The collapse started a month ago. On Nov. 8, the Latvian government announced it was taking a controlling 51 percent interest in the market-leading Parex Bank, setting off a chain of events that has now drawn Latvia deep into financial crisis.

Until then, the prevailing view of the government was that the international financial crisis that had set capitalism’s finest institutions shaking would do little harm to Latvia, which was protected by its isolation and its hitherto exemplary liberal economic management.

The month since has plunged Latvia into the abyss. The government’s involvement in Parex has deepened to around 85 percent and it is desperately looking for buyers as investors withdraw money. But other prognoses for the economy have also worsened. The budget adopted just a few months ago had already forecast a drop in the Gross Domestic Product of around 1 percent, in line with the prevailing world economic downturn in 2008. But that has been radically revised and now is likely to be nearer 5 percent, signalling a damaging economic recession and a sharp decline in government revenue. The forecast budget deficit has doubled from 1.5 to 3 percent, endangering prospects of Latvia joining the euro zone in the coming few years.

A series of backdowns and reversals on the part of Finance Minister Atis Slakteris has made ludicrous his earlier confident assertions that Latvia, unlike some other countries (such as Iceland and Hungary), would need no help from the International Monetary Fund or other international financial institutions. In mid-November the government admitted it may need to borrow around EUR 3 billion. Now the sum mentioned is EUR 5 billion, although some analysts say around EUR 7 billion is the likely figure.

The IMF or any other international benefactor will impose strict conditions on government spending in the form of a stabilisation plan. Here is the really bad news: in Prime Minister Ivars Godmanis’ address to the Saeima last week he forecast a cut in government spending of around LVL 600 million—around 11 percent of all expenditures—and predicted that it would not be possible to avoid education, health, social services and other large areas of government spending.

The politics of this will be intense. In September a huge demonstration of teachers, health workers, police, fire officers, transport workers and others in the public sector called for a halt to their relatively declining wages and a guarantee of better conditions. This widely supported action was given extra fillip by Government Auditor Inguna Sudraba, who revealed systematic abuse of payment guidelines for government bureaucrats: a system of bonuses (prēmijas) has supplemented already generous salaries. In the Transport Ministry, run by chief government head–kicker and tycoon Ainārs Šlesers, officials had had 14 bonus payments in one year! The train, tram, bus and trolley bus drivers and maintenance crews had on the other hand received no such largesse.

To some extent, the scenario in Latvia reflects that in so many other countries still trying to make sense of a vicious global economic downturn, and trying to restore confidence in financial institutions. Certainly the situation is far worse in Russia, although denied by its government. It was partly the flow of Russian money that had made Latvian banks rich, employing the extraordinary slogan “We are closer than Switzerland”!

As elsewhere, property prices have also plunged steeply in Latvia, threatening all those who had been banking, literally, on continually growing prices to cover their loans. This may bring some sanity to Latvia’s overheated property prices (why does the price of a property in Rīga approach that of one in Paris or Berlin?), but along the way will bankrupt many.

Latvia showed it was capable of its own financial crisis nuances: in a move that caught the attention of the international press, Latvian security police brought in for questioning two people—a musician and a university economics lecturer—for spreading false information about the state of Latvian financial institutions. According to law, the deliberate spreading of such false information is illegal. It is a provision that had been introduced in a number of Eastern European countries to counter malicious disinformation that had resulted in several runs on banks in still fragile post-Communist economies in the 1990s. The musician made a throwaway comment about the banks during a concert. The economics lecturer’s view that people should not put money in banks and or keep it in the national currency, the lat, was reproduced in a Ventspils newspaper. Ironically, the actions of the security police made his views known nationally and even internationally: the American Wall Street Journal headlined this as “How to Combat a Banking Crisis: First, Round Up the Pessimists.” Despite the air of Keystone Kops, the issue of confidence in the financial sector remains.

The economic meltdown represents the final catastrophe in a year of great difficulty for Godmanis’ coalition government, criticised on all fronts for its handling of a number of economic and social issues, as Godmanis tried desperately to distance himself from the politics of the previous failed Prime Minister Aigars Kalvītis. As well as the growing dissatisfaction of public sector workers, the government narrowly defeated a popular referendum that would have allowed the dissolution of the Saeima through a referendum process. Relations with President Valdis Zatlers—originally seen as a badly chosen puppet of the coalition parties—have grown increasingly tense as he criticises the government both for lack of economic planning and for failure to move on a number of constitutional issues that have long debilitated Latvian politics. The failures of the year have also brought the leading People’s Party (Tautas partija) to its lowest point ever, a recent poll showing only 2.9 percent of the electorate would vote for it now. 

