RIGA - The International Monetary Fund (IMF) has urged Latvia to take steps to curb the high rate of lending in the economy and to tie pay rises to increased labor efficiency, so that Latvia's economy "cooled down", the IMF Executive Board said in its report on Latvia's economic development. The IMF also advised Latvia to choose and announce a new, realistic date for transition to the European single currency.
The board of IMF directors were concerned about the present "overflowing" economic expansion, driven by integration in the EU. The expansion is leaning too much on strong domestic demand, creating serious risks which could undermine the future equalization of income.
The IMF especially noted that the Latvian economy is currently functioning above the efficiency of its supply, with high prices and salary inflation weakening the country's competitiveness on the international level while the private sector is taking out sizable loans in foreign currencies.
The IMF believes the main challenge is to direct Latvia's economy away from overheating and limit its vulnerability. The IMF Executive Board advisesd Latvia to take measures to curb the lending rate, reduce fiscal incentives and ensure an environment where pay rises are tied to increased labor efficiency. The IMF recommended that Latvia set and announce an ambitious and realistic revised date for euro adoption, in order to help raise the credibility of these measures.
The IMF noted that the framework of Latvia's economy, a national currency pegged to the euro and an open capital account, restricts the efficiency of standard policy instruments. However, experts still believe that a wide range of such instruments might ensure significant results as long as they are coordinated and clearly announced.
IMF experts said that Latvia should avoid adding fiscal policy stimuli to the already existing pressures of demand coming from the private sector.
The experts also urged the Latvian authorities to restrict any additional spending and to start reducing compensation payments. In their opinion, the government's plan to introduce strategic spending and mid-term budget planning could help move away from the current practice of amending the state budget.
The IMF also proposed that Latvia put off the planned personal income tax cuts until the pressure of overheating is reduced.
The report said that real estate tax policy has been pushing up mortgage lending and housing prices in Latvia. The IMF therefore proposed expanding the personal income tax basis to include revenues gained from selling real estate. The IMF also called on Latvia to strengthen its monitoring structure to reduce risks in the financial sector. An IMF mission worked in Latvia from May 25 until June 6. During this time, the mission studied Latvia's macroeconomic development, which was necessary to draw up the annual report to the IMF Executive Board on Latvia's economic development and its monetary and fiscal policy. Similar reports are prepared annually on each IMF member state.