While one of the fiercest—and at times most beautiful—winters has gripped Latvia and most of Europe during the past months, we have already seen the first preparations for what is likely to be a very hot spring and summer for Latvia politically, leading up to the Saeima elections in October.

Latvia is still heavily damaged by the economic downturn. Unemployment is heading towards 20 percent, there is little confidence in any foreseeable recovery, the economy is kept alive by international loans that will need to be repaid, and emigration seems to be growing. Despite this, the Valdis Dombrovskis-led government is patiently working away to meet its international obligations to its creditors, particularly the International Monetary Fund and European Commission, and to right the economy and government spending after the previous government’s self-promoted “fat years.” Yet Dombrovskis has to do this in a coalition government where every other party is positioning itself for the Saeima election to convince voters they were not to blame for the mess. This presents Dombrovskis with multiple problems.

The present coalition situation is tense, and presents each party and major player with a diabolical choice: basically, whether it is better for a party to seek to destroy this uncertain coalition, hoping to establish a better government it itself can lead and try to make a fist of the country’s problems, or whether there is no alternative but to be seen to be constructively working in the government until October, hoping that Dombrovskis does not take all the glory for any good policy, and that the parties can get the voters to forget the past. It is an invidious choice. Meanwhile, the parties outside the coalition are also positioning themselves and looking for partners. The first moves to destabilise the coalition have already come.

To briefly set the scene, Dombrovskis is from New Era (Jaunais laiks, or JL), the party that was so long kept out of government by the dominant party in recent years, the People’s Party (Tautas partija, or TP), whose long-term rule under Prime Minister Aigars Kalvītis is blamed for much of Latvia’s woes. Now the TP is in the Dombrovskis coalition, along with the Union of Greens and Farmers (Zaļo un Zemnieku savienība, or ZZS), the breakaway Civil Union (Pilsoniskā savienība, or PS) and the nationalist For Fatherland and Freedom Party (Tēvzemei un brīvībai / LNNK, or TB/LNNK). Each party has its own woes and has to evolve its strategies. For TP, ZZS and TB, which were also in the previous long-term coalition, it is the matter of how to recover their lost prestige due to their governing the country into its present economic crisis.

Yet the governing parties are not the only players. Outside the coalition is the Harmony Centre (Saskaņas centrs, or SC), the mostly Russian-oriented centrist party which did exceedingly well in the Rīga City Council elections last June and now rules there in coalition with headkicker Ainars Šlesers‘ First Party of Latvia (Latvijas pirmā partija, or LPP). They believe they can make a huge impact in the next Saeima election, and are forging alliances and biding their time.

TP took its chance at the end of January by opposing a crucial vote in the Saeima authorising the government to continue negotiations with its international creditors. In an evidently planned but feebly executed move, the TP claimed the Saeima was not given enough say over these negotiations. It looked as though the government might fall on this vote, but some TP members broke rank, the SC abstained and the LPP voted with the government, obviously not wanting to throw out this government at this stage. It was an ignominious outcome for the TP, especially in the light of party founder Andris Šķēle’s previous announcement that he is returning to politics: he must now be seen as having failed at this first attempt to make an impact. His star may well and truly have waned.

So the Jan. 21 vote was carried by the government, without its major coalition partner, but with the help of the opposition, which does not see any advantage in having the government fall before October. On the one hand this may signal that Dombrovskis is relatively safe, being able to head off the TP treachery, but on the other hand it shows how thin is the glue holding the coalition together.

TP may sulk but it is capable of further bastardry. As another example of its contant niggling, it refused to have one of its favourites sacked, the State Revenue Service head Dzintars Jakāns, after various disciplinary moves had been made against him for alleged corruption and incompetence. Once again threatening to leave the coalition, the TP forced a compromise that Jakāns would not be fired but moved to another position of lesser rank.

The antics of the TP do nothing to raise the regard in which the public holds politicians and the parliament (polls often show around 4 percent trust!), and even in terms of gaining populist publicity for opposing the government the party’s stance may have backfired.

