OREANDA-NEWS. February 22, 2011. Many people consider the last year to be a turning point for Latvia. Following the first economic crisis in its contemporary history, the country has managed to recover from the shock and has passed to the status of gradual stabilisation, accompanied by continuous cuts of the state budget and growing taxes. Alexander Kalinovski, Member of the Council of Rietumu Bank, which is the most successful bank in Latvia at present, shared his opinion on how to evaluate the current events and what to expect in the future, reported the press-centre of Rietumu Bank.

– What has Latvia managed to do last year for overcoming the economic crisis, in your opinion?
What stage are we now at?

Last year Latvia did a lot to overcome the crisis. Some painful but necessary reforms have been introduced to consolidate the budget and to reduce its deficit. It is disputable whether these measures are sufficient and whether emphasis has been put correctly, but this very fact is undoubtedly positive. The budget’s consolidation during this complicated period has booseted the stability of our economy.

As a result, the signs of stabilisation have become apparent. By the way, psychological factor has played a large role here. Today we see that the panic attitude, which was still dominating on the market a year or a year and a half ago, has settled down and has given way to a more realistic assessment of the situation. And this, in its turn, has allowed the government and entrepreneurs to act pragmatically. With time, everybody has realised that life goes on even during the crisis and one has to adapt to the real situation and reconsider one’s strategy and plans.

Latvia, as a small and very open economy, largely depends on the situation in related markets, primarily in the EU. It is too early to declare that a warm tropical wind is blowing from there – the situation in the European Union is also complicated and hard to predict. However, reconsideration of economic processes is taking place in the world, attitudes of market participants are being stabilised and this is good in itself, including for Latvia.

– How has our private sector overcome the economic difficulties, in your opinion?

During the past two years practically all trends of our private sector were left to themselves – sink or swim. It forced the majority of companies to restructure themselves and to start working taking new realities into account – much more efficiently and cautiously. The positive moment here is that the crisis has forced entrepreneurs to clearly define their priorities, to focus on what is more beneficial and promising, to cut expenses, to increase production efficiency and to review the organization chart. Many entrepreneurs have retreated from grandiose but dim plans of development, which were characteristic for the economic boom period. Now these plans mostly are much more specific and clear.

Therefore, Latvian private enterprises, as a whole, are now more stable in the face of the economic phenomena of the crisis than 2-3 years ago and this is, certainly, very positive. We have to understand that in any case, sooner or later, rose-tinted perspectives drawn by many people before will melt and one will have to face the objective reality. Thus, in some sense, the earlier this happens, the better.

– You have mentioned that whether our government gets priorities right is disputable. How do you evaluate the recent tax reform: increase of VAT, social tax and real estate tax…?

– I have said many times that it is impossible to levy more taxes by means of their simple arithmetic increase in such a country as Latvia, where the share of the shadow economy is rather large. We already have the experience showing that the VAT rate increase directly proportionately leads to decrease of income from this tax in the budget. As for the social tax, I would not be surprised if this year it were levied even less than previously. Besides, the costs of labour force have been inadequately high here up to now – and this not only creates an excessive load on business, which is experiencing hard times as it is, but also scares away investors.

Another thing is that tax reform is required; however, it should not be a mechanical, but a balanced one. I think that the main load must be transferred from the labour force to real estate. Today, those who live in expensive apartments pay too little to the state and those who work for an average salary pay too much – this is obvious. Besides, the property tax, in contrast to many others, is levied practically 100%, as you cannot take a house and carry it away in your pocket.

The chaotic nature of the events also does not add a positive attitude. The approach of constantly offering to increase a little bit here and to cut a little bit there does not, to put it mildly, create a feeling of stability.

– Has the attractiveness of Latvia increased in international markets following the introduced reforms?

The question of the country’s attractiveness is many-sided. During the past two years, numerous declarations and forecasts made from the outside regarding the Latvian economy were based on a very superfluous study of the real situation. When the pallid statistics reported on the impetuous growth, primarily in the real estate market, bank resources were blindly accounted here, though in reality these resources were the actual source of this growth.

At the time when the classical bubble was being blown here, many analysts asserted that this growth would continue almost eternally. When the world markets dropped down and the Latvian market practically collapsed, the forecasts turned from white to black ones and the same analysts started talking about the local end of the world, predicting the country’s default, devaluation of its currency and all sorts of misfortunes that can take place in one separately taken economy.

