Country Report Latvia July 2009

Outlook for 2009-10

• The five-party, centre-right government is led by Valdis Dombrovskis. The government is unlikely to survive until the election due in October 2010, and there is still some chance of an early election.
• The budget deficit will widen sharply as the economy contracts. With expenditure likely to be above target, the Economist Intelligence Unit expects deficits of 11% of GDP in 2009 and 7.5% of GDP in 2010.
• We forecast that real GDP will contract by 17% in 2009 and by 4% in 2010 as private consumption falls sharply and exports weaken. There is a high risk of a sharper contraction if domestic demand falls by more than expected.
• Average annual inflation is forecast to fall from 15.4% in 2008 to 3% in 2009 and -2% in 2010 as sharp rises in commodity and food prices come to an end, and as the economic recession generates deflationary pressures.
• The authorities are committed to keeping the lat within its current narrow band against the euro. However, there is a very high risk of devaluation.
• The current-account deficit is expected to narrow from 12.8% of GDP in 2008 to 2% of GDP in 2009 and 1.5% of GDP in 2010, initially as the fall in domestic demand slashes imports, and later as exports strengthen.

Monthly review

• On June 6th Latvia held local and European Parliament elections. Parties that were not part of the governments that took Latvia into its economic crisis performed best; a number of traditional parties slumped to heavy defeat.
• A centre-left party, Harmony Centre, came second in the European Parliament election and also did well at local level, taking the mayor's post in the capital, Riga. A new conservative party, the Civic Union, also performed well.
• Opposition to austerity measures is gradually mounting. The health minister, Ivars Eglitis, resigned over healthcare cuts in June, and large demonstrations against spending cuts took place in Riga and several other cities.
• Parliament has approved a revised budget for 2009 with drastic expenditure cuts to keep the budget deficit in check. This prompted the EU and IMF to agree to release further funding under Latvia's stabilisation programme.
• In the first quarter of 2009 real GDP declined by 18% year on year. Recent monthly data give no clear evidence that the economy is stabilising; industrial output, having shown signs of recovery, fell again in May.
• Consumer price inflation continues to decelerate sharply, and in month-on-month terms, deflation has now begun. Year-on-year inflation slowed to 4.7% in May, down from 6.2% a month earlier and a peak of 17.9% in May 2008.