RIGA - The rating agency Standard & Poor's last week deprived Latvia of its premium "A-" borrowing grade due to the Baltic state's "persistent" macroeconomic imbalances and "increasing risks" of a sharp economic deterioration, the latest in a series of warning bells sounding in the international investment community. S&P downgraded Latvia's long-term sovereign rating to "BBB+" from "A-" and maintained a negative outlook for the Baltic economy, meaning the rating could be lowered again.
"The downgrade reflects expectation that the government's anti-inflation plan will only slowly reverse rapid growth in the current account deficit and external debt, resulting in an adjustment process that is potentially more disruptive than a more comprehensive policy approach," Eileen Zhang, a credit analyst at Standard & Poor's, said.
Commenting possible rating adjustments in the future, Zhang said, "The negative outlook reflects the prospect of another downgrade if the economic imbalances continue to be addressed at a slow pace and the risk of a hard landing increases."
Latvia's economy grew 11.9 percent last year 's the best result in the 27-member European Union 's leading to fears of an overheating economy that could crash and bring GDP growth down to 2 percent per year.
At the same time, a yawning current account deficit and inflation have put pressure on the local currency in recent months, and speculation that the lat may need to be devalued for the sake of exports has intensified.
"If the overheating continues, external pressures may ultimately weaken public and private balance sheets, although the government's currently strong balance sheet provides an important buffer," she said.
Danske Bank said in a statement that the rating downgrade "will require urgent action in the form of fiscal tightening to reduce the imbalances in the Latvian economy and the risk of financial distress." The bank recommended that investors hedge exposure to the Latvian market.
Since March the government has adopted an "inflation-fighting program" to address the macroeconomic instability, but it was namely for Latvia's leadership that Standard & Poor's reserved its harshest criticism. "The government does not seem to have a sense of urgency in tackling the mounting imbalances," the agency said.
Finance Minister Oskars Spurdzins said in a statement that S&P's decision was unpleasant, but it is a real signal that the Baltic state should reinforce its fiscal policy.
All ministries and state institutions should ensure maximum efficiency of expenditures and provide other activities necessary for the balanced development of the national economy, Spurdzins said.
He also pointed out that on May 17 the parliament passed amendments to several laws within the inflation curbing plan, introducing stricter requirements for consumer lending and imposing tax on real estate transactions. (See story on Page 11.)
Nevertheless, for weeks now the ministry has been trumpeting its anti-inflation campaign, yet consumer prices continue to soar, reaching 8.9 percent annually at the end of April. The current account deficit, meanwhile, skyrocketed 120 percent year-on-year, pointing to super-charged consumption.
The central bank, which until recently was the lone voice of fiscal discipline in the Baltic state, said that Standard & Poor's had been "hasty" in making the downgrade.
"The Bank of Latvia considers this statement to be too hasty as it is released on the day when Latvian parliament is just adopting the necessary bills on the recently made government's inflation curbing plan," bank spokesman Martins Gravitis told the Baltic News Service.
"We believe that a more objective assessment will have to be done after the first results are seen, which Standard & Poor's failed to have patience to wait for before downgrading the credit rating," said Gravitis, admitting however that the downgrade would be "an additional stimulus" for Latvia to bolster the anti-inflation program.
Bank of Latvia President Ilmars Rimsevics, speaking May 17 at a press conference, reiterated that the government needed to draw up a balanced budget for this year, not just 2008. What's more, Rimsevics is calling for a surplus in 2008, while the Finance Ministry wants to stick to a balanced budget.
In Spurdzins' opinion, "society" might not be prepared for a balanced budget, since it would require all ministries to make cuts at a time when they are under pressure to increase salaries for doctors, teachers, policemen and other budget workers.
Recently the center-right government approved the basic budget parameters for 2008-2010. Next year the budget should be balanced, while in 2009 there could be a 0.1 percent surplus and in 2010 the budget could show a surplus of 0.3 percent of GDP.