Latvia's economy: the long road to recovery

RIGA - As Latvia wakes from a year-long fiscal snooze, analysts and
government officials are tallying the lessons learned in the worst
recession this decade.

No one disputes Latvia's economy has taken a step back - the deficit
and unemployment are up while exports and GDP are down - but the
recession forced more ties with the West that will likely, in the
long term, push the economy two steps forward.

"It will make the economy stronger in the future," said Andris Vilks,
an analyst with Unibanka.

Devaluation of the Russian ruble in August 1998 and the decline in
Russia's import demand threw trade partners, the Baltic nations among
them, into the worst economic slump in the post-Soviet era.

During the first half of 1999, exports from Latvia and Estonia
dropped more than 10 percent while in Lithuania, which retained close
pre-crisis trade ties with Russia, exports fell nearly 25 percent.

Export losses helped shrink the gross domestic product in all three
countries. In Latvia, the GDP dropped 2 percent during the first half
of this year, and best-case predictions are no growth in 1999,
cementing its position as the country with the lowest GDP per capita
in Eastern Europe.

"I don't expect any GDP growth this year," said Druvis Murmanis, a
board member at Hansabanka and head of the finance market analysis.
"I think the best we can hope for is zero growth."

A declining GDP and an increasing foreign debt led to budget cuts
last summer recommended by the International Monetary Fund and
carried out in a flurry of protest aimed mostly at proposed cuts to
the national pension fund.

But the cuts began to trim the deficit and renewed the IMF's faith in
Latvia's economic reforms, which will lead to more deficit-fighting
loans from the World Bank and, the government hopes, invigorate
investor confidence.

This week, Parliament will begin considering the budget, replete with
cuts that will reduce the deficit to the IMF benchmark of 2 percent
of GDP.

Stabilizing economic indicators also compelled the international
rating agency Fitch IBCA to re-assign Latvia's reasonably favorable
international bond rating.

"The government is doing a lot to help the economy," said Toms
Baumanis of the World Bank in Riga. "But for financial stability,
more must be done, and we believe another round of budget cuts must
be done."

Most analysts forecast the stepped-up growth will continue through
next year, as do the IMF and most rating agencies.

Through it all, thanks to nearly daily interventions by the Bank of
Latvia, the lat stood tall against the ruble and handled itself well
against the U.S. dollar, signs that the young currency has some
international clout.

Encouraging trade figures with Western Europe and the United States
have analysts hopeful that export markets will stabilize.

Export markets

Great Britain and Germany emerged as Latvia's biggest export markets.
Trade to the British Isles increased 4 percent from January to June
this year compared to last year to 16 percent of exports while
Germany climbed to just under 2 percent to 16.5 percent. Trade with
Sweden also increased.

As expected, trade with Russia fell by more than half from 15.9
percent to 6.7 percent.

But industries used to much less competition and better profits in
the Russian markets took it hard on the bottom line.

"It was a rather hard lesson for entrepreneurs in Latvia," said
Druvis Murmanis. "But it forces them to think more about risk and
long-term stability."

The food industry was hit hardest, with a 24 percent decline that
illustrated the different tastes of Western markets.

Though it will mean profit losses that will likely never be recouped,
analysts say the recession further pushed Latvia and the other Baltic
countries further from Russia's economy, where the profit margins are
higher but the instability maddening.

"We understand risks that were not so clear a year ago," said Finance
Minister Edmunds Krastins.

Each morning, Krastins walks past an empty Rigas Komercbanka cash
machine, unplugged and collecting dust in the corner of the
ministry's lobby. Komercbanka, the nation's third largest bank and a
victim of the Russian crisis, closed its doors last March but is
staging a comeback, allegedly by mid-October.

Nonetheless, the cash machine serves as a reminder that the good
times can go dry at any time.

"With our knowledge of Russian markets, we should have left them
faster," said Krastins.

Krastins, who was in Washington, D.C. last week to share Latvia's
economic policy with the IMF, has declared the recession over.

As the economic figures have begun to improve, foreigners have looked
to invest more in Latvia, according to second-quarter statistics.
Direct foreign investment increased to 56 million lats ($96.55
million) during the second quarter this year, versus 43 million in
the first quarter.

Even unemployment, which hit record lows this year, is begining to fall.

Road to recovery?

Given all these statistics, it would appear that Latvia's economy is
well on its way to a bright and rosy future.

Not so fast, warn analysts. There is still some work to do.

Latvia's banking sector, labeled "among the most anguished in
emerging markets globally" in a Standard and Poor's report released
in August, needs to consolidate to be taken seriously.

The Russian economic crisis last year delivered another punishing
blow to a banking industry still recovering from crisis in 1995.

Legal and economic reform helped prop the industry back up until the
bottom fell out of the ruble.

Ten of 31 banks in Latvia held more than 10 percent of their assets
in Russian and Commonwealth of Independent States securities, "the
highest of any banking system in the world," according to the
Standard and Poor's report.

A handful of smaller banks dissolved along with Komercbanka.

Again, crisis forced an industry to look within.

"We lost a lot of money in Russia, but it was a good lesson, as banks
started to turn more attention to local customers and local
business," said Murmanis.

There are still 26 banks licensed in Latvia, though that number will
drop considerably at year's end when government capital requirements
will likely kick start consolidation.

Like exports and the economy as a whole, banking is becoming further
insulated from the manic tendencies of the Russian economy, according
to World Bank's Baumanis.

"There will probably be no more surprises like Komercbanka."