Latvia strategy overview

Full strategy  (0.6Mb) Approved 15  Nov 2005

Stratēģija Latvijai  (0.6Mb) (LV)

Invitation to comment

The Republic of Latvia continues to meet the conditions specified in Article 1 of the Agreement Establishing the Bank. In recent years Latvia has made substantial progress in transition and this Strategy document recognises the laudable success of Latvia and its economy. Some 75 per cent of economic activity is in the private sector and price and trade liberalisation, enterprise privatisation and effective financial sector reforms have taken place. As a performing market economy, there is an open foreign trade regime and no major constraints to foreign investment.

Macroeconomic environment

The macroeconomic environment remains broadly favourable, but rising inflation poses a challenge. The impact of EU accession has been positive in terms of trade and enterprise investment. The economy grew by 8.3 per cent in 2004, and has averaged annual growth of 7.5 per cent since 2000. Capital formation, exports and private consumption were major contributors to growth, although average inflation rose to 6.2 per cent in 2004. The trend in fiscal consolidation continued in 2004, when the national fiscal deficit decreased to 1 per cent of GDP, on the back of strong revenue performance. The current account deficit grew to 13 per cent of GDP in 2004, due largely to the import of capital goods. Net foreign direct investment (FDI) increased in 2004 to US$ 0.596 billion. Unemployment remains significant at about 10 per cent. Following the Lat re-peg to the Euro from the SDR in January 2005, Latvia was admitted to the European Exchange Rate Mechanism (ERM II) in May, further aligning the economy with that of the Eurozone.

Following the current government’s formation in November last year, efforts have been made in improving the business climate, fighting corruption and strengthening the prevention of money laundering and fraud. Nordic and German strategic investors in the main banks continue to strengthen the financial sector and to broaden the range of credit and banking products available to enterprises and consumers.

However, with respect to the Bank’s mandate, a small number of key transition challenges in Latvia have been identified and this strategy aims to address those challenges in order to further increase the competitiveness of the Latvian economy. The key transition challenges for Latvia are as follows:

Infrastructure and Environment

With extensive investment and operational needs, there is limited private sector participation in municipal sectors including district heating, water and sewage, and urban transport, and in the development of state transport infrastructure. Energy efficiency is a concern. There are remaining energy inefficiencies related to municipal-owned heating networks and buildings and some privatised industrial enterprises. In energy generation, Latvia remains somewhat reliant on fuel and power imported from neighbouring countries, particularly Russia and Lithuania.

Enterprise Sector

Further improvements in the business environment are needed, including more extensive and consistent enforcement of laws and reduction in corruption. Corporate governance, strategic development potential and market competitiveness are relatively weak, while tax evasion and the negative aspects of the business environment are eroding the long-term sustainability of the enterprise sector.

Financial Sector

Financial institutions need to ensure that the risk of money laundering is eliminated from their operations and that they all operate according to international best practice. Financial intermediation remains low, particularly to the SME sector and there is a lack of equity and mezzanine capital to support economic growth.

As of 31 October 2005 the Bank had signed a cumulative total of 24 projects for Latvia with a total project cost of €0.95 billion, including Bank financing of €0.30 billion, or 32 per cent. The private/state sector portfolio ratio stood at 73/27.

While expectations of new business in 2005 and 2006 are modest, the Bank can continue to play a role over the strategy period by focusing selectively on areas where it is additional and where it can address the remaining transition challenges. These include providing equity and cross-border financing, promoting public private partnerships and strengthening corporate governance and good business practice.

Operational objectives

In addressing the transition challenges, the Bank’s activities in Latvia will be based on the following operational objectives:

• Support large, complex or sensitive transactions that would benefit from the Bank’s expertise in project structuring, corporate governance and mobilising co-financing;
• Support the expansion of local companies, particularly in cross-border projects, for example into or from Russia or other CIS countries;
• Promote SME and municipal financing and energy efficiency through financial intermediaries, enhanced where appropriate with EU or other donor support;
• Encourage the development of local capital markets, for example in investing in the local securitisation of mortgage loans.

The Bank will continue to ensure that all EBRD operations in Latvia meet sound banking principles, have transition impact, are additional and are subject to the Bank's Environmental Procedures and incorporate, where appropriate, Environmental Action Plans.