RIGA - The International Monetary Fund’s (IMF) executive board approved giving Latvia access to a further 200 million euro from its bailout loan package. At the same time, the biggest international donor, the European Commission, promised to transfer the next tranche, 500 million euros, in mid-March. However, the IMF highly recommends that Latvia abides to its agreed higher taxes and to not decrease the value added tax (VAT) on the tourism industry, something that some of the coalition parties are intent on doing.
The IMF predicts a slow recovery for Latvia, however, while there remain many tough measures to implement. Right now, about an a fifth of the country’s workforce is unemployed, lending is in decline, and higher-educated people are leaving Latvia, stated IMF officials.
“We advise Latvia’s government not to decrease taxes. The IMF has always held to the value added tax flat rate, because it makes tax administration easier and also prevents pressure from the other industries who also want to get an advantage,” said the IMF resident representative in Latvia, David Moore, at a news conference with the head of the state’s European Commission Office, Iveta Sulca.
Despite the objection of Prime Minister Valdis Dombrovskis (New Era), the parliament already agreed on submitting a reduction of VAT, from 21 percent to 10, percent for consideration. The opposition parties managed to achieve this with the cooperation of the biggest coalition member, People’s Party, who voted for the draft bill.
However, the IMF hopes that Latvia will follow its advice and hopes for the country’s recovery late this year and into 2011, said the IMF’s mission chief for Latvia, Mark Griffiths, in the interview to the IMF Survey.
“When we discuss Latvia’s future, it’s important to understand its recent past. From 2000 to 2007, Latvia grew at annual rate of 9 percent, making it one of the fastest growing economies not only in Europe, but in the world. Between 2005 and 2008, wages doubled. In 2006 and 2007, the current account deficit grew to more than 20 percent of GDP. This meant that Latvia was borrowing roughly 20 percent of its income from abroad. By end 2007, foreign debt, most of it private sector debt, had increased above 125 percent of GDP. As we now know, none of this could last. Foreigners stopped [additional] lending to Latvia, foreign depositors withdrew their funds, and in late 2008, Latvia faced a deep recession.”
Emigration has increased dramatically, with skilled labor leaving for Britain and other countries. This is one of the topics the IMF intends to focus on in the next annual assessment of Latvia’s economy, said Griffiths.
“Emigration is a safety valve that can help overcome Latvia’s severe unemployment problem. But if entrepreneurs and the most skilled workers leave in big numbers, Latvia will lose the very people who could be creating new companies and jobs. And by reducing the labor force, emigration will also reduce output in Latvia. Unless it is offset by substantial remittances, emigration will reduce tax revenues and make it harder to finance government spending, such as pensions.”
Griffiths also pointed out that lending to small businesses and consumers is clearly in decline.
“This decline in credit will dampen the recovery, but it’s an unavoidable consequence of the unsustainable boom that came before. Credit grew by 58 percent in 2006, and by 34 percent in 2007. This jump in lending volume caused real estate prices to increase by 75 percent from the start of 2006, to the peak in spring of 2007. This also increased credit, to almost 90 percent of GDP in 2007.”
The struggling Baltic state obtained the international loan agreement of 7.5 billion euros from a group of lenders in December 2008. The package includes contributions from the European Union (3.1 billion euros), the IMF (1.7 billion euros), the Nordic countries (1.8 billion euros), the World Bank (400 million euros), the Czech Republic (200 million euros) and the European Bank for Reconstruction and Development, Estonia, and Poland (100 million euros each).