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Macroeconomic review for Taipei Mission in Latvia Key Macroeconomic Indicators Indicator Reporting period Data Data of corresponding period of previous year Real GDP (year-on-year; %) 2007 IV-VI 11.0 11.1 Registered unemployment (%) 2007 X 4.9 6.6 Current account deficit (in millions 2007 IV-VI of lats) 795.6 517.7 Current account deficit to GDP (%) 2007 IV-VI 23.5 19.2 Foreign direct investment in Latvia 2007 IV-VI (in millions of lats) 400.1 237.2 External debt (% of GDP) 4.6 5.8 2007 VI Source: The Bank of Latvia Different views on of economic growth in Latvia – soft landing scenario Moody’s: Latvia’s country ceilings and the government’s foreign and local currency bond ratings recognize the country’s successful economic transition over the past decade, its low level of government debt and its strengthened financial system. Latvia’s strong economic performance over the past decade bears testimony to both the quality of the policy framework and dynamism of the private sector. The ratings are anchored by the political consensus on the direction of structural reforms within the context of EU and ERM2 membership. However, the ratings are presently constrained by large domestic and external imbalances, which leave the economy vulnerable to external shocks. The degree of risk is mitigated by a number of reassuring factors, specifically the government’s strong balance sheet and the nature of the financial system. Source: Moody’s credit analysis, December, 2007 According to Latvian Financial and Capital Market Commission (FCMC) head Uldis Cerps, there are people, who talk of growing instability, at the same time there are banks increasing their exposure to Latvia, including the ones very critical towards Latvia, like Danske Bank, as its subsidiary's Sampo Banka loan portfolio grew by over 90 percent within 12 months. "So I do not know what to do – either to listen to their words, or to look at their actions," FCMC head added. There are no reasons for devaluation of lats and such decision would be absurd, Uldis Cerps said in the interview to Latvian daily Neatkariga Rita Avize published on 21 November 2007. "My personal opinion is that the devaluation of lats would be absolute stupidity and idiocy, and I do not see any reasons for doing so," Uldis Cerps said. Source: BNS 1 At its 1 November 2007 plenary session, the Saeima of the Republic of Latvia has confirmed the present head of the central bank, Ilmars Rimsevics, in his office as Governor of the Bank of Latvia for another six-year-period to begin on 21 December. "The re-election gives the Bank of Latvia the possibility to continue monetary policy which will ensure the stability of the lats," Rimsevics said after the election. Source: The Bank of Latvia Governor of the Bank of Latvia Ilmars Rimsevics said there is ``no doubt'' that the economy is heading for a ``soft landing'' as Swedish banks are cutting back on lending to cool growth. Source: The Bank of Latvia Franciszek Rozwadowski, the head of the IMF mission to Estonia, said in beginning of November saw no risk of currency devaluation in the Baltics. Source: Bloomberg The three Baltic countries, among the fastest-growing in the European Union, are heading for a ”soft landing'' with help from their currency boards, JPMorgan Chase & Co said. ``I don't see that a currency devaluation in the Baltics is likely and a soft landing for these countries is our main scenario,'' Yarkin Cebeci, an economist at JPMorgan Chase & Co., said in a telephone interview on 14 November 2007. Source: Bloomberg Steep economic growth decline started in the overheated economies of the Baltics, but the devaluation of national currencies is not expected even in Latvia, the international financial services company Morgan Stanley report shows. Morgan Stanley experts do not expect mass unemployment, wide social unrest and devaluation in Latvia, like it happened in Argentina, which could press the authorities to change the present currency pegging policy, underscoring that Latvian situation does not look close to Argentinean crisis several years ago. According to the experts, the Baltic States will be able to avoid lending and liquidity crisis of Kazakhstan, yet, the economic growth reduction, which has already started, seems to be inevitable in Baltics and, while controlled, it is going to be long term. Source: BNS "As far as fundamentals are concerned, the economic development continues. So I do not think now that the Baltic countries are heading for the hard landing scenario", Darius Daubaras, vice-president of Credit Suisse investment bank, said in an interview to the Lithuanian business daily Verslo Zinios on 3 December 2007. Source: BNS Inflation curbing measures As inertia is typical for the inflation indicator, no steep drop in inflation rate should be anticipated soon after the first signs of the economic recovery. Moreover, new upward movements in administered prices (more costly heating services projected for February and March of 2008, more expensive electricity) and a higher excise tax on tobacco are to be expected in the near future. Therefore, inflation is 2 likely to rise moderately