Economic pain just starting for Baltic states

By Patrick Lannin and David Mardiste - Analysis

RIGA/TALLINN (Reuters) - Latvia's rescue of its second-largest bank shows global turmoil has finally hit the Baltic region, but the pain is just beginning for the three former high-flying nations as a painful recession awaits.

As the countries' currency pegs again come under the spotlight, the authorities are expected to hang on to them at all costs, but this means people face the prospect of a back-door "devaluation" and hardship via falling wages and prices.

The currencies of Estonia, Latvia and Lithuania are all pegged to the euro and stable exchange rates have been one of their economic bedrocks since the fall of the Soviet Union.

If that link were broken people's debts would become much more expensive to service and confidence would take a huge blow.

Latvia is the most extreme example, with its yo-yo like economy expanding in double digits over the last two years and sliding four percent in the third quarter of 2008. The culprit is a huge influx of credit, which dried up in the global financial crisis.

But Lithuania and Estonia are also vulnerable to protracted problems.

"Latvia faces a very serious recession, it is only just beginning," said Morten Hansen, economics professor at the Stockholm School of Economics in Riga. "It is only just beginning for all three (Baltic states)."

Latvia is now clearly seen as most risky of the three former Soviet nations as Standard & Poor's on Monday downgraded the country's debt rating to BBB- in the wake of the rescue of second-largest bank Parex, just one step away from junk status.