Latvia's economy stabilizing, but remains 'fragile'

RIGA - Latvia may be able to drop its national currency, the lats, and switch to the euro already in 2013, a year earlier than its official target date, if the government manages to narrow the budget deficit, says central bank Governor Ilmars Rimsevics, reports Bloomberg. The Baltic state’s economy, facing the deepest recession in the European Union, will start to grow again in the second half of next year, Rimsevics said. He said that GDP may contract 2.5 percent in 2010, better than the bank’s earlier forecast of 4 percent.

Latvia is ahead of schedule in reducing its budget gap as the government pushes through austerity measures needed to keep bailout funds flowing in, Prime Minister Valdis Dombrovskis said on Dec. 2, a day after the parliament approved next year’s budget. The government targets a deficit of no more than 10 percent of GDP for this year and 8.5 percent of GDP in 2010.
The central bank expects the current-account surplus, the widest measure of money flowing in and out of the country, to be 7.5 percent this year and peak at 8.9 percent in 2010. The surplus should then narrow to 6.6 percent in 2011 and 4.3 percent in 2012, said the bank governor.

Latvia’s GDP is expected to drop 18 percent this year, according to Danske Bank, reports news agency LETA. The bank had previously said that Latvia’s GDP would fall 20 percent year-on-year, but the third quarter macroeconomic data give reason to hope that the worst of the Latvian recession is over already. Latvia’s GDP dropped 18.4 percent year-on-year in the third quarter of this year, a slight improvement on the 18.7 percent year-on-year fall in the second quarter.

The third quarter GDP contraction “fueled hopes that the worst of the Latvian recession is over. However, a significant part of the more favorable GDP figure came from the ‘base effect.’ The stabilization process is still fragile and we believe the risks related to future growth perspectives have not yet disappeared,” said the bank in its macroeconomic outlook on emerging markets.
The deflation trend in Latvia should also continue in 2010, say bank analysts. “A poor domestic outlook in 2010 is likely to result in even steeper price declines. We therefore expect the average consumer price index to decelerate, to 3.6 percent, in 2009 and to see deflation of 1.9 percent in 2010.”

The bank sees one of the major risks for the Latvian economy as the external trade imbalance, which continues to shrink. The current account has recently recorded a surplus position and the bank expects a positive current account balance for the year overall. It, however, forecasts that unemployment will continue to be a serious problem, where the rate could reach up to 18 to 19 percent by the end of 2009.

Analysts also believe that renewed pressure on the currency peg can not be ruled out.
Rimsevics in his statement reiterated the government’s policy of bringing Latvia back to international competitiveness through the so-called internal devaluation process, in which local prices and wages are forced down, and ruling out any need for currency devaluation.

Saeima on Dec. 1 approved spending cuts and tax increases of 500 million lats (714 million euros) to meet this goal and comply with the terms of a 7.5 billion-euro loan package from a group led by the European Commission and the International Monetary Fund.