Finally, spare a moment’s thought for Godmanis. He is a significant figure in Latvian politics and was the prime minister at the most difficult time in 1990-1993 when he oversaw the end of Soviet rule in Latvia. He also oversaw the first huge economic downturn of the time that brought the old stagnant Soviet economy into a period of huge inflation, bankruptcy of enterprises, job losses and general turmoil. Somehow the government did get Latvia out of the Soviet Union and even set the basis for its future stable currency, and had the peculiar distinction of being the only government in Eastern Europe to survive a full term in that period. Godmanis could go down as presiding over both major economic disasters of recent history in Latvia—neither of them of his own making.

The Russian invasion of Georgia has cast a pall over European politics, not least for the Baltic states. As members of the NATO defense alliance and the European Union, they have been looking with alarm at the reckoning that Russia handed out to Georgia for daring to attempt to reclaim its two disputed regions of Abkhazia and South Ossetia.

Russia’s formal declaration of recognition of these two breakaway provinces as newly independent countries is a provocation to all countries on Russia’s borders, may have consequences for other potential breakaway provinces with the Russian Federation itself, and above all is an instruction to the United States and the EU that Russia has its interests and neither America nor Europe can do anything about them. The largely muted responses by Europe (trying always to broker a peace and asking “both sides” to be reasonable) and the empty campaign-related rhetoric of the United States against the invasion point to the difficulty of affecting the situation in any way. While the Baltic states along with all of Eastern Europe condemned the attack, it was not possible to persuade the EU to adopt a stronger response.

Two broad lines of interpretation arise from this situation. The first is that whatever immediate gains militarily and diplomatically Russia may have made, and however quiet the present response from the EU and U.S., this will negatively affect Russian relations with the world in the medium to longer term. It will first of all expunge the last of the fantasy that Russia is, if slowly, becoming a democratic state and that one will be able to deal with it as a “normal” country. Secondly, it will make all Western governments and businesses more wary of economic contacts with Russia. Already there has been a massive withdrawal of Western investment. And thirdly it will make all countries look much more seriously at whatever ways they are dependant on Russia, particularly in energy and specifically gas supplies to Europe, and seek alternatives at an accelerated rate.

A second line is more pessimistic. It points to the strategic strength of Russia in capitalising on U.S. and European weaknesses. The U.S. is overextended in the Middle East and in no position to challenge Russia in the Caucasus. Moreover, the U.S. needs Russian help in its dealing with Iran, Syria and others, or face increasing Russian arms sales and strategic help to these countries. The U.S. needs Russia more than Russia needs the U.S. Europe has too many vulnerabilities. It has dismantled much of its old energy infrastructure in exchange for easy Russian gas. History shows that individual European countries will often try to make friendly deals with Russia rather than oppose them. Germany’s ex-Chancellor Gerhart Schröder’s and Italy’s Silvio Berlusconi’s open love affairs with Russia are telling examples. Recent moves, such as Poland’s hasty signing off on a deal to house strategic NATO units in response to the Georgian invasion, will be an endless bone of contention with Russia. We may not be at the beginning of another cold war.

Meanwhile, there have been hasty reassurances from NATO leaders that security commitments to their new members in Eastern Europe—including the Baltic states—are still sound.

For all its potentially critical consequences, the Georgian situation has arisen at a time when the Latvian government is in continuing deep trouble both politically and economically on the home front. It has been a very active summer in Latvian politics indeed, with two referendums, marked signs of an economic downturn amid still high inflation, and a number of politically sensitive positions to be filled, including the head of the Corruption Prevention and Combating Bureau (Korupcijas novēršanas un apkarošanas birojs).

The Aug. 2 referendum was on a constitutional amendment to give the electorate the power to dismiss the Saeima, and though the referendum did not get the numbers, it was another important warning to a universally unpopular parliament.