The polls

The most recent political poll at the end of January gave notice that the elections in seemingly distant October are very much on people’s minds. SC gained the highest support (18.8 percent), indicating the Rīga result was no fluke, and it will be a very serious contender to be in the new government. But Domrovskis’ JL also gained, up from 5 percent to 9.9 percent, indicating there is growing support for his patient if rather gloomy style of governing. PS also gained, and there is now growing certainty that JL, PS and the other breakaway party Society for a Different Politics (Sabiedrība citai politikai) will form a coalition for the Saeima elections. Meanwhile, the once mighty TP stands at 3.5 percent and the LPP were struggling at 2 percent of the vote. Most significantly, however, there was a drop in the proportions of people declaring they would not vote or who had not yet made up their mind. For there not to be a Russia-oriented government with SC dominant in October, there will need to be a significant mobilisation of alienated voters who would support the centre or right Latvian parties—if only they could stop making war on each other!

We shall see increasingly tense lobbying among the parties to try to shore up their positions, find partners and convince the public to vote for them, and probably increasingly desperate measures if the polls don’t improve for several of Latvia’s traditional heavies. Will there be a spring offensive from the forces trying to unseat the government? The dominant question may well be who else—if anyone—is willing now to take responsibility for the country in the lead-up to the Saeima election.

The grueling budgetary process in which Latvia has been engaged for months is coming to some resolution with a final adoption of the 2010 budget scheduled by Dec. 1.

Latvia’s politicians are faced with unpalatable choices of cutting more expenditure and trying to raise revenue in a declining economy. They are being carefully watched by international institutions fearful that a total collapse in Latvia’s economy may rebound onto other countries, but concerned that Latvia is still able to meet its obligations to pay its considerable debts.

At the heart of the problem of revenue has been Latvia’s reliance on two taxes that most affect those on poorer incomes: an income tax with a flat rate of 23 percent and a value-added tax, which was raised from 19 percent to 21 percent this year for most goods. The huge property boom of the past 10 years, when Rīga prices hit those of the largest European capitals, was unhindered by any capital gains tax (a sure sign of the economic interests of previous governments), and unhindered too by any tax on bank interest.

The disproportionate reliance on income tax is linked to two features that underlie both official corruption and the sources of the private debt bubble that has now enveloped Latvia. As part of employees’ desire to reduce their taxes (and for employers to escape other charges associated with labour costs), the system of payment by “envelopes”  was widespread. In other words, workers were getting a lower official salary on which they paid tax but receiving under-the-table topping up that was untaxed. Readers will no doubt remember that President Valdis Zatlers fell into trouble with one variant: “envelope payments” to doctors and surgeons so that patients would be looked after better. For many in the workforce, such payments ensured a higher untaxed income at the expense of government revenue, a loophole that previous governments did very little to combat.

One disincentive for such envelope payments was provided by the social security system, which bases pensions on a base minimum plus regard to salary earners’ income and social service tax contributions, so those declaring less income than they received would gain a lower pension in the future. This was only a future disincentive, often not considered by present employees; moreover, constraints on the budget have meant that the gap in pension payments, between those who contributed substantially through their taxes and those who contributed little, has diminished.

However, the envelope payment system is also linked to private debt, as investigations into the operations of the banks have revealed. In determining loans to private individuals, banks would ask for what people earned, but would ask for total payment—official as well as envelope payments—to determine risk. Thus the corruption of the public sector tax evasion also affected private borrowing.

The government’s negotiations with the International Monetary Fund and European Commission to plug deficits and to enable structural reform are nearing their end, with the government agreeing to cut another LVL 500 million from the 2010 budget to minimise the budget deficit, and look to new revenue-raising methods. But the negotiations have been continually interrupted by the political positioning of some coalition parties, and a difficulty in having a rational debate over budgetary measures. International institutions were concerned when some coalition partners doubted whether further budgetary cuts were necessary. With populist language, those coalition partners claimed the cuts will hurt those most vulnerable, but dragged their feet over new and long-overdue tax measures: a capital gains tax, a tax on bank interests and discussions over a progressive income tax. The various proposals are before the Saeima (parliament) now together with the 2010 budget.

The big picture needs to be kept in mind. Latvia must eventually be able to balance its own budget, not continually borrow from international institutions. Moreover, for Latvia to be able to enter the eurozone by 2014, the budget deficit cannot afford to blow out. The problem for Latvia’s politicians is to focus on this, knowing the pain inflicted by them on the population may be well remembered at the next year’s Saeima elections.

