The aim of the governments economic policy is to ensure sustainable and balanced economic and
social development, implement the transition form a labour-intensive economy to a knowledge-based one
reaching in this way the EU average GDP per capita level within the next 20-30 years.
The reforms that were carried out in the previous decade have consolidated the private sector
and good macroeconomics conditions have been created to foster growth. Private initiative and
capital are the main driving forces for development. The law guarantees the protection of foreign
investment, non-residents can repatriate profit and capital freely and equal terms are provided to
domestics and foreign entrepreneurs.
In October 2005 the government adopted the National Lisbon Programme of Latvia for 2005-2008,
which describes Latvias mid-term priorities and measures aimed at fostering growth and employment.
The goal is to ensure GDP growth at 6-8% annually in the next years and to increase the employment
rate up to 67 percent by 2010.
The reforms carried out in the country and integration into the EU have made a positive impact
on economic development. In the period between 2001-2005 GDP grew on average by 8,1% annually and by
10,2% in 2005. These growth rates are the highest in the European Union.
Sectoral Composition of Economy
Economic activity is accelerating in all main economic sectors. Domestic demand fosters the
development of services especially trade and construction. High growth rates can also be observed
in the transport and communications sector. Output in manufacturing in the period between 2001-2005
has increased on average by 7.6% per year.
Nearly 80% of GDP growth was on account of the development of the services sector fostered mainly
by the development of the trade, transport and communications sectors. Constructions is growing fast
while industrial growth has been more moderate. Construction output in 2005 was by 15.5% higher than
in 2004.
After EU accession freight transport grew particularly quickly and passenger transport services
including air transport services were also in the rise. Transport and communications services in
2005 increased by 16.2% in comparison with the previous year.
Manufacturing
Recent years (2001-2005) have witnessed steady growth in manufacturing. Manufacturing output has
been growing by 7.6% per year so the increase in manufacturing can be put nearly in the same level
as the overall economic growth.
Straight after EU accession growth rates in manufacturing decreased as enterprises had to adjust
to the new trade conditions. A remarkable growth started again in May 2005.
Investments
In 2005 gross fixed capital formation doubled in comparison with 2000. Investments within this
period have increased by 15.7% per year.
At the end of 2005 foreign direct investment stock amounted to 2836 mln lats or 40.4% of GDP.
The incoming foreign direct investment in the last five years accounted on average for 3,4% of
GDP and after EU accession it increased to 4% and in 2005 covering nearly 15% of the gross fixed
capital formation.
Export and Import
The value of Latvian commodity exports in 2005 was much higher by 34%, at current prices, in lats)
than in the previous year. The increase of imports was, in turn, slightly less conspicuous by 28%.
Exports in 2005 increased substantially on all the markets trading Latvian goods, especially in
the direction of the new EU member states. Imports in 2005 also considerably exceeded the level
of the CIS countries, rose particularly quickly (one third of the total import growth), as did the
imports of machinery and food products.
EU is the main trading partner of Latvia. After accession to the EU Latvias foreign trade with
Lithuania and Estonia, as well as other new EU member states, has increased very rapidly.
A comparison with the EU pre-accession period shows that within two years Latvias foreign trade
with the other Baltic States has more than doubled.
Balance of payments
Latvia, typically, has a relatively big deficit of the current account. The main source of the
deficit is the markedly negative trade balance. The negative current account balance is covered
mainly by foreign direct investment and other long-term capital flows. The reserve assets of the
Bank of Latvia are increasing.
The positive balance on services covers approximately one fifth of the negative trade balance.
The balance of services is slightly worsening year by year despite the improvement of the traffic
balance due to the more rapid increase in the expenditures of resident travellers abroad than in
the expenditures of foreign tourists in Latvia. The export of various other services (communications,
construction, financial, information and computer services) likewise increased at slower pace than
imports.
However, the sharpest fluctuations in the current account balance are nevertheless determined
by the changes in the trade balance. On the whole, the negative current account balance in 2005
decreased due to the improvement of the trade balance.
