Country Report Latvia December 2008

Outlook for 2009-10

• The four-party, centre-right government is led by Ivars Godmanis. Corruption scandals will continue to create instability, and the coalition government is unlikely to survive until the election due in October 2010.
• Sharply slowing economic growth means that the government's target of a balanced budget in 2008 is unlikely to be realised, and the Economist Intelligence Unit expects sizeable budget deficits in 2009 and 2010.
• We expect real GDP to contract by 1.5% in 2008 and by 7% in 2009a sharper recession than previously forecast, reflecting a worsening export and financing outlookbefore rebounding modestly to grow by 1.2% in 2010.
• Average annual inflation is forecast to fall from an estimated 15.7% in 2008 to 5.5% in 2009 and 4% in 2010 as large commodity and food price rises come to an end and as domestic demand pressures weaken.
• The current-account deficit will narrow from an estimated 14.2% of GDP in 2008 to 7.5% of GDP in 2009 and 6% of GDP in 2010, initially as the fall in domestic demand slashes import growth, and later as exports strengthen.

Monthly review

• Police have launched criminal proceedings against a university lecturer and a musician over alleged alarmist comments about the stability of the lat and the country's banks, a move that has led to concerns about freedom of speech.
• The government's position as it confronts the growing economic crisis is weak. The popularity of the governing parties is low, and doubts remain over whether the coalition can survive the test of the economic downturn.
• Parliament passed the budget for 2009, with a deficit of 1.5% of GDP, but the budget's assumptions are already outdated because of rapidly slowing economic growth, and the government is preparing further spending cuts.
• The government announced the nationalisation of the country's second-largest bank, Parex Banka, after it suffered a run on deposits.
• The lat's peg to the euro has faced further pressure, with the Bank of Latvia (BoL, the central bank) intervening to support the currency.
• The government has opened talks with the IMF and the EU on financial assistance. The IMF said that Latvia would be able to keep its currency peg, but warned that a heavy domestic adjustment would be needed.
• Real GDP contracted by 4.2% year on year in the third quarter, on a preliminary estimate. Unemployment rose to 7.2% and wage growth slowed.
• In the third quarter the current-account deficit was LVL500.7m (US$1.06bn), on preliminary monthly data, down by 44% from the year-earlier period.