Latvia Business Forecast Report Q4 2008

Difficult Times Ahead

We believe that the political and economic outlook for Latvia over the medium-term is fairly bleak. On the political front, the electorate is becoming increasingly dissatisfied with the governing coalition and parliament itself. Indeed, a vote held in August on whether to amend the country's constitution to give voters the right to initiate a referendum on the dissolution of parliament only narrowly failed to succeed. The economic picture also provides little reason to be optimistic. Cooling domestic demand combined with the projected eurozone slowdown will weigh on Latvian economic growth over the course of 2008-2009. Nevertheless, we forecast that Latvian economic growth will pickup in 2010, coming in at 5.0% in 2010, and will average 5.9% in 2011 and 2012 due to an improvement in external conditions.

The Latvian electorate's dissatisfaction with the Saeima has been growing. Parliament and the government have been accused of corruption, and are perceived as working in favour of a select group of businessmen and their allies. Discontent has also been rising due to concerns over the impact of the slowdown in economic growth following double digit outturns between 2005 and 2007, to our forecast of a paltry 2.2% this year. Persistently high inflation at 17.7% y-o-y in June, the highest growth in the European Union, is also fuelling the electorate's upset. We now believe that the there is a significantly heightened risk that the current administration will collapse before the next parliamentary elections, scheduled for 2010 - resulting in the need for a snap election.

We expect that a number of factors will lead to a slowdown in Latvian growth over the medium-term. In particular, we anticipate that domestic consumption will be weighed down due to the continued effects of tighter lending conditions. Furthermore, the medium-term outlook for the external sector also looks poor. With eurozone economic growth forecast to slow to 1.6% and 1.4% for 2008 and 2009, respectively (down from 2.6% in 2007), this will weigh on Latvia's economic growth. EU members have consistently accounted for over 72% of Latvian exports between 2000 and 2007, mitigating the possibility of Latvia exporting its way out of the slowdown. We now forecast that the Latvian economy will grow by 2.2% and 2.6% in 2008 and 2009, respectively.

Latvia's retail banking sector continues to grow apace, according to the latest data from the country's Association of Commercial Banks. The number of bankcards issued in the country rose to 2.5mn by the end of June 2008, an increase of 4.6% compared to end-2007. In addition, the number of automated teller machines (ATMs) in operation in Latvia rose to 1,197 in June, an increase of 4.7% compared to the end of the first quarter of 2008. The number of retail outlets receiving bankcards for payments rose to 23,074, an increase of 13.3% compared to end-2007. We see this as a positive sign of the country's continued institutional development.