Inflation
In 2004 the inflation rate accelerated sharply in Latvia. Inflation growth in 2004 more than
doubled in comparison with 2003. The price increase was mostly caused by some factors on the
supply side gradually strengthening their influence during the whole year.
The high domestic demand that was stimulated by a perceptible wage rise in previous years and
the high growth of crediting intensified the second-phase effect of inflation. That is why high
inflation remained also in 2005 and was affected in addition by the continuously rising fuel pries
in the global markets. In 2005 the 12=month inflation was 7% and the annual average inflation
was 6.7%.
The main reasons behind the price growth are: inflation expectations caused by the high inflation
in the previous two years, high mortgage lending, the steep rise in the administratively regulated
prices (for electricity, gas, heating) and a wage increase in the private sector.
Monetary indicators
The stability of the banking sector, the rising welfare and economic activity of the population
are the reasons stimulating steady growth of the basic monetary indicators.
Compared with April 2005, the amount of broad money M2X in April 2006 rose by 40.4%, currency in
circulation increased by 20.2% and deposits rose by 45.8%. In the same period loans to enterprises
and private persons also continued to increase (by 61.7%).
Reacting to the increasing domestic demand and in order to slacken the growth of crediting,
the Bank of Latvia in March and November 2004 raised its re-financing rate by 0.5 percentage points
to 4% and increased in July its reserve requirements from 3% to 4%, in August 2005 to 6% and
in December 2005 to 8%. However, the effectiveness of these measures in Latvia is limited by
the fixed exchange rate regime and several other specific factors.
In April 2006 the average weighted interest rate on short-term credits in lats was 6.8%, but on
long-term credits 8.9%. For credits in the currencies of foreign countries these rates were 4.9%
and 5.9% respectively.
Budget and central government debt
The budget deficit in 2005 was lower than planned 91.6 mln lats or 1% of GDP. The revenues of the
general government budget in 2005 were by 27.1% higher than in 2004 and, accordingly, expenditures
were by 27.7% higher.
The Parliament has confirmed the general government budget for 2006 with a deficit of 145.2 mln
lats (1.5% of GDP). The priorities of the budget for 2006 are: raising the welfare level of the
population, integration into the EU and NATO, effective and full absorption of the allotted resources
from the EU funds balancing it at the same time with the governments support to the social needs
of the society.
The level of the central government debt in Latvia is one of the lowest in the EU. At the end
of 2005 it was 1064 mln lats or 11.9% of GDP.
Personal income
The average net monthly wage in 2005 was by 26 lats or 17% higher than in the preceding year.
However, with inflation taken into account, real wage in 2005 rose by 9.7%.
By implementing a socially responsible policy, the minimum monthly wage has been raised as of
1 January 2006 from 80 to 90 lats, the minimum monthly untaxable income of the population from
26 lats to 32 lats and the monthly allowance for a dependent person from 18 lats to 22 lats.
The overall wage rise was to a great extent influenced by the high inflation in 2004 and 2005,
as well as by the wage rise for the employees of several budget-financed institutions (teachers,
doctors).
The increase in the size of old-age pensions in 2005 was also noteworthy. Pensions in December
2005 were on average alost by 12% lats higher than in December 2004.
Employment and unemployment
Economic development in recent years in Latvia has positively influenced the situation in the
labour market. Although the number of working age population decreases, the number of economically
active population is rising and the employment rate is increasing as well.
The level of female employment in Latvia is sill higher than in the EU average and this difference
tends to increase. It can be explained by the small share of manufacturing in the economy and the
dominance of sectors with higher female employment (trade, hotels, restaurants and other services).
According to data of the Labour Force Survey done by CSB, unemployment rate has went down from
14.4% to 8.7% in 2005 compared to 2000. The unemployment rate at the end of 2005 was 7.4%, which
is a considerably lower level than a year ago (8.5%).
The number of unemployed is decreasing not only on the account of the rising employment rate.
In recent years after Latvias accession to the EU an outflow of the labour force to the old EU member
states (Ireland, UK and Sweden) has been observed, where the labour markets are open to the citizens
of the new EU member states. Therefore, shortage of labour force in several sectors is starting
to develop in Latvian labour market.