The referendum was initiated by the trade union federation, covering mostly educational, medical and transport workers, as an attempt to rectify the situation where currently only the president can move to dismiss the Saeima. This provision has never been used by any president. The trade unions’ proposal was to allow the public the initiative to propose dismissing the parliament.

About 600,000 people voted, but this was short of the required 750,000 votes—half of all eligible voters, a stiff demand for a constitutional change. Yet it does show that more than 600,000 people were motivated enough to vote, maintaining the anger that has characterised Latvian attitudes to the Saeima and government now for over a year.

The second referendum on Aug. 23 was on a change to the state pension law. The referendum required a smaller number of voters to succeed. But it also failed, with about 300,000 people voting where some 450,000 were required. The proposal was to immediately increase pensions, and make adjustments to categories and ratios of entitlements that would better reflect years of work. It was proposed by a number of pensioner groups and the new political association A Different Politics (Savienība citai politikai), formed by breakaway politicians from the People’s Party (Tautas partija). The referendum was bitterly opposed by the government, which accused the proposal of being financial vandalism. The government ran a relentless scare campaign, arguing that the new rates of payment would exhaust the social security budget in a few years.

Seeing off the two referendums no doubt gave the government a brief relief, and in both cases the strategy of encouraging voters not to participate—a more than unusual response in a democratic country—was a seemingly successful strategy. Yet potential disasters loom for the government both economically and politically.

Economically, the “fat years” of former Prime Minister Aigars Kalvītis’ reign have come to a halt, with slower growth figures but still double-digit inflation affecting families and businesses. This has presented the government with a seemingly impossible budget situation, and responses to this have alternated between the comic and the tragic. A freeze on all public sector wages has been proposed, an extremely unpopular move in the light of still rising prices. Meanwhile, examples of rampant spending on luxury items by government departments and ministries (particularly on some handsome furniture) have hardly helped the cause. A proposed 5 percent cut in the budget of every ministry and department led to a symphony of special pleading and excuses.

Politically, after the manipulated dismissal of the former head of the anti-corruption bureau, the position still needs to be filled. This is an issue that has already brought down one prime minister and will be closely watched in Latvia as well as internationally.

Latvia’s coalition government is determined to wield power and has worked hard to marginalise or co-opt the opposition and the newer political forces trying to provide alternatives in politics. Meanwhile, Russia is relentlessly trying to intensify its influence, buoyed by Latvia’s gas dependency and by a curious side-step into sport.

April saw a successful outcome of the trade union-led petition for a consitutional amendment to give the electorate the power to initiate the termination of the Saeima and force it to an election. Many more voters signed the petition than the required 10 percent of the number voting in the previous parliamentary election. The constitutional change process required the proposal be debated by the Saeima. If the Saeima agreed, it would become part of the constitution. However, if the Saeima rejected the proposal, the proposal would go to a referendum. The proposal—always opposed by the coalition government—was in fact rejected by the Saeima, leading now to a national referendum on Aug. 2.

The success of the petition, and the success in early opinion polls of new political groupings led by Sandra Kalniete and Ģirts Valdis Kristovskis (Pilsoniskā savienība, or Civil Union) and by Aigars Štokenbergs and Artis Pabriks (Sabiedrība citai politikai, or Society for a Different Politics), initially forced the coalition to tone down its political ambitions. The coalition’s previously much-questioned reappointment of Jānis Kažociņš as director of Latvia’s main intelligence organisation, the Constitutional Defence Bureau (Satversmes aizsardzības birojs) finally went through with all coalition parties publicly supporting him (though several coalition Saeima members it seems nevertheless voted against him in the secret ballot). More trouble arrived for the government when Ina Gudele, the minister in charge of “e-matters,” had to resign when she used government finances to pay for her birthday celebration, which included a media-appealing strawberry torte. Prime Minister Ivars Godmanis’ announcement of achievements during his first 100 days in office was decidedly muted.

Yet these setbacks have clearly stirred the coalition into renewed action, trying to bolster its flagging fortunes, regain the political initiative and still do well by its mates.

