Since issuance of the staff report (SM/01/366), additional information has become available on macroeconomic developments, fiscal and monetary performance, and structural issues. This information does not alter the thrust of the staff appraisal.
Economic growth has begun to slow, broadly in line with expectations. Real GDP growth in the third quarter was 6.3 percent, and economic activity indices point toward a further gradual moderation of growth during the fourth quarter. Inflation remained low: the end-of-period CPI increased by 3.2 percent in 2001.
The merchandise trade balance widened in the third quarter. This reflects the slowdown of export growth to about 5 percent, while the strong import growth, mainly of investment goods, was sustained at about 10 percent. In light of this development and recent indications that the Latvian Shipping Company (LASCO) made major capital purchases in the fourth quarter (equivalent to about 1½ percent of GDP), the 2001 current account deficit could exceed the staff projection by 2 percentage points of GDP or more. Foreign direct investment financed about three-fifths of the current account deficit in the first three quarters. The spread on Latvia’s 2004 Eurobond has declined further and was under 60 basis points in early 2002.
The Latvian authorities met most policy targets for end-December 2001, but exceeded the performance criterion on the general government fiscal deficit. The performance criteria on the NIR and NDA of the Bank of Latvia and on external debt were all met comfortably. However, preliminary data (that still need to be verified) suggest that the fiscal deficit target was exceeded by LVL 8 million, as the Riga city budget outcome was worse than expected. This implies a fiscal deficit of 1.8 percent of GDP for the year as a whole.
The liquidity situation in the banking system eased somewhat in late December and early January. This has led to about a 1½ percentage point decline in the short-term money market interest rate spread against the SDR. Credit to the private sector grew by about 50 percent in 2001; however, abstracting from a large loan from a major bank to its leasing subsidiary in December, credit growth was 39½ percent, in line with expectations.
In the structural area, the new Commercial Law was brought into effect on January 1, 2002. The pension amendments adopted by Parliament in late December postponed to 2005 the abolition of early retirement and will steadily lift the ceiling on the pension payments that may be received by working pensioners, removing the ceiling in 2005; no estimates are yet available of the costs of the revised package. The Government has decided on the terms for the privatization of LASCO, envisaging the sale of 51 percent of the shares via the Riga Stock Exchange. In late December, Latvia closed an additional chapter in its EU accession negotiations, bringing the total to 23.