August 27, 2009
1. This statement reports on recent developments since the issuance of the Staff Report.
2. These developments do not alter the thrust of the staff appraisal, and underline thedepth of the contraction. Real GDP in the second quarter of 2009 declined by 19.6 percent year on year, according to preliminary data, broadly in line with projections in the staff report. The unemployment rate (labor force survey basis) increased to 16.7 percent in the second quarter, up from 14 percent in the first quarter and around 6 percent in the second quarter of 2008. After stabilizing in April and May, retail sales fell 5 percent in June. And following a sharp fall in 2008, industrial output has stabilized at the start of this year, and grew by 1.4 percent seasonally adjusted in June. However, the sector accounts for less than 15 percent of GDP.
3. Consumer price inflation has continued to fall. The 12-month CPI inflation rate fell to 2.5 percent in July, from 3.4 percent in June. On a month-on-month basis, prices fell by 0.6 percent, the fourth consecutive month of price declines. Producer prices fell 8.4 percent in July compared to one year earlier.
4. The current account surplus has widened significantly, reaching 2 percent of annual GDP in June alone. In large part this reflected foreign banks’ losses (largely due to write-offs), which are recorded as a credit item in the income account, with a counter-entry in the capital account. That said, in June for the first time this decade Latvia recorded an overall surplus on goods and services. The cumulative current account surplus in the first half of the year has reached 4 percent of annual GDP, and the program projection for the year as a whole will likely need to be increased. The nominal and real effective exchange rates were stable in July, and have appreciated by 3½ percent and 3 percent respectively since December 2008.
5. Financial market pressures have eased. Since early July, neither the Bank of Latvia nor the Treasury has bought or sold foreign exchange vis-à-vis the private sector. Since the start of August, overnight interest rates have remained below 5 percent. However, the situation remains fragile. On August 10, Standard & Poor’s downgraded its sovereign rating from BB+ to BB, with a negative outlook, pointing to the political and economic challenges facing Latvia as a result of rapidly contracting nominal and real incomes and the associated pressures on public finances.
6. The Latvian government has decided to proceed with a L43 million (€60 million, or 0.3 percent of GDP) recapitalization of the state-owned Mortgage and Land Bank. This transaction, which will be recorded as budget expenditure, will help maintain the bank’s capital adequacy ratio above 11 percent at a time when the bank is experiencing rising credit losses.