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PP RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
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DE RUEHRA #0125/01 0641553
ZNR UUUUU ZZH
P 051553Z MAR 09
FM AMEMBASSY RIGA
TO RUEHC/SECSTATE WASHDC PRIORITY 5675
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHZL/EUROPEAN POLITICAL COLLECTIVE

UNCLAS SECTION 01 OF 02 RIGA 000125 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD PGOV LG
SUBJECT: LATVIAN ECONOMY: BAD TO WORSE 
 
Ref: Riga 105 
 
¶1. Summary: Latvia's economic downturn has proved to be worse than 
expected.  Falling household purchasing power, induced by rising 
unemployment and real wage cuts, is significantly reducing domestic 
demand.  Falling consumption is having a negative effect on tax 
revenues, which despite higher VAT rates continues to fall 
substantially below needed levels.  Revenue shortfalls and the 
deficit limit requirements of recent IMF-EU financial assistance 
packages are pressuring the government to make additional budget 
cuts.  Experts are predicting no economic turnaround until the end 
of 2010 or even 2011.  The only bright spots are that relatively 
strong export growth and plunging imports helped slash Latvia's 
current account deficit from 26% of GDP to 12%, and inflation fell 
to single digits (9.8%) for the first time since July 2007.  End 
summary. 
 
Bleak Statistics 
-------------------- 
 
¶2. According to a Latvian Statistics Bureau flash estimate, the 
Latvian economy contracted by a massive 10.5% in the fourth quarter, 
which exceeded even the bleakest expectations.  Third quarter data 
reveals that the principal sectors pulling the Latvian economy down 
(i.e. where growth is negative) are accommodation and food services 
(-11.4%), finance (-10.9%), manufacturing (-8.9%), retail and 
wholesale trade (-8.6%), and construction (-7.4%). 
 
Tourism Woes 
---------------------- 
 
¶3. The decline in the accommodation and food service industry, 
already hit from weakening global tourism, may worsen even further 
due to tax increases that lifted the applicable VAT for hotels from 
5% to 21%.  This increase will damage Latvia's appeal as a tourism 
destination relative to other Baltic and Scandinavian countries. 
The hotel industry already served 9% less customers in the fourth 
quarter of 2008 than a year earlier, and hotel room occupancy rates 
fell to a mere 28.8% in December.  In total, the contribution to the 
GDP from accommodation services fell by 11.4% in the third quarter. 
 
Bank Profits Down 
--------------------------- 
 
¶4. Latvian banks posted a 79% decline in profits for 2008.  The 
financial sector has been hit hard by the global liquidity squeeze, 
the bust of Latvian property and lending bubbles, and increasing 
rates of bad loans.  The quality of the banks' credit portfolios 
have deteriorated significantly.  The proportion of loans with 
overdue payments reached 15% by the end of 2008, and this percentage 
will likely increase in 2009.  A recent study carried out by a local 
bank found that 49% of households are struggling to meet mortgage 
payments. 
 
Manufacturing and Retail Sales Hit 
------------------------------------------- 
 
¶5. Manufacturing has suffered from diminishing competitiveness, 
weakening global demand, and falling commodity prices in key 
industries such as wood, causingmanufacturing output to plummet to 
levels only comparable to the Russian crisis of 1998.  Latvian 
manufacturing output contracted by 18.2% in December.  Exports of 
wood products decreased by 20% in 2008, and the wood industry's 
contribution to GDP fell by 15% in the third quarter.  Figures for 
the last three months of the year will likely be even worse, as 
several additional wood product manufacturers went out of business 
or scaled back production.  Another industry in the manufacturing 
sector that experienced a significant drop (-11%) in output was 
non-metallic mineral products.  The poor performance of this 
industry is not unexpected, since its products (clay, glass, and 
concrete) are related to construction - which has come to a near 
standstill in Latvia. 
 
