Latvia’s Economy Fell 22% Last Quarter, Survey Shows

By Aaron Eglitis

Aug. 7 (Bloomberg) -- Latvia’s economy may have contracted 22 percent last quarter, the steepest decline since the country regained independence from the Soviet Union and shed communism almost two decades ago, a survey showed.

Gross domestic product contracted 22 percent in the three months through June from a year earlier, according to the median in a Bloomberg survey of eight economists. Estimates ranged from a 17 percent contraction to a 28 percent decline in output. The central statistics office will release the preliminary GDP report on August 10.

Latvia’s economy, the fastest growing in the European Union in 2006, is now suffering the bloc’s severest recession together with neighboring Lithuania. The country was forced to turn to a group led by the European Commission and the International Monetary Fund for a 7.5 billion euro ($10.8 billion) loan after its second-biggest bank needed a state rescue and a debt-fueled property bubble burst.

“We haven’t seen declines in western Europe like this, except possibly during the war,” said Morten Hansen, head of department at the Stockholm School of Economics in Riga, who estimated a 22 percent slump.

The economy slumped 18 percent in the first quarter as the government agreed to reductions in state pay and pensions in an effort to rein in the budget and comply with the terms of the bailout. The IMF and the Commission both withheld disbursements earlier this year until lawmakers committed to budget cuts.

Austerity

Austerity measures have left households struggling to make ends meet, with spending in shops plummeting, while the slump in demand has left businesses floundering. Retail sales fell 28.5 percent in the second quarter and industrial production dropped 18.7 percent.

Consumer prices rose an annual 2.3 percent in July, the slowest pace since February 2003, according to the median estimate of seven economists in a Bloomberg survey. On the month, consumer prices fell 0.9 percent, the survey showed.

Latvia’s spending and wage cuts threaten to exacerbate its recession this year. The country’s parliament passed spending cuts worth about 500 million lati ($1 billion) on June 16 to ensure the continued inflow of loan payments. The government has committed to cutting spending or raising revenue by 500 million lati a year until 2012 to enable euro adoption. Latvia pegs its lats to the euro as part of the exchange rate mechanism.

The output slump is threatening to roll back economic gains made during the boom Latvia enjoyed after joining the EU in 2004, Hansen said. Output expanded more than 10 percent on average in 2005 and 2006, slowing to just under 10 percent in 2007.

Competitiveness

A 25 percent contraction in the second quarter “would reduce Latvian GDP to what it was in the same period of 2004, and thus have wiped out all the growth accomplished after EU membership,” he said, citing constant prices.

The Baltic country, which allows its currency to move 1 percent around a midpoint to the euro, is trying to bolster competitiveness through wage cuts and structural measures that will involve closing some hospitals and schools, instead of devaluing its currency.

The lats real effective exchange rate, a measure that shows the price development of Latvian goods versus those of trading partners, improved in April, May and June, the first three-month gain since the beginning of 2005, according to data on the Web site of the central bank.

Austerity measures are starting to yield gains in competitiveness as inflation slows and producer prices fall, said Andris Vilks, chief economist at SEB AB’s Latvian unit.

‘Strong Deflation’

“There has been very strong deflation” in producer prices, from July the outlook for deflation will be “very supportive.”

Annual inflation slowed to 3.4 percent in June from 4.7 percent in May, while producer prices fell an annual 7.8 percent in June, the third consecutive decline.

Vilks, who estimates the economy contracted 18 percent in the second quarter, said he expects the outlook for the third and fourth quarters to improve and sees an average decline in output of could be 12 percent in the second half.

Latvia’s interbank lending rates, which peaked in June at record highs on fears the currency might be devalued, have fallen and the currency has strengthened since the country passed budget cuts and received a 1.2 billion euro loan tranche from the European Commission.

The IMF and Latvia reached a preliminary agreement on July 28, which may lead to the transfer of another 195 million euros after the fund’s board reviews the assessment.

To contact the reporter on this story: Aaron Eglitis in Riga at aeglitis@bloomberg.net