Of the measures proposed, the capital gains tax seems to now have approval. The taxes would amount to a tenth of a percent of cadastral value for owner-occupied properties, with progressive rises for those not owner-occupied, an important move but one that will only bring returns in future years and be very dependent on the property market improving. Intense debate is continuing over reform of income tax. It now seems clear that no progressive tax will be introduced, as no other Baltic country has one, and it is feared companies would register in Estonia or Lithuania to take advantage of flat tax. Debate now centres on whether there should be a reduction of the tax-free threshold (from LVL 35 to LVL 25 a month, a move that would hurt the poorest people) or an increase in the tax rate as a whole from 23 percent to 25 percent.

In other cases, desperate measures have been proposed. Prime Minister Valdis Dombrovskis should have known better, but his government raised a short-term proposal to ease private debt pain by adopting the American solution of limiting the debt incurred on a property loan to the value of the property. In other words, if one has borrowed more than the current property is worth because of the declining property market,  one is only responsible up to the value of the current property. Such a provision in the United States has seen thousands of debtors simply walk away from their properties, leaving them to the banks that cannot chase up the balance of the debt. Originally introduced to ensure banks would lend money with due and careful regard to the property market, the phenomenon of sub-prime lending threw this caution to the wind. Luckily, the howl of protest quickly sunk the proposal in Latvia. 

Finally, two other issues deserve comment. Many readers of this column will have used the Internet version of Latvia’s leading newspaper Diena, whose outspoken commentaries on Latvian politics, and relentless exposure of corruption and political chicanery, was one of the antidotes to Latvia’s odious political culture. But in moves that have not yet been fully explained, Diena‘s ownership changed (it was previously owned by a Swedish publishing company), and the new owners (seemingly related to murky British interests but with suspicious links to some of Latvia’s oligarchs) began an immediate cleaning out of the most outspoken journalists, causing others to resign in protest. While the official explanation for these machinations was falling advertising revenues, the change in the character of Diena has been marked, with a decidedly less critical edge to current journalism. Meanwhile, the Diena refugees have started their own online publication, Cita Diena.

And despite the priority of the budget, the Saeima has no forgotten other political necessities as well. In a shock result for the Latvian judicial system, the Saeima in a secret ballot refused to appoint Administrative Court Judge Māris Vīgants to the Supreme Court. Vīgants, supported by the Judicial College and by the Saeima’s own Judicial Committee, was one of the judges who sent Venspils mayor and chief oligarch Aivars Lembergs to prison in 2007. His political opponents in the Union of Greens and Farmers, who had once proposed Lembergs as prime minister, ensured the defeat and underlined once more the considerable forces that still protect corruption at the highest levels in Latvia. In a sublime footnote, Lembergs claimed that he should be considered to have furthered Vīgants’ career, not hindered it.

While Latvia is still fighting to save its economy, prevent further deterioration in living standards and ensure equitable distribution of European and International Monetary Fund loans, recent political focus has been mostly on international affairs. For the Baltic states significant issues of the past and present were closely aligned.

Considerable world attention has been paid to the 70th anniversary of the Molotov-Ribbentrop pact (Aug. 23), to the associated 70th anniversary of the beginning of World War II (Sept. 1) and, of more general concern, to an increasing closeness between Germany and Russia that brings eerie reminders of 1939.

The Molotov-Ribbentrop Pact, the vehicle by which Germany and the Soviet Union paved the way for the beginning of the Second World War, has always been an issue of the greatest importance to the Baltic states. In its secret protocol, the deal between Adolf Hitler and Joseph Stalin split up Eastern Europe into spheres of influence. It allowed Hitler to march unopposed into Poland and allowed the Soviets to do the same in the eastern part of Poland a few weeks later. Annexation of the Baltic states and Bessarabia (present-day Moldova) followed. The annexation of Finland was only prevented by the Finns’ astonishingly brave Winter War with the Soviet Union.

