RIGA - The hangover has begun. Latvia's economy, over the past few years the hotrod of the European Union, is in the middle of coming to a screeching halt, with annual growth of gross domestic product falling to 3.6 percent in the first quarter.
By comparison, GDP growth in the fourth quarter of 2007 was 8 percent, while growth in the first quarter was 11.2 percent.
The result, announced by the statistics agency on May 9 and based on preliminary data, surprised many analysts, even though all had predicted a slowdown. Expectedly, it also put government leaders on spin control alert.
Considering economists agree that quarterly growth this year will continue to fall, it would appear that, despite official statements to the contrary, Latvia is undergoing a hard landing 's a term used to describe a scenario when robust GDP expansion suddenly plummets to 2 percent or less.
Analysts and government officials did reiterate that the downturn was inevitable given Latvia's stellar economic performance from 2005 's 2007. In 2006 GDP growth reached a staggering 11.9 percent.
"Such a correction of the economic situation was unavoidable," said Dainis Stikuts, economist at Hansabanka.
He said that only exports were facilitating growth in the current environment since domestic demand and investments were falling and there are no profitable opportunities in the domestic consumption industries.
"Production and exports should form the basis of Latvian economic growth instead of domestic consumption. This is why stimulating production and exports should not be delayed 's to make this correction less painful," Stikuts said.
Zigurds Vaikulis, market analyst at Parex Bank, stressed that Latvia's flagging economy was part of a wider global process.
"The real estate market and the economic slowdown is not a Latvian phenomenon. Both processes are of global nature. They are faster here, as the economic growth before was faster," he said.
"It seems that no sensible person doubted that the party 's crazy appreciation of housing prices, rapid growth of lending, dictatorship of construction companies 's could last forever," Vaikulis said.
Still, he stressed that thanks to the years of robust growth Latvia managed to increase the standard of living of its citizens from 37 percent of the average level in Europe in 2000 to 60 percent now.
Vaikulis said Parex was reducing its GDP forecast this year from 5 percent to 3 's 4 percent.
By comparison, last year the economy grew 10.2 percent.
Government ministries said the sudden fall in GDP growth was natural.
"The factor that provided for the steep economic growth in Latvia in the previous years and supported by huge financial assistance, has been exhausted," the Economy Ministry said. "Domestic demand was considerably reduced by the realistic approach of households to the spending strategy."
Indeed, retail sales were down 3.4 percent over the first quarter, according to the most recent data, which demonstrates the scope of how Latvian consumers have cut back on spending.
A Bank of Latvia spokesman stressed that the first quarter result was preliminary, or based on a narrow range of information, and that a clearer picture would emerge in June when fuller data are announced.
The bank said it was crucial that the government promote exports, which are now crucial to the economy's sustainability.
"To ensure sustainable export growth in the future, the government's export promotion measures should be implemented to ensure international competitiveness," said Martins Gravitis.
He also pointed to the role of psychological factors in the current environment. "Consumers should not sink into the opposite extreme from optimism, which influences contribution of domestic demand in the growth GDP," the bank spokesman said.
Stikuts of Hansabanka agreed. "Stimulating production and exports should not be delayed to make this correction less painful," he told the Baltic News Service.
He also said the government's fiscal policy should be adjusted so as to not to exacerbate the cyclical fluctuation. In other words, the government may want to rethink its policy of a budget surplus.
This contrasts to the advice of central bankers, who have said that the 1 percent surplus in this year's budget should not be regarded as a "mythical reserve" that can be tapped.
In a statement, the Economy Ministry called for a stimulus package.
"It is important to stimulate industrial development, especially in the export-capable industries, and to reduce labor costs. Corporate income tax concessions should be mentioned as one of the instrumentsâ€¦ Similarly investment in R&D, allowing the companies to purchase new technological manufacturing equipment and increase productivity should be stimulated," the ministry said.
The ministry also said that diverse financial instruments, including the establishment of a stimulus fund, should be developed as banks shy away from riskier loans.
"Not later than by the end of the year an investment fund will be established that will organize accessibility of financial instruments to all types of companies. The investment fund will manage at least 200 million euros, which will be available as loan security, increased risk loans, risk capital funding and financing and lending on export loans," the ministry said.