Public Information Notice: IMF Concludes 2001 Article IV Consultation with the Republic of Latvia
IMF News, January 25, 2002
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- Published: January 25, 2002
Background
- Executive Board conclusion date: January 18, 2002.
- Recent growth and inflation:
- Real GDP growth: 6½ percent in 2000; 8¾ percent in the first half of 2001.
- Inflation: 3 percent in 2000 and 2001.
- External accounts and financing:
- Current account deficit: fell to 7 percent of GDP in 2000, after reaching almost 10 percent of GDP in 1998-99.
- Export growth: 9 percent in 2000; robust export growth appears to have been sustained in 2001.
- Foreign direct investment: financed about three-fifths of the current account deficit.
- Market evidence: relatively low yield spread on Latvia's first Eurobond; successful issue of a second Eurobond in November 2001.
- Fiscal developments:
- General government fiscal deficit: likely reduced by about 1½ percentage points in 2001, to 1.7 percent of GDP.
- Expenditure ratio: reduced by about 6 percent of GDP from the high level reached in 1999.
- Revenue ratio: fell by about 4 percentage points from 1999 to 2001.
- Monetary and financial sector:
- Exchange rate regime: peg of the lats to the SDR contributed to price stability.
- Credit: relatively rapid expansion of credit to the private sector facilitating investment.
- Financial supervision: introduction of unified financial sector supervision under the Financial and Capital Markets Commission in July 2001.
- EU prospects: Latvia’s structural reforms and liberal market economy support the prospect of joining the EU in 2004.
- Main macroeconomic concern: persistent current account deficit; deficits of the observed magnitude pose potential risk to external sustainability.
- IMF program status: 20-month Stand-By Arrangement (SBA) approved in April 2001; first review under the SBA was not completed at this time due to concerns about the 2002 budget.
Executive Board Assessment
- Overall appraisal:
- Latvia's 2001 performance among the best of the EU accession candidate countries.
- Growth: strong and broad-based, driven by domestic demand and investment.
- Inflation: remained low.
- Concern: magnitude and persistence of the external current account deficit.
- Regret: delay of the first review under the Stand-By Arrangement.
- Exchange rate and monetary stance:
- Directors agreed the peg to the SDR remained appropriate under present circumstances; must be underpinned by sound fiscal and monetary policies.
- Recommendation: peg should remain an anchor in the period leading to EU accession.
- Welcome: Bank of Latvia's discontinuation of long-term foreign exchange swaps ahead of schedule and limiting short-term swaps by relying more on open market operations.
- Fiscal policy and medium-term outlook:
- Strong medium-term growth prospects conditional on disciplined macroeconomic policies, improved public sector efficiency, and continued structural reforms.
- 2002 outlook: domestic demand expected to underpin significant growth, albeit below 2001 pace; global slowdown likely to add stress to external current account.
- Under fixed exchange rate, fiscal policy is the primary macroeconomic instrument.
- Directors supported government's intention to move toward a balanced budget over the medium term but expressed reservations about the expansionary 2002 budget.
- Spending needs associated with EU and NATO accession recognized; however, improved prioritization and containment of public expenditure—especially in election year 2002—were deemed crucial.
- Encouraged: enhance tax administration and strengthen public sector reforms, including at municipal levels.
- Noted: adoption of fiscal targets for first half of 2002 aligned with a modest annual deficit; concern that the budget adopted by Parliament would imply substantial fiscal loosening in the second half of 2002.
- Financial sector and safeguards:
- Welcome: participation in the joint IMF-World Bank Financial Sector Assessment Program; no major vulnerabilities identified.
- Smooth transition to unified supervision under the Financial and Capital Markets Commission.
- Money-laundering framework: adequate legal framework established; urged strengthening enforcement capacity and monitoring of large inflows of non-resident deposits.
- Commended quick introduction of anti-terrorism financing legislation after September 11.
- Some Directors expressed reservations about a possible Financial Services Center.
- Credit growth and banking sector quality:
- Concern with continued rapid expansion of private sector credit, particularly at very short terms.
- Urged authorities to be ready to tighten monetary conditions if loan portfolio quality worsens.
- Structural reforms and governance:
- Welcomed advances in structural reforms to reduce unemployment and external vulnerability.
- Noted improvements in the environment for investment and foreign investment.
- EU accession process providing impetus to reforms; progress in accession negotiations welcomed.
- Urged continued privatization of large-scale public enterprises, strengthened fight against corruption, and improved governance.
- Commended maintenance of a very open international trade regime.
Selected Economic Indicators (as reported)
- Real Economy — Changes in percent
- Real GDP: 1996: 3.3; 1997: 8.6; 1998: 3.9; 1999: 1.1; 2000: 6.6
- Unemployment rate (end of period): 1996: 7.2; 1997: 7.0; 1998: 9.2; 1999: 9.1; 2000: 7.8
- Consumer price index (period average): 1996: 17.6; 1997: 8.0; 1998: 4.7; 1999: 2.4; 2000: 2.6
- Public Finance — In percent of GDP
- General government balance: 1996: -1.8; 1997: 0.3; 1998: -0.8; 1999: -3.9; 2000: -3.3
- Total government debt: 1996: 14.4; 1997: 12.0; 1998: 10.5; 1999: 13.1; 2000: 13.2
- External government debt: 1996: 8.4; 1997: 7.4; 1998: 7.7; 1999: 10.6; 2000: 9.9
- Money and credit — End-period; changes in percent
- Reserve money: 1996: 25; 1997: 30; 1998: 7; 1999: 12; 2000: 8
- Broad money: 1996: 20; 1997: 39; 1998: 6; 1999: 28; 2000: (not reported in table)
- Domestic credit (non-government): 1996: 1; 1997: 76; 1998: 59; 1999: 15; 2000: 37
- Balance of payments — In percent of GDP unless stated otherwise
- Trade balance: 1996: -15.5; 1997: -15.0; 1998: -18.6; 1999: -15.4; 2000: -14.8
- Current account balance: 1996: -4.2; 1997: -5.1; 1998: -9.8; 1999: -6.9; 2000: (not reported in table)
- International reserves (in months of imports): 1996: 2.8; 1997: 2.5; 1998: 2.9; 1999: (not reported in table); 2000: (not reported in table)
- Exchange rate
- Exchange rate regime: Peg to the SDR
- Exchange rate (lats per US$; end-of period): 1996: 0.556; 1997: 0.590; 1998: 0.569; 1999: 0.583; 2000: 0.613
- Real effective exchange rate (1997 = 100) 1/: 1996: 100.0; 1997: 115.8; 1998: 125.4; 1999: 125.6; 2000: (not reported in table)
- Sources: Data provided by the Latvian authorities; and IMF staff estimates.
- Note: 1/ End-of-period.
Source: Public Information Notice: IMF Concludes 2001 Article IV Consultation with the Republic of Latvia, January 25, 2002.