Press Release No. 12/180

Press Release No. 12/180
May 16, 2012

An International Monetary Fund (IMF) mission visited Riga May 7–16 for the first post-program monitoring discussions—part of the IMF’s regular surveillance of countries with IMF credit outstanding above 200 percent of quota. The mission cooperated closely with an European Commission mission that visited for post-program surveillance discussions. At the end of the visit, IMF mission chief Mark Griffiths issued the following statement:

“Latvia’s economy is recovering strongly. Growth rose to 5.5 percent in 2011, and reached 6.8 percent year-on-year in the first quarter of 2012, led by higher domestic demand. The mission has raised its 2012 growth forecast to 3.5 percent. Short-term indicators suggest 2012 growth might end up slightly higher, provided the external environment does not deteriorate. Underlying inflation remains low, and headline inflation should fall to around 2.6 percent in 2012, provided there are no shocks to world energy or food prices.

“This year’s budget deficit should fall to around 2 percent of GDP, well below the 3 percent Maastricht criterion. Tax revenues in the first quarter of 2012 came in above plan. Given the strength of domestic demand, the bulk of this overperformance should be saved. However, some additional spending in areas that have adjusted the most and where funding in the 2012 budget was limited—primary health care, road maintenance, and the social safety net—could be warranted. Public sector wages need to be made more competitive with the private sector, to stem the loss of highly qualified staff and to recruit staff needed to strengthen tax administration. But any spending increases would need to be limited and well targeted.

“Major changes to the tax code or to spending are best made when preparing the annual budget, not in the middle of the year or through supplementary budgets. Given that unemployment remains high at around 15 percent, if tax cuts are introduced, they would be best targeted at lowering labor costs, especially for the long-term unemployed. Although cutting the VAT may appear attractive, given that earlier crisis-related increases were substantial and the VAT is now slightly higher than in neighboring countries, it could also boost consumption and weaken the current account.

“For 2013, we continue to have concerns over proposals to save money by decentralizing the funding of GMI, since poorer local governments will have difficulties paying this. We hope that the study being conducted by the World Bank and the Ministry of Welfare will provide recommendations on how to prevent poverty traps and better target social assistance, and that these recommendations will be included in the 2013 budget.

“The authorities are implementing their structural reform agenda. The Fiscal Responsibility Law is being aligned with the Fiscal Compact, but more work is needed on the methodology for computing the structural fiscal balance. On Mortgage and Land Bank (MLB), the authorities should sell all commercial assets unless there is clear evidence that the bids are well below market value. Once the sales process is completed, the remaining development part of MLB should be merged with other development finance institutions, to create a single development financial institution, and the banking license removed. In 2011, the government injected L58 million (0.4 percent of GDP) into airBaltic. The government should closely monitor implementation of the new business plan to return the airline to profitability quickly and should sell the airline to a strong strategic investor to avoid further taxpayer losses.

“The authorities have made good progress toward the program’s exit strategy of euro adoption. Impressive fiscal consolidation during the program means the Maastricht fiscal criteria should be met with a large margin. Despite successes in keeping underlying inflation low and returning to investment grade, meeting the inflation and interest rate criteria will be challenging given the impact of external shocks and uncertainty surrounding the level of the reference values for the Maastricht criteria. Joining the euro would be beneficial for the Latvian economy: exchange rate risk would be eliminated, financial market stability should improve, and interest rates should fall. The authorities should continue their strong policy implementation to increase the chances that the Maastricht criteria for euro adoption are met sustainably.

“The IMF team would again like to thank the authorities for their generous hospitality and frank discussions during the mission, the many social partners and non-government officials who made time to meet with us, and to the Mayor of Salacgriva for hosting us and for showing us examples of sustainable development projects.”

Further information: http://www.imf.org/external/country/LVA/index.htm