The pact and its consequences continue to affect Eastern Europe and beyond. The existence of the pact was strenuously denied by the Soviet Union, whose officials regarded it as Western propaganda. During the last years of the Soviet Union and its false dawn of political change, the pact in 1989 was acknowledged and condemned by the Congress of People’s Deputies. But since the coming of Vladimir Putin’s regime, there has been an astonishing rehabilitation of the pact. The pact is increasingly promoted by Russia as a wise strategic move by the Soviet Union in response to the West’s failure to contain Hitler through the appeasing Munich agreement. Moreover, the Kremlin released new archival documents purporting to show the West was hoping for a war between the Soviet Union and Germany so that the it would not have to soil its hands.

Allied to this have been repeated and continuing assertions that the Baltic states voluntarily joined the Soviet Union in 1940—and denials of occupation. Significantly, Aug. 23 was also the 20th anniversary of the Baltic Way—the world’s longest (in kilometres) political demonstration when, still under the Soviet Union in 1989, people joined hands from Vilnius to Tallinn, via Rīga, to demonstrate against the occupation.

Recent years have seen increasingly tense relations between Poland and Russia, and the commemoration of the beginning of World War II brought these issue to a head once more. An impressive ceremony in Gdansk, where World War II started in 1939, brought together many world leaders. But while Poles stressed the harm that had come to Poland and the rest of Europe through Nazi and Soviet actions, Russian responses were ominous, refusing to accept responsibility for Poland’s fate, and attacking those who would “rewrite history.” This time there was also a new slant on another Soviet atrocity: the murder of thousands of captured Polish officers after the defeat of Poland by the Soviet army at Katyn. Stretching historical credulity, Russia now claims that this incident, while regrettable, was an understandable Soviet retaliation to the way Soviet prisoners of war had been treated by Poland in its independence battles in 1918-20!

These Russian arguments have been condemned by many in Poland and the Baltic states, as well as by former Latvian journalist Frank Gordon, who has long warned of the unremitting desire of Russia to regain control over this territory. Equally critical have been a number of European writers, for example Pavel Felgenhauer of the Eurasia Daily Monitor, who argues that “in Soviet times the Kremlin adamantly denied the existence of a secret Molotov-Ribbentrop protocol. Today, the protocol is also praised, since the Kremlin clearly wishes to re-enact it.”

Re-enact the pact? While this sounds fantastic, we must pay attention to a very contemporary issue: the growing closeness between Germany and Russia, now developing into an important economic and potentially strategic partnership. The keys here are energy and the poorly performing economies of both Germany and Russia. For several years now Russia has been able to gain increasing influence in Europe through its importance in energy supply—particularly natural gas. Russia now supplies Germany with more than two-thirds of its gas needs plus oil, as Germany has reduced its own dependence on coal power. Former German Chancellor Gerhard Schröder has been prominent in advancing Russian interests both economically and politically: the Nord Stream project (chaired by Schröder) intends to build a gas pipeline under the Baltic Sea from Russia to Germany, bypassing the present supply routes through the Ukraine and Poland, both countries that have recently had tense relations with Moscow. Politically, Schröder has been a continual apologist for recent Russian actions whether in Georgia or elsewhere.

Germany’s insistence on its own energy security is now very much at odds with a European Union desire to forge a common energy policy and diversify energy supplies. Even more worrying is that Germany’s economic malaise has found some saviours in Russian oligarchs and government-backed entrepreneurs, who are taking stakes in troubled German industries, and a hope that close links with Moscow will favour Germany in selling heavy industrial and transport goods to Russia and investing in Russian infrastructure. Such moves would also give Putin and Russian President Dmitry Medvedev some sorely needed economic gains.

Historically, Germany and Russia have dominated Eastern Europe since the late 19th Century, and the present-day financial (and energy) crisis seems to have delivered an unexpected set of factors to re-establish this joint dominance.

Things to watch for

While most eyes were turned to Molotov-Ribbentrop and to Poland, some recent internal events in Latvia also claimed attention even in normally politically soporific August.

Latvia was finally able to achieve agreement with the IMF over its deficit and start receiving funds to stabilise the economy. Yet this success has not stopped leaders of coalition partner People’s Party (Tautas partija) from continually sniping at government actions—even those actions they had formally agreed to. Such actions are clearly positioning by this once dominant but now poorly rated party for the next Saeima (Parliament) elections just 13 months away, and introduce an unwelcome instability into Latvia’s government.

Meanwhile, the newly elected Rīga City Council continues to strengthen its ties with—Russia, who else?

These developments deserve close watching.