base of support among Russian-speakers
and, like the People’s Party, has 17 parliament seats out of
100. But the party also hopes to attract ethnic Latvians angered
by the crisis.

The Unity bloc, which includes Dombrovskis, is also popular.
The bloc currently musters 22 parliament seats.

Dombrovskis’s current coalition ally, the Union of Green and
Farmers, also with 17 seats, has been standing in third place in
the polls. However, the polls also show a large number of “don’t
knows” ahead of the election, meaning the actual result could
differ from the poll predictions.

Harmony was critical of the IMF/EU programme as too harsh,
yet also helped Dombrovskis win a parliamentary vote in January
to stay in the 7.5 billion euro bailout programme by abstaining.

Harmony wants to introduce a progressive income tax, which
the IMF has also advocated, but its spending cut plans are
vague. The IMF has said a mixture of spending cuts and tax rises
will be necessary to meet future budget deficit cuts.

Dombrovskis, who hopes to become prime minister again after
the election, has promised to keep Latvia within the bailout
programme, but not revealed how he would meet the revenue rise
and budget cut targets needed. [ID:nLDE63E1VM]

There is a question over whether the People’s Party and the
Latvia’s First Party/Latvia’s Way group, with 10, will make it
into the next parliament, though they are led by prominent
businessmen who can finance a strong electoral campaign.

The two parties have been key players on the political scene
for about a decade, but their popularity has plunged.

If they win seats in parliament, it is not clear who they
would throw their weight behind in a coalition.

What to watch:

— Will the Harmony bloc and Dombrovskis’s Unity agree to
work together in government after the election? In theory, this
could be difficult as Unity includes a strongly nationalist
element that would be hostile to Harmony’s pro-Russian stance.
But for the sake of achieving power could they bury their
differences?

— Will the new government lead to a softening of Latvia’s
adherence to the IMF programme? This could again get financial
markets nervous about the sustainability of the economy and the
peg to the euro. [ID:nLDE6300ZG]

— If Latvia stays in the bailout programme, its lat
currency will stay stable within its pegged band and interest
rates will stay low. If it drops out of the programme, then
devaluation speculation will return and rates will rise, which
could again cast a shadow over the other two Baltic states.

ESTONIAN EURO BID

Estonia got a green light from the European Commission on
May 12 to say it can adopt the euro on Jan. 1, 2011. European
Union finance ministers still need to give their formal
approval, but this is expected in July.
[ID:nLDE64B1VW][ID:nLDE6131JR]

Estonia achieved its goal because it set aside funds during
the boom years, which have cushioned it from the downturn.
Nevertheless, it also cut spending and raised taxes to keep its
budget deficit within euro zone limits.
[ID:nLDE63C0RP][ID:nLDE61N1RG]

What to watch:

— Entry to the euro zone would likely give the ruling
parties a huge boost in elections due in March 2011,
particularly to the dominant partner in the coalition, the
Reform Party. This would keep Estonia on a centre-right path.

— However, some instability inside the ruling coalition is
expected as the country nears the March elections, with the
junior coalition partner, Pro Patria and Respublica Union,
trying to stand out from the Reform Party’s shadow.

— The new government will still need to keep the country on
the path of fiscal austerity and some economists predict years
of slow growth as the price of making sure the small nation
remains competitive within the euro zone.

LITHUANIAN BUDGET MEASURES

Lithuania’s 2009 economic drop of 15 percent was second only
in magnitude to Latvia’s. The coalition government of Prime
Minister Andrius Kubilius had to take tough spending measures
but has now lost its majority in parliament by one vote.

He says he can depend on the support of a small group of
non-aligned lawmakers.

What to watch:

— Possible further defections from the coalition: junior
coalition party the Liberal and Centre Union has threatened to
quit the government after failing to get support for direct
elections of city mayors.

— There have also been tensions with the National
Resurrection Party, a new party for the 2008 election and which
has already split into factions, one of which joined the
opposition. The leader of the rump group that stayed in the
government has had arguments over ministerial posts, but stayed
in the government. If this rump group also leaves the coalition,
that would spell deeper trouble for Kubilius.

— A major test for the government will come in December,
when parliament has to vote on a budget for 2011. It also has to
approve a number of fiscal consolidation measures before that.
[ID:nLDE63J1FB][ID:nLDE63F1RD][ID:nLDE6240SW]

— If the government’s weak position leads to fiscal
slippage and problems financing its budget deficit, then
speculation against the currency could mount and local market
interest rates rise. This could also spread worries, as in the
case of problems in Latvia, to the other two Baltic states.

Stock Trading
(Reporting by Aija Braslina, Patrick Lannin, Nerijus Adomaitis
and David Mardiste, editing by Peter Apps)

FACTBOX-Key political risks to watch in the Baltic states