However, in both cases, the reality differed from statistical forecasts. Today the situation in the society has stabilised, crisis developments have been taken under control, and painful and wide-scale changes are being introduced to increase the efficiency and reduce costs. This strengthens the country’s solvency and stability in the face of disturbances. As a result, we can see that the international ratings agencies are increasing the Latvian ratings, and this indicates the growing stability of the country and its attractiveness for investments in the eyes of the world’s investment community.

Another important factor is the appearance of additional niche opportunities for attracting investors. For instance, recent amendments to the Immigration Law allowing foreign investors to receive a European residence permit here in a simplified way. The very existence of such a law will attract attention to this country on the part of those who might not have thought about investments into Latvia up to now. That is, by making this step we have not only improved the image of our state in the investors’ eyes who already work with this country, but have also attracted new potential partners.

– There have been many discussions in the society recently with regards to the effect of the Immigration Law. Some politicians think that it will not bring the desired effect…

All these discussions are nothing but political games with electors. In reality, the number of investors who are considering the possibility of investing into Latvia now, following amendments to the Immigration Law, is constantly growing. Rietumu Bank alone has several dozens of such clients who came to the Bank during several months since the adoption of the Law, when it was not yet precisely clear how it would work in practice. Now, when it is clear that the Latvian residence permit may be obtained in a rather simple way, the word of mouth effect starts and it is bound to multiply the number of such investors.

Is Latvia worse than other countries which have successfully managed to attract large international resources? If we act correctly and create favourable conditions for foreign investments, we shall inevitably feel the positive effect from the investment growth. This will also impact the real estate market and the accompanying industries – construction, infrastructure development and transport. There are all the necessary preconditions.

– Can new strategic productions be established in Latvia like, for instance, Nokia in Finland?

Nokia for Finland is a common noun – this production has become the core business of the country. But in Latvia, I think, to establish the production on the European or even the international scale is practically impossible. We have no objective prerequisites for this, the first of which is the availability of huge internal or external venture capital. In Russia, for instance, astronomical amounts are sometimes allocated from the state budget to develop such high-tech productions, but only a country which has considerable natural resources – in the given case, oil reserves - can allow this.

Therefore, our Nokia can rather consist of small and numerous Nokias, which can appear only if we find the correct niche, taking the local realities into account. It is hard to say hypothetically what trends will become successful. However, among the ones which have already been operating and have good prospects, one can name the niche pharmacy, which has been in Latvia for a long time, and transit.

– Will transit also remain one of the main businesses in Latvia, due to our geographical location, in the foreseeable future?

Our favourable geographical location in itself does not guarantee the successful development of the transit business. For this, high technologies, good quality infrastructure and the entire complex of services for freight owners are extremely important: services of railways, ports, customs warehouses and the accompanying financing from banks.

Meanwhile, our infrastructure is far from being ideal and investments into it are not promising and it is extremely important for transit to remain one of the pillars of the Latvian economy. Our ports must be multifunctional and our infrastructure, as well as the tariffs and conditions of freight transportation, must meet the highest international standards.

In the 90s people believed that nothing needed to be done to modernise transit and that is Russian oil would just keep on going. Life has proved that it is not so and only within the last decade something started to be done to increase attractiveness of Latvia as a transit country. As a result, there is obvious progress: if earlier we really only had freight traffic from Russia and Belarus to the West, now freights are also going in the opposite direction.

Besides, the position of the state considerably influences transit – from political relations with our neighbours to establishing tariffs and duties.

– The first official visit of the President of Latvia to Russia has recently taken place. Will it help our businesses, in your opinion?

Good relations with Russia are very important for Latvia, and not only from the business viewpoint. We are neighbouring countries, we have a common border and it is important for us to cooperate also in such issues as prevention of smuggling and illegal immigration, to provide assistance to each other in situations of natural calamities, for instance, in case of breaks with electricity supplies.

Therefore, I am glad that the visit of President Zatlers to Moscow, in spite of this being postponed several times, still took place. High-level visits to different other countries which are located much further occur much more regularly. And now it is important for this visit not to become a single light spot on the not yet bright background and for Latvia to continue strengthening its relations with Russia on the political level and transfer them to a new and friendlier level.

When speaking about our economy, we, as an EU border country with an educated Russian population, could become a support point for Russian business going to Europe. At present, many large Russian companies implement their new strategy related to transfer of their activities to other countries and strive to enter the international market by means of direct investments into their businesses abroad. With this purpose, they purchase assets in Europe and America. And here it is not about speculative, but about large long-term investments