Almost as a godsend (or from more earthly powers?) for the coalition came the April revelation that around LVL 130,000 had been stolen from the Corruption Prevention and Combating Bureau (Korupcijas novēršanas un apkarošanas birojs, or KNAB). It was the previous government’s desire to dismiss KNAB Director Aleksejs Loskutovs that led to public outrage, the “umbrella revolution” and Prime Minister Aigars Kalvītis’ eventual resignation late last year. The unexplained theft brought Kalvītis and others to call once more for Loskutovs’ dismissal. Also related to money matters, the Saeima has just passed a late surprise amendment to water down a criminal law proposal for confiscation of illegally gained assets, leaving everyone wondering in whose interests this was done. President Valdis Zatlers has responded in a curious fashion. Although he has the power to ask the Saeima to reconsider, at the time of this writing he is cautiously asking an ad hoc committee to advise him on what he should do. And also related to criminal law, a dubious coalition-backed candidate, Ivars Bičkovičs, was voted in as chief judge of the Supreme Court by the Saeima.

Prime Minister Godmanis has worked hard, not always helped by his ministers, to regain public trust in his government. But in May normal political transmission was interrupted by an attention-grabbing stunt featuring Kalvītis again: a group of ice-hockey backers had succeeded in having a team Rīga Dinamo join the newly re-created Russian hockey league lavishly sponsored by natural gas giant Gazprom. Despite all protests about Latvia’s energy dependence on one Russian source, Gazprom will expand its business in Latvia with the imminent building of a new gas-fired power station. Among the backers for both the power station and the new hockey team is now ordinary Saeima deputy Kalvītis. The measure of the man is seen from this exchange on his hockey dealings in an interview in the newspaper Diena:

Diena: Your declaration of income [required of all parliamentarians] does not show that you will be able to pay for your Rīga Dinamo shares.
Kalvītis: Don’t worry. That’s my business. I have already paid 50,000 and over the next year I need to pay another 150,000.
Diena: Where will you get the money?
Kalvītis: I’ll earn it.

No doubt he will.

Meanwhile, the opposition parties and new political groupings struggled. In May’s opinion polls the Kalniete-Kristovskis and the Štokenbergs-Pabriks partiea both slipped below the 5 percent mark they had earlier reached. (Five percent is the threshold a party must reach to have members elected to the Saeima). New Era (Jaunais laiks), which Kalniete and others abandoned, slipped even further below the 5 percent barrier, aided by persistent rumours it may make an alliance with the coalition’s leading People’s Party (Tautas partija). Some commentators stressed that this was typical of a period of lull when elections are not near and apathy takes over, but others warned this signalled a deeper malaise within the new political forces, which were essentially not new people but known politicians recycled.

Internationally, Latvia-Russia relations again soured when the Latvian documentary Soviet Story was released. The film showed not only the publicly known face of Nazi-Soviet collaboration as in the Molotov-Ribbentropp pact, but hitherto unknown details of much longer collaboration between the SS and NKVD (KGB) on tactics and methods, down to anti-semitism and its uses in both Germany and the Soviet Union. Several prominent Russian historians contributed to the film. Although well received by western media, Russia reacted sharply. Director Edvīns Šnore was burned in effigy in Moscow by members of New Russia, the youth organisation fostered by former president and now Prime Minister Vladimir Putin. This alarmed members of the European Parliament (the film was partly subsidised by European Union money), who added this to their list of Russian anti-democratic initiatives that are now felt more sharply by some in Western Europe.

But to show that local Latvian politicians are every bit as able to undermine Latvia’s interests as any force across the border, there is renewed agitation to dilute the language Laws and give greater legitimacy to the use of Russian in Latvia. Former President Guntis Ulmanis waxed eloquent at a Latvia-Russia forum about the greater role the Russian language was playing in Latvia. Surveys show many companies and organisations continue to use Russian rather than Latvian in their work. And while Foreign Minister Māris Riekstiņš told the local Russian-language press he would no longer answer questions in Russian, Godmanis still uses Russian frequently in public to “explain” policy to Russian speakers, now some 19 years after the initial language laws restored official status to Latvian. Employer groups have fought moves to extend Latvian language requirements to more occupational groups, and a particularly dangerous initiative is being debated that may allow universities to teach in Russian again, threatening to restore a Soviet-era two-track higher education system.

Given summer’s arrival and the looming Song Festival, the coalition will have hoped the distracted population will pay even less attention to politics and to its particular machinations. But anger over the stolen assets legalisation, the appointment of Bičkovičs and the referendum could lead to a hotter summer than the coalition expected.