Economic situation in Latvia [19 Mar 2010]

• The global economic crisis and the recent Latvia's unsustainable economic policy have caused sharp economic decreases in Latvia.
• In 2009 Latvia's GDP decreased by 18% (year-on-year (y-o-y), Central Statistical Bureau of Latvia (CSB)), while the seasonally adjusted quarterly (q-o-q) change in the 4th quarter (Q4) of 2009 was -2.9% (CSB data).
• The main reasons for the drop in GDP are the fall in retail trade, manufacturing, as well as the decrease of government spending.
• A crucial part in Latvia's exit strategy from the economic crisis is reaching a sustainable and competitive economy, so that Latvia could meet the Maastricht criteria and introduce the Euro in 2014. Latvia's position on Maastricht criteria:
• The existence of the criteria portray the stability of eurozone;
• Changes in criteria would weaken the stability of eurozone – participants that have not reached convergence with the eurozone would be admitted, perhaps, causing problematic situations in the future;
• LV can fulfill the set criteria. The accomplishment of this task will prove that Latvia has reached convergence with eurozone and can be a full-fledged participant of the eurozone.
• In order to achieve Euro introduction Latvia implements structural reforms and shifts the economy to a more sustainable path – towards an economy based on exports. Importantly – we see the first positive results: the export growth has become positive!
• Although on m-o-m basis in January 2010 the goods export amounts decreased (by 15%), on a y-o-y basis the growth is +4.7% (the reduction on m-o-m basis is mostly explained by seasonal factors, mostly, the 'January effect' – reduced economic activity after the December's period). The yearly change in imports in January 2010 was -13%.
• The change in overall exports in 2009 was -19% compared to 2008; change in imports was -38%.
• Several additional indicators (such as manufacturing, foreign direct investments, current account, stock market, interbank market rates) show that the situation in Latvia's economy has started to stabilize. Positive quarterly GDP growth is expected already in the third quarter of 2010.
• In January 2010 the overall manufacturing produce (typically outpaces GDP dynamics) (compared to January 2009) has increased by +5.7% (CSB working day adjusted data).
• The current account continues being in the positive area – in Q4 2009 it was 12.2% of GDP.
• Despite the events in the UAE, Greece etc, since the lowest point in March 9, 2009 the NASDAQ OMX Riga index has increased by +56% in March 9, 2010 (Nasdaq OMX).
• The period's inflow of foreign direct investments in Q4 2009 compounds to 0.7% of the quarterly GDP.
• Rigibor (the interest rate for which the commercial banks are ready to lend lats to each other) rate for 3 month deals has stabilized and became lower: on March 12, 2010 it was 2.29% (last time a similar rate was quoted in the end of 2005, before the shocks in financial markets).
• Similarly stabilization and trust by investors is indicated by the regular demand for lats (the Bank of Latvia intervenes in the market, sells lats, purchases of euro). The opposite activity (purchasing lats, selling foreign currencies, that indicates a decreased demand for lats) was last observed in the end of October in 2009.
• Latvia has started to display fiscal discipline that the majority of countries probably will have to demonstrate in the near future.
• The first budget consolidation measures (3.9% of GDP 2009) were launched in June 2009, therefore yielding a budget deficit of 6.5% of GDP 2009.
• Saeima accepted the budget for 2010 on December 1, 2009; it included a consolidation of another 4% of GDP 2010, hence yielding a budget deficit to GDP 2010 ratio of 6.1%.
• (the ratios are according to cash flow budget compilation methodology, the agreements with the international lenders are according to the ESA95 methodology, according to it the budget deficit in 2010 will be less than 8.5% of GDP).
• The budget forecasts are very precise: the collected tax income in January 2010 form 99.6% of the month's plan. Therefore the budget surplus in January 2010 was LVL 71 mln (or 21% of the expenses). Nevertheless it should be noted that typically there is a large surplus in Januaries, the main reason: the most important part of tax income (VAT) is collected for the previous – December's period, when increased economic activity can be observed in the market, hence adding up to larger tax income.
• International lenders have positively acknowledged the anti-crisis policy and the measures adopted by the Government of Latvia and have granted further support.
• On February 17, 2010 IMF decided to proceed with the 3rd tranche (EUR 200 mln) of the financial support package to Latvia. Up to now Latvia has received 2 tranches from IMF: EUR 600 mln in December 2008 and EUR 200 mln in August 2009.
• The third tranche from the European Commission was granted to Latvia at the end of February 2010 and the payment of EUR 500 mln was done on March 11, 2010. Up to this Latvia had received EUR 1 bn in February 2009 and EUR 1.2 bn in July 2009.
• In March 2010 the World Bank approved the transfer of 100 million EUR to Latvia for social safety-net spending. Additional EUR 200 mln have already been taken from the World Bank.
• On January 21, 2010 Saeima authorized the Cabinet of Ministers to coordinate the negotiations with international lenders, hence "legalizing" the existing agreements and easing the reception of the following parts.
• A swelling issue is the growing unemployment – the challenge in medium perspective will be to maintain social stability, while trying to maintain a balanced social budget.
• On January 2010 Latvia again had the highest seasonally adjusted unemployment in EU27 – 22.9% (Eurostat).
• In turn, the data of State Employment agency (SEA) show that the registered unemployment in February 2010 was 17.1% (m-o-m growth by +0.5 percentage points).
• The remarkable difference is explained by the different age structures used – SEA data include registered unemployed aged 15-62 (which is more appropriate for Latvia, as there is a different pensioning age than average in the EU).
• Although the pace of both producer and consumer price growth continues to decline, now being in negative territory, a deflationary spiral is not expected.
• In February 2010 (y-o-y) the change in Consumer price index is -4.2%. On m-o-m basis the prices have remained unchanged (+0.0%).
• The Producer price index has changed by -8.8% in 2009.
• It should be noted that a long lasting deflationary spiral (with the consequential negative impact on the economic development) is not expected in Latvia, since Latvia is a small and open economy, whose price levels are mostly determined by the price levels abroad. By the optimum scenario the inflation on a yearly basis could become positive already in 2011.