in the next few months, with a drop in its annual rate likely only next spring. Source: The Bank of Latvia The government introduced a new anti-inflation plan in March 2007. In contrast to past anti-inflation measures, which were somewhat superficial, the current plan takes a comprehensive and rigorous approach to the problem. The plan seeks to cool the housing market and reduce inflation through three broad instruments: 1) The government has committed to tightening fiscal policy, limiting public sector wage increases, not introducing new tax reductions and increasing taxes on property; 2) New regulatory restrictions have been introduced on property loans and there are new incentives to promote savings; and 3) Structural measures are planned to enhance competition, improve productivity and make the labor market more flexible. Source: Moody’s credit analysis, December, 2007 The inflation curbing measures and financial instruments implemented will bear results in 2008, Latvian Finance Minister [former Finance Minister] Oskars Spurdzins said at Latvian parliament budget and finance committee session on 16 October 2007. He told that the annual inflation could reduce effectively in mid 2008, which will be facilitated by the surplus budget project for 2008 and slower salary rise. "These are the instruments aimed at achieving lower annual inflation," Spurdzins said. Source: BNS Current account deficit and its financing; Latvia's central bank Governor Ilmars Rimsevics attempted to allay investor concern about an economic slowdown, saying foreign lenders remain committed to the Baltic nation and will continue to finance the current account deficit. ``This is the most crucial thing -- as long as the Swedish banks, German banks and Norwegian banks are here and continue to finance it, I don't see any danger to the economy,'' Ilmars Rimsevics said in an interview to Bloomberg in Riga ob 6 December 2007. Banks ``would lose a lot of money and their reputation'' if they left Latvia. Source: Bloomberg Stability of the banking system Key banking sector indicators: 1997 32 1998 28 1999 24 2000 22 2001 23 2002 23 2003 23 2004 23 2005 23 2006 24 2007 Q3 23 banks 31 27 23 21 22 22 22 22 22 21 21 branches of foreign banks 1 1 1 1 1 1 1 1 1 3 2 178 183 160 184 193 199 206 202 215 224 * Number of banks* incl.: Number of bank branches 3 Staff 8414 8230 7786 7863 7943 8240 8895 9664 10520 11611 * Number of customer accounts, '000 - 1387 1298 1397 1651 2041 2207 2403 2912 3316** 3521 Number of payment cards, '000 - 207 328 635 893 1022 1176 1365 1711 2107 2336 - 238 374 643 791 842 868 875 878 957 1077 - 3390 4462 5381 6908 8326 10268 15170 18495 17571** 20106 Number of ATM's Number of POSs * no information ** data updated in July of 2007 - no data Source: Association of commercial banks Moody’s: The stable outlook and ratings for Latvian banks reflect their improving credit quality, their efforts to grow market share and their good profitability. Source: Moody’s banking system outlook, November 2007 Moody’s: The profitability of Latvian banks has undergone a steady improvement since the early part of the current decade, supported by the strengthening economic environment, sector consolidation, a growing demand for financial services and improved credit quality. At the end of 2006, all Latvian banks reported a profit, although for a few of them the profits shrank. In particular, total consolidated profits before tax for Latvian banks amounted to LVL307.4 million for the whole of 2006 and LVL207.8 million for the first half of 2007, a 65% year onyear increase. Source: Moody’s banking system outlook, November 2007 Future outlook. IMF predicts significant cooling for Latvian economy. Latvia's GDP will increase 10.5 percent in 2007, which will be the steepest growth in the so called emerging Europe, but next year growth rate will become much more moderate and drop to 6.2 percent, the International Monetary Fund (IMF) says in its latest global economic outlook. Source: BNS According to the report that was presented to the government on 27 November 2007, in 2008 Latvia's current account deficit will be 21.6 percent of GDP, and will decrease to 19.6 percent in 2009 and to 17.8 percent in 2010. "Exports will grow at a slightly slower pace in the following years due to moderate foreign demand and possible weakening of exporters' competitiveness amid rising labor costs. Since the growth of domestic demand and lending is expected to slow down, import growth will slow significantly and will increase at a slower rate than exports," the Finance Ministry said. Source: BNS 4 In September 2007, the Latvian Government revised the initial plan for the adoption of the euro and decided to specify the target date at the latest 24 months prior to the actual changeover to the euro when the three-year forecasts of Latvia's Convergence Programme come close to the compliance with the Maastricht criteria. According to the Ministry of Finance, Latvia's changeover to the euro might tentatively take place in 2011-2013. The introduction of the euro in Latvia will be an issue of the EU multilateral relations affecting common interests of all EU countries. Source: The Bank of Latvia 5