Country Report Latvia June 2008

Outlook for 2008-09

• A four-party, centre-right government, led by Ivars Godmanis, took office in December 2007. Corruption scandals will continue to create instability, and the coalition government is unlikely to survive the forecast period.
• Sharply slowing economic growth means that plans for sizeable budget surpluses in 2008-09 are unlikely to be realised, and the Economist Intelligence Unit expects the budget to be close to balance in 2008 and 2009.
• We expect real GDP growth to slow sharply to 2.4% in 2008 and recover slightly to 2.6% in 2009; we have cut our forecast for 2009, from 3%, because of a worsened export outlook. The risks of a greater slowdown are high.
• We now expect average annual inflation to rise to 15% in 2008 before falling to 7.5% in 2009. We have raised our forecast, from 13.2% and 7% respectively, because we have increased our forecast for global oil prices.
• The current-account deficit is likely to narrow from 22.8% of GDP in 2007 to 14% of GDP in 2008 and to 11% of GDP in 2009, up from our previous forecast, as higher global oil prices negatively affect Latvia's trade balance.

Monthly review

• The political temperature in Latvia is rising again. The government has renewed its attempts to dismiss the head of the anti-corruption agency, and there has been controversy over a law on money-laundering.
• Municipalities have challenged the government's plans for local government consolidation in the Constitutional Court. This could delay the reform, and there are also tensions in the governing coalition over the changes.
• Fiscal performance continues to deteriorate. In January-April 2008 the central government budget ran a deficit of LVL3.1m (US$6.7m), compared with a surplus of LVL97.8m a year earlier. The tax intake fell in real terms.
• The Bank of Latvia (the central bank) has called on the government not to loosen fiscal policy as the economy slows. The government is considering spending cuts in order to avoid the budget finishing the year in deficit.
• The economy has slowed sharply. Real GDP growth was 3.3% in the first quarter of 2008, down from 8.1% in the previous quarter. Domestic demand remained flat, and export growth slowed markedly.
• Growth of bank lending has slowed substantially, which has played a role in dampening domestic demand and import growth. Year-on-year credit growth is now close to a sustainable level for the economy, of around 20%.