Press Release No. 99/58

Press Release: IMF Approves US$45 Million Stand-By Credit for Latvia

December 10, 1999

The International Monetary Fund (IMF) today approved a 16-month Stand-By credit for Latvia in an amount equivalent to SDR 33 million (about US$45 million) to support the government's 2000 economic program. The government of Latvia does not intend to make drawings under the Stand-By credit and will treat it as precautionary.

After the IMF Executive Board's discussion on Latvia, Shigemitsu Sugisaki, Deputy Managing Director, made the following statement:

"Directors welcomed the Latvian authorities' resolve to return to a path of prudent fiscal policies and to complete a well-focussed structural reform agenda under the requested stand-by arrangement. This policy stance, coupled with a continued tight monetary policy, is expected to lay the foundation for durable growth driven by the private sector and to ensure that Latvia's external position remains sustainable. The authorities have indicated that they intend this arrangement to be precautionary.

"Given the importance of fiscal consolidation as the cornerstone of the program, Directors welcomed Parliament's recent approval of the budget for 2000. Directors urged the authorities to implement the measures cited in their Memorandum of Economic Policies aimed at enhancing the effectiveness, efficiency, and transparency of the public sector. Directors emphasized that the financial situation of the Social Fund must continue to be monitored closely, and that additional measures be taken during the course of 2000, if needed. They also encouraged the authorities to continue in their endeavor to develop measures to ensure the financial health of the public pension system over the medium term and to lay the foundation for the creation of a second private pillar.

"Directors observed that the exchange rate peg to the SDR has served Latvia well. They noted that Latvia's external position remains sustainable, provided that appropriately tight fiscal and monetary policies continue to be pursued and the remaining structural reforms are completed.

"Directors welcomed the return of confidence in the financial system and commended the Bank of Latvia for bringing prudential regulations largely in line with the relevant international standards. With respect to the authorities' plans for implementing the planned unified supervisory agency for the entire financial sector, Directors urged the authorities to ensure that the existing standards established by the Bank of Latvia are maintained and that adequate safeguards to ensure the agency's independence are put in place.

"Directors noted that structural reforms have reached an advanced stage, but underscored the importance of effectively completing the privatization of the three large remaining public enterprises by end-2000, coupled with an overhaul of the regulatory framework for the natural monopolies to ensure competition and proper pricing. In addition, they observed that further improvements in the business climate and in the legal and regulatory framework will foster an environment conducive to foreign direct investment and private sector activity, and facilitate Latvia's eventual accession to the European Union. Directors commended the Latvian authorities for their reaffirmed commitment to a liberal trade regime," Sugisaki said.

ANNEX

Program Summary

The impact of the Russian crisis on Latvia's trade and financial sectors has been more severe than expected earlier, but it appears that the economy has bottomed out. Real GDP is expected to grow by about 1% this year and 4% in 2000. Inflation is expected to remain subdued at about 3% during 1999-2000. The external current account deficit is projected to decline to about 8.5% of GDP in 1999 and below 8% of GDP in 2000 from 9.5% of GDP in 1998, benefiting in particular from a redirection and expansion of exports to western markets. The unemployment rate eased to 9.3% in early November from 9.5% in October and 10.2% in April, while employment continued to grow in the third quarter to surpass the level at end-1998. Latvia's medium-term outlook remains positive, and its external position is likely to remain sustainable, although potentially vulnerable to large external shocks.

The government's program¹ under the Stand-By credit is centered on a return to a conservative fiscal stance. With a view to achieving nearly a balanced budget over the medium term, the government aims to keep the fiscal deficit below 3.9% of GDP in 1999 and to 1.9% in 2000, mostly through expenditure restraint. The program also contains important measures to enhance the transparency, effectiveness, and efficiency of public spending.

Latvia's current monetary policy with its exchange rate peg to the SDR has served the country well, and no change is planned during the program period, although the government is planning a shift to a euro peg over the medium term. The monetary program, which will be sufficiently tight to support the current peg while allowing adequate expansion of private sector credit, reflects a gradual increase in confidence in the economy and the banking system. The government continues to enhance financial sector oversight to bring the Bank of Latvia close to full compliance with the Basle Core Principles of Effective Banking Supervision and the relevant EU directives, and an increase in the minimum capital requirement is likely to accelerate the consolidation of the banking system.

Fiscal policy under the program is aimed at containing the fiscal deficit primarily by restraining spending. The 2000 budget provides for a near freeze on nominal spending, reducing the expenditure-to-GDP ratio to 42% in 2000 from almost 45% this year. The government envisages further savings from changes in the pension law, from rationalizing public expenditures, and from improving the efficiency and transparency of public sector operations. At the same time, the revenue-to-GDP ratio, which at 41% in 1999 and a projected 40% in 2000 is high in comparison with other transition economies, allows the government to resort to only very targeted tax measures so as to avoid choking off the economic recovery.

Structural reforms include the near completion of the large-scale privatization program by end-2000 and improvements in the legal and regulatory framework for public utilities such as a telecommunications law that was recently drafted. The program further includes measures aimed at supporting the creation of new companies, promoting investments, reducing red tape, strengthening the judicial system, and continuing efforts to liberalize the trade regime.

Latvia joined the IMF on May 19, 1992 and its quota² is SDR 126.8 million (about US$174 million). Its outstanding use of IMF financing currently totals SDR 36.22 million (about US$50 million).