Latvia: Latvia Outlook for 2013-17

The country (Latvia) is situated in Eastern Europe, bordering the Baltic Sea, between Estonia and Lithuania. It has borders with Belarus for 141km, Estonia for 339km, Lithuania for 453km and Russia for 217km.
Land in Latvia is low plain. The climate is maritime; wet, moderate winters. (official) 58.2%, Russian 37.5%, Lithuanian and other 4.3%

OVERVIEW

The government is a three-party centre-right coalition without a formal majority, led by the prime minister, Valdis Dombrovskis. Real GDP grew by 5.6% in 2012. We forecast that increase will slow to 3.9% in 2013, owing largely to an unfavourable external environment. Annual average inflation fell to 2.3% in 2012, and we expect it to drop further, to 0.7%, in 2013. The authorities are likely to succeed in keeping the lat within its narrow band against the euro. Latvia will join the single currency in January 2014.

The current-account deficit narrowed to 1.7% of GDP in 2012, but we expect it to widen gradually throughout the estimate period as domestic request recovers.

Political outlook

The governing three-party coalition lacks a formal majority, but is supported by independent members of parliament. This creates the possibility of political instability, although the major opposition Harmony Centre has struggled to widen its support base beyond the ethnic Russian community, which will prevent it increasing its share of the vote. Relations with Russia remain subject to tensions, but have improved in recent years.

Economic policy outlook

The government is committed to cutting tax rates, and at a conference in August the cabinet approved plans to reduce the personal gain tax by 1% annually starting in 2014. Budget data in the initial half of 2013 showed strong revenue increase, thanks to inflows of EU funds, and the deficit is likely to remain well within the Maastricht criteria's 3% of GDP limit in 2013-14.

Economic forecast

The Central Statistical Bureau's initial estimate of second-quarter GDP showed the economy growing by 3.8% year on year, an development on the 3.1% expansion posted in the initial quarter. However, in quarter-on-quarter terms increase fell to 0.5%, a three-year low, indicating slowing momentum. The pronounced slowdown in Russian increase will be a concern given the two economies' strong trade and investment links.

Outlook for 2013-17

   - The ruling coalition lacks a formal majority and in its current form will struggle to last for a full term (until October 2015), although the number of alternative coalition partners in the current parliament is limited.
    -Latvia's accession to the euro zone in January 2014 will reduce systemic risks emanating from large euro-denominated debts. However, surrendering control of monetary policy will require continued fiscal vigilance to prevent new inflationary pressures emerging.
    -Real GDP is expected to expand by 3.9% in 2013. While strong in the European context, this is a marked slowdown from the 5.6% increase posted in 2012. In 2014-17 the economy is estimate to expand by 4.5%, well below pre-crisis levels.
    -The budget deficit (excluding net acquisition of non-financial assets) is expected to post a deficit of 0.2% of GDP in 2013. Inclunding net acquisition of non-financial assets, we estimate a shortfall of 1.2% of GDP.
    -Consumer price inflation is estimate to average 0.7% in 2013 as domestic request remains relatively weak. Inflation is expected to average 2.7% per year in 2014-17.
    -The current-account deficit will expand gradually as domestic request recovers, reaching 1.9% of GDP in 2013 and averaging 3% in 2014-17.

Review

    -In June the European Commission confirmed that Latvia had met all the criteria for accession to the euro zone. It will join the bloc in January 2014.
    -The economy grew by 3.8% year on year in the second quarter of 2013, according to the Central Statistical Bureau's initial estimate. In quarter-on-quarter terms increase dropped to 0.5%, the slowest rate for three years.
    -Real retail trade increase by 4.6% year on time(working-day adjusted) in June, a seven-month low.
    -The unemployment rate fell to 9.6% in June, a multi-year low. However, this was largely attributable to emigration, with the in general number of people in employment only up slightly since the peak of joblessness in 2010.
   - Consumer price inflation reached 0.3% year on year in July, up from 0.2% in the previous month.
    -Industrial output contracted by 0.6% year on year in January-June, reflecting to a large extent problems at the Liepajas Metalurgs steelmaker. Output of basic metals contracted by 42% over the same period.
    -The merchandise trade deficit fell to US$1.5m in January-June, from US$1.9m in the same period of 2012, reflecting strong export increase.