Latvia's economic picture clears

  • 2000-08-03
  • Ieva Raubishko
WASHINGTON, D.C. - Latvia has managed to overcome its financial difficulties and has been on the track of economic rebound since the second half of last year, several international financial institutions and acclaimed analyst units stated in their recent reports.

Latvia's positive outlook is viewed by many as a result of tight fiscal policies, cautious monetary strategy and continuous structural reforms. The 3 percent economic growth in the fourth quarter of the last year resulted in 0.1 percent overall economy expansion. In the end of 2000, the GDP growth is likely reach 4 percent, above the 2000 budget target of 3.5 percent, according to Fitch IBCA Latvia report released in July.

Fitch IBCA, a leading international rating agency, based the positive prognosis on the indications of the expansion of Latvia's export volumes since the second half of the last year, as well as the increase of industrial production and transit services.

The International Monetary Fund pointed out the growth of tax revenues by 4 percent in the first quarter, the increase of the credit to private sector by 11 percent in the first four months, and the rise in consumer spending. The IMF's latest Latvia review spoke approvingly of decrease of the unemployment rate to 8.8 percent in May and the continuously low - about 3.5 percent - inflation rate.

The decline of budget deficit to 4.2 percent of GDP in 1999 and determination to reach 2 percent barrier in 2000, as agreed with the IMF, purports a promising fiscal development.

The positive tendencies notwithstanding, international analysts have expressed concerns about several weaknesses that present risk to Latvia's external stability.

The current account deficit that reached 9.7 percent [data presented in the IMF report] last year is viewed as one of the main vulnerabilities. The prognoses for this year's 2000 deficit range from 8 and 8.5 percent of GDP as projected respectively by the Bank of Latvia and the IMF to 11.6 percent of GDP as forecasted by the Economist Intelligence Unit, a reputed analyst group.

The current account deficit is likely to narrow gradually over the longer term, said Sharon Leech, senior Latvia analyst at Fitch IBCA. The tendency will be supported by industrial restructuring, an improving ability to satisfy the demand for consumer durables, and the boost of private savings enhanced by pension reforms, according to Leech.

A quicker growth than expected would be the main risk in the near term, Leech said. This could fuel stronger import growth and result in a more disappointing current account performance. The readiness of authorities to tighten fiscal policy further, if necessary, is a positive sign, she added.

The IMF also stressed the current account deficit could be further reduced by continuing tight fiscal policies and structural reforms, the main targets of Latvia's stand-by arrangement with the Fund.

Tightening of fiscal policies include no additional budgetary spending up to 0.7 percent of GDP as was intended to provide increase of pensions, teachers' salaries, benefits for families, subsidies for pork producers and road constructions. The government has also prepared a contingency measures' plan to be implemented to save 0.5 percent of GDP in case of a sharp increase of current account deficit and shortage of foreign direct investments.

Fiscal tightening could be hindered by sharp rise of minimum monthly wage, an IMF staff member, who asked not to be identified, said in an interview with The Baltic Times.

The increase of minimum wage might bring some revenues in short term, the IMF staff member said. But it could have a negative effect on economy, such as slow-down of foreign investments and increase of the export prices.

The rise of minimum wage would put a pressure the wage structure in general and result in the wage increase throughout the economy, according to the IMF analyst.

"Wage increase is the ultimate goal, but it should reflect the gains of productivity, not just government's willing to raise wages," he said.

But Latvian government managed to reach a compromise by deciding this week to increase the minimum wage in public sector starting with July 2001, news agency LETA quoted Finance Minister Gundars Berzins as saying.

The Cabinet passed a decision, according to which the minimum wage for public sector employees will be increased in proportion to their current wages. People with a current wage of 50 lats to 60 lats will get an increase of 10 lats, employees receiving 60 lats to 80 lats will get an increase of five to seven lats, but employees whose current wage is 100 lats to 150 lats will see a slight increase of two lats.

Berzins said, according to LETA, that the decision would be enacted only in the second half of 2001, because a wage rise already in the beginning of the next year would significantly increase the budgetary spending. The decision, however, did not satisfy the trade unions that support a sooner [January 2001] wage increase.

While government is taking steps to raise the income in public sector, the IMF would prefer no wage increase in the near term.

Government should consider the sizable current account deficit and concentrate on strengthening Latvia's competitiveness, the IMF staff member said. But the recent decision wouldn't stop the IMF program in Latvia, he said.

Current account deficit, however, is not the only drawback mentioned by international economic observers. The deep disagreement among various political groupings within the country over privatization issues and close ties between some politicians and privatized companies have earned Latvia a measure of notoriety.

Latvia's latest prime minister, Andris Berzins, awaits a tough time ahead as he is not likely to cut the powerful ties between business and politics and may not survive in the post until next elections, the Economist Intelligence Unit wrote with pessimism in its Latvia review released in June.

Government instability could threaten the pace, if not the direction of structural reforms, Fitch IBCA agreed in its July report on Latvia. It is not at all certain if the new government will be less politicized than the previous one that stepped down in April, Fitch IBCA noted. But the measures taken by the new government to distance politics from the privatization process by inviting international investment banks to advise on sales, will be helpful in boosting investor confidence, Fitch IBCA's Sharon Leech said.

Latvia's difficult relationship with Russia is another risk factor for Latvia, given the importance of transit of Russian oil and goods in the country's economy, according to Fitch IBCA. The agency noted, at the same time, that the Russian crisis has spurred a further industrial restructuring as more producers have been pressed to redirect their trade towards Western partners.