Country Report Latvia March 2009

Outlook for 2009-10

• A new five-party, centre right government has been formed, led by Valdis Dombrovskis. The government is unlikely to survive until the election due in October 2010, and there is a significant chance of an early election.
• The budget deficit will widen sharply as the economy contracts. With revenue likely to be below government targets, the Economist Intelligence Unit expects deficits of 8% of GDP in 2009 and 5% of GDP in 2010.
• We expect real GDP to contract by 12% in 2009 and by 2% in 2010. Domestic demand will fall sharply and exports will decline. There is, moreover, a high risk of a sharper contraction in real GDP.
• Average annual inflation is forecast to fall from 15.4% in 2008 to 3% in 2009 and 2.5% in 2010 as sharp rises in commodity and food prices come to an end, and as the economic recession generates deflationary pressures.
• The current-account deficit will narrow from 13.3% of GDP in 2008 to 5% of GDP in 2009 and 4.5% of GDP in 2010, initially as the fall in domestic demand slashes import growth, and later as exports strengthen.

Monthly review

• Ivars Godmanis and his government resigned on February 20th. On February26th the president, Valdis Zatlers, nominated Mr Dombrovskis, from the centre-right opposition New Era party, to form a new government.
• Mr Dombrovskis has formed a five-party coalition, including three of the four parties from the previous coalition. The government looks stronger than its predecessor, but its unity will be strained by the need to tighten spending.
• An immediate task for the new government will be to make further spending cuts, after the Ministry of Finance revised its forecast for real GDP in 2009 to a contraction of 12%, compared with 5% in the budget approved in December.
• Fiscal data show that the public finances deteriorated rapidly over 2008 and into 2009 as revenue weakened. The central government deficit for 2008 was LVL430m (US$895m), or 2.6% of GDP.
• Unemployment rose sharply, to 9.9% in the fourth quarter of 2008 from 5.3% a year earlier, and is set to increase further. Real wage growth slowed to 1.9% in October-December, down from 14.7% in the year-earlier period.
• The current-account deficit has declined considerably, although it remains large. According to preliminary monthly data, the deficit in the final quarter of 2008 came to US$820m, almost one-half of the year-earlier level of US$1.6bn.

Source: Country Report