¶6. Retail sales growth has been consistently falling since late 
2007, reaching a record low of -19.8%, year on year, in January 
¶2009.  Categories experiencing the biggest sales drop are luxury 
items, home decor, and domestic appliances and electronics.  While 
declines in luxury and electronic goods signal normalization of the 
reckless consumption which was greatly responsible for the 
overheated, pre-2008 Latvian economy, the decreased spending takes a 
significant toll on economic growth.   Of all retail categories, 
dwindling motor vehicle sales took the largest toll on GDP growth, 
as the portion of GDP related to car sales decreased by 27%. 
According to industry statistics, the new car market in Latvia has 
shrunk by roughly 75%.  Low consumer confidence will continue to 
negatively affect sales and lead Latvians to further postpone large 
purchases. 
 
Construction Boom Over 
------------------------------ 
 
 
RIGA 00000125  002 OF 002 
 
 
¶7. The construction sector's downturn is mostly due to the near 
freeze in new residential construction.  Residential property 
construction's share of GDP fell by 33% in the third quarter. 
Tighter and more expensive credit, significant loss of household 
purchasing power, and low economic expectations deter people from 
investing in new property.  Worries about the stability of the Lat 
add to the hesitation to invest.  The most common currency for 
consumer loans continues to be the Euro, not only as banks protect 
themselves from currency exchange risks, but also due to the fact 
that loans in Lats are presently extremely expensive.  As the market 
declines, property developers stuck with empty or uncompleted 
housing projects are filing for insolvency.  In fact, property 
developers and construction companies constitute the majority of 
insolvency or bankruptcy protection applicants. 
 
Positive Notes - Inflation and Current Account Deficit Down 
------------------------------ 
 
¶8. Price and wage inflation have deteriorated Latvia's economic 
competitiveness during recent years.  Latvia's short-term 
competitiveness has also been affected by currency depreciations in 
nearby countries.  Despite these factors, Latvia's export growth 
remained fairly strong through most of 2008.  In the last three 
months of 2008, however, export volume began shrinking, with 
tightening credit worsening the business environment. Andris 
Rozentals, the Vice President of the Commercial Banking Association, 
told us that banks are reluctant to lend both for the increased 
risks associated with the instability in the market and due to 
liquidity problems arising from the necessity to increase reserves 
for bad loans.  Added to this, some banks face the potential of 
unplanned syndicated loan repayment calls.  Combined with falling 
foreign investment and weak global demand, Latvian export businesses 
will mainly focus on maintaining their existing market share, not 
conquering new markets.  Despite the harsh export environment, 
weakening local demand is causing imports to decline faster than 
exports, and the relative strengthening of exports has help Latvia 
start to close its once-ominous current account gap.  The current 
account deficit already decreased to 12.6% of GDP in the third 
quarter of 2008, down from a high of 26%. 
 
¶9. The latest data on employee compensation show that wage growth 
has significantly slowed, and in the private sector has even turned 
negative. Compared to the third quarter of 2008, the average monthly 
gross nominal salary in the private sector fell by 0.5% in the 
fourth quarter.  Salary reductions, coupled with tax increases and 
lower government spending, has already started to cause some 
societal unrest, but if this trend persists it will aid in restoring 
Latvia's economic competitiveness. 
 
Comment 
-------------- 
 
¶10.   Press and government alike predict no short-term improvements 
in the Latvian economy.  While the public is braced for needed 
fiscal tightening, the lack of foreseeable positive results will 
likely strain that public support.  Despite tax rate increases, tax 
revenues in the first eight weeks of this year are down 16.2% 
compared to the same period last year, which makes many Latvians 
wonder what good the unpopular VAT increases serve.  There is also 
frustration over the second round of budget cuts needed to comply 
with IMF and EU assistance conditions.  On top of the previous 15% 
budget cuts, due to GDP contraction being more than double what was 
projected, another 15% cut is being contemplated.  This latest round 
of budget measures will affect a wider spectrum of the public, 
surely adding to the ranks of discontented.  The new PM-designate 
has promised that Latvia will meet the obligations of its IMF-EU aid 
packages, and no opposition parties are offering a "Plan B", but 
maintaining a stiff upper lip for two to three years to come may be 
difficult for even the hardiest of Latvians. 
 
Rogers