Latvian economy to shrink 12 percent

Crisis-hit Latvia faces even deeper trouble as its economy will shrink 12 percent this year, more than double the fall expected when it took an IMF-led rescue last year, the Finance Ministry said on Wednesday. The new forecast, made as Latvia holds talks with a visiting IMF team on its economic programme, showed the meltdown hitting the whole Baltic region, though Lithuania and Estonia have not had to call for financial help.
The forecast, more pessimistic than the already grim 5 percent fall expected when Latvia took its 7.5 billion euro ($9.44 billion) bailout last year, would mean more budget cuts on top of the painful measures already decided, analysts said.
Latvia chose to deal with its economic and budget woes via spending and wage cuts rather than allow a devaluation, which some economists said would lead to a faster drop in output, but also a quicker recovery. The lat currency is pegged to the euro. Finance Minister Atis Slakteris said in a statement that the external climate had worsened, meaning exports were suffering.
"Consumption and investment is getting even weaker. Latvia's main trading partners, including EU partners and in the east, are also expecting negative growth," he added. The forecast of a 12 percent drop in gross domestic product (GDP) was made by officials from the Finance Ministry, central bank, the Economy Ministry and by commercial bank economists.
The ministry also said annual average inflation would fall to 3.3 percent from 10.5 percent in 2008, lower than the 5.9 percent expected. Unemployment would average 12.7 percent rather than the 9 percent expected previously, it added. The forecasts will be used in amending the 2009 budget and are set to mean further cuts in spending as Latvia has to keep its deficit this year to 4.9 percent of GDP under the IMF programme, though it might ask for leeway on that target.
"If nothing is done then the budget deficit could go to 10 percent (of GDP) so it's important to act fast," said Swedbank chief economist Martins Kazaks. "I think that in the end a reasonable cut in expenditure could be 0.5 billion lats."
It might also be necessary for the government to adjust requirements from its lenders to allow a larger budget deficit. The 7.5 billion euro rescue included 1.7 billion from the IMF and 3.1 billion euros from the EU. The Nordic countries, whose banks are heavily invested in the Baltic region, agreed to lend 1.8 billion euros, the World Bank 400 million euros and the Czech Republic 200 million euros.