Abstract
This 2003 Article IV Consultation highlights that the Republic of Latvia has enjoyed continued strong economic performance since the last Article IV Consultation in January 2002. Real GDP growth was 7.9 percent in 2001 and 6.1 percent in 2002; growth has been led by investment and, more recently, consumption. Real per capita GDP now stands some 50 percent above its 1995 level. Inflation remains low and was under 1½ percent in 2002. The current account deficit rose to nearly 10 percent of GDP in 2001, partly reflecting stagnant external demand and one-time factors.
Since issuance of the staff report, the following information has become available on macroeconomic developments, fiscal and monetary performance, and external debt. This information does not alter the thrust of the staff appraisal.
1. Economic activity continues to be strong. Industrial production grew by 10 percent in February, while retail trade turnover rose by 14 percent. Import growth, at 19.8 percent year-on-year, outpaced export growth, at 16.6 percent, during the first two months of 2003, with exports to the EU expanding by 20.3 percent. End-of-period inflation was 2.2 percent in March, mainly reflecting rising prices for clothing and fuel.
2. The Treasury reports a general government fiscal surplus of LVL 14 million for the first quarter of 2003. While the first quarter outcome is usually strong, this is the first time since 1998 that a surplus has been recorded. The surplus could reflect the delayed adoption of the 2003 budget law, which limited spending during the first two months of the year to 1/12 of last year’s budget authorizations. Notwithstanding the rate reductions of the social and the corporate income taxes, tax revenues grew by more than 8 percent year-on-year, with excise tax and VAT collections performing particularly well. Based on recent statements by government officials, it appears unlikely that the planned mid-year supplementary budget would lead to a significant tightening.
3. The outstanding stock of short-term foreign exchange swaps fell sharply to $16.6 million at end-March, as the Bank of Latvia shifted the provision of liquidity to repo operations. While reserve money and broad money developed in line with annual projections during the first quarter of 2003, credit to the private sector remained buoyant, growing by 38 percent year-on-year, significantly higher than projected for 2003 in SM/03/121.
4. Based on newly released international investment position data, strong inflows of non-resident deposits during the fourth quarter increased Latvia’s gross external debt to 83 percent of GDP at end-2002. This is higher than the estimate provided in the staff report. Nevertheless, as most of these nonresident deposits continued to be placed abroad, end-2002 net external debt was raised only slightly, to 23 ½ percent of GDP, and the ratio of reserves to short-term debt (excluding non-resident deposits) remained above the benchmark level of 1. The full-year debt data do not alter the conclusions of the external sustainability exercise.
5. The spread on Latvia’s Eurobond maturing in 2004 fell to a record-low of 23.7 basis points as of mid-April.