With the resumption in growth, the economic recession triggered by the Russian crisis has ended. Additional efforts will be needed to reduce the current account deficit and increase its financing. The IMF staff commend the intention to streamline tax benefits granted to enterprises and to eliminate the benefits that are inconsistent with EU regulations. Financial sector development is imperative for continued external sustainability and economic growth. The government’s ability to implement the privatization program and address the remaining impediments to an enabling business climate is crucial.
The Latvian government has completed the three prior actions required for Board consideration of the first review of the stand-by arrangement.
First, the Minister of Finance has provided a list of contingency expenditure reductions, amounting to 0.5 percent of GDP. These measures would be implemented should the external current account deficit fail to decline in line with projections or foreign direct investment fall significantly short of expectations. The identified measures include reductions in spending on specific goods and services and selected investment projects across a number of ministries and special budgets; allowing selected vacancies to go unfilled; and additional across-the-board spending reductions.
Second, the necessary steps have been taken to reverse backtracking in the area of public expenditure management. In particular, the Ministers of Finance and Economy have submitted letters to Fund staff stating that, from now on, all privatization receipts—other than for those legally earmarked for administrative costs and the reserve fund of the Latvian Privatization Agency and for transfers to local government privatization funds—will be transferred to the Treasury. This policy has also been agreed to by the full cabinet of ministers, which has also approved the Supplementary Memorandum of Economic Policies.
Third, a draft law streamlining tax benefits granted to enterprises in free ports and eliminating benefits not consistent with EU regulations, has been submitted to parliament.
Developments since the issuance of the staff report have been broadly in line with the program. Economic activity continues its recovery, with real growth for the first quarter of the year estimated at 5.3 percent. The 12–month rate of consumer inflation declined to 3.2 percent in May. Preliminary data for end-May indicate a cumulative fiscal deficit of about LVL 25 million, compared with an end-June target of LVL 54 million. In addition, net international reserves at end-May were above the program floor, and net domestic assets of the Bank of Latvia below the program ceiling, for end-June.