Country Report Latvia October 2009

Outlook for 2010-11

• 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 recession has slashed revenue, and despite large spending cuts, the budget deficit is forecast to remain large, contracting from an estimated 9.8% of GDP in 2009 to 8.9% of GDP in 2010 and 6.4% of GDP in 2011.
• We estimate that real GDP fell by 16.9% in 2009 and expect it to fall by 3.8% in 2010 as private consumption and investment fall sharply. Recovery will begin in the second half of 2010, with GDP rising by 2.4% in 2011.
• Average inflation is estimated at 3.3% in 2009, but consumer prices are forecast to fall by more than 2% in 2010 as the recession generates deflationary pressures. Prices will be broadly stable in 2011.
• The authorities are committed to keeping the lat within its current narrow band against the euro. However, Latvia's payment position remains weak and there is a high risk that the government will eventually devalue the currency.
• We forecast that the current account, which recorded a deficit of 13.2% of GDP in 2008, will post a surplus of around 6% of GDP in 2009-10 and 4% of GDP in 2011 as weak domestic demand limits imports.

Monthly review

• The decision of the People's Party to vote against the proposed real estate tax demonstrates the difficulties that the governing coalition is having in pushing through the measures agreed with the IMF.
• Recent figures for government borrowing suggest that the budget deficit for 2010 is broadly on track to meet the IMF target of 10% of GDP.
• The government is reluctant to make the full LVL500m of spending cuts and tax increases agreed with the IMF and the EU for the 2010 budget. This has already led to public criticism from Sweden and the central bank.
• Real GDP fell by 18.7% year on year in the second quarter as domestic demand fell sharply.
• More recent monthly indicators show that output in export-oriented industries is now beginning to stabilise, and industrial output rose in August. Domestic spending continues to drop.
• The current account posted a surplus of 14% of GDP in the second quarter, boosted by write-offs to the value of foreign investors' assets in Latvia. There was a surplus in trade in goods and services for the first time since 1994.