Additional information on macroeconomic issues

• On February 12, 2010 the credit rating agency Standard&Poor's changed the future perspective of Latvia's rating from negative to stable. The main reasons are: (1) the ongoing economic recovery, (2) reduction of the global imbalances, (3) government's efforts in stabilization of the state financial sector.
• In Q4 2009 the change in the average real wage (y-o-y) was -11%; the change in overall gross wage (before taxes) in the governmental sector was -20%, while in the private sector the wages dropped by5% (CSB data). The Ministry of Finance forecasts that the correction will continue also in 2010: by -10% on average (the forecast is explained by a further labor market's adaption to the economic situation (mostly in the private sector)).
• The industries that have displayed the highest output growth y-o-y, January 2010 (working day adjusted data):
• Manufacture of wood and cork articles, except furniture (+43%);
• Manufacture of chemicals and chemical products (+26%);
• Electric power and gas supply (+25%);
• Manufacture of basic metals (+8%).

On the situation in the banking sector

• According to the calculations by the Financial and Capital Market Commission the total commercial bank losses in 2009 in Latvia have reached LVL 773 mln.
• The change in credit portfolio was -7% and in the end of 2009 the credit portfolio added up to LVL 15 bn.
• The debts, whose payback is delayed by more than 90 days, constitute 16% of the total portfolio. The loans with no late repayments add up to 74.5%. The accruals for bad debts are one of the main reasons for the negative profits – approximately LVL 1.2 bn were written down in 2009. In the meanwhile it should be noted that almost a half (10) Latvian banks still operate with profits.

On Latvia's budget 2010 and structural reforms

• Most important extracts from budget 2010:
• The reduction of expenses is not based purely on mathematical cutting, but also on structural reforms, which take longer to implement than one year;
• A unified reward system for state employees is introduced;
• Optimization of state administration and separate spheres (ministries, state agencies, hospitals, schools);
• Increased personal income tax (23%à26%);
• New taxes for capital gains for dividends, deposits, speculative deals etc. (10% or 15%);
• Personal use of company's car is treated as income, taxed respectively;
• Increased real estate tax (1%à1.5% of cadastral value);
• New progressive tax for residential areas (0.1%, 0.2% or 0.3% from cadastral value, depending on the value of property);
• Increased excise tax for wine and cigarettes;
• Duties for the use of cars increased by approximately 100% on average;
• Unchanged corporate income (15%) and value added taxes (21%).

On international financial support

• In 2009 to 2011 financial support of EUR 7.5 bn is available for Latvia;
• The financial support already received has allowed to i.a.:
• Ensure liquidity through refinancing loans;
• Create a social safety net;
• Cover state budget deficits;
• Ensure the credibility of the state financial sector, i.a. by bailing out the 2nd largest commercial bank in Latvia – Parex.

Financial support available in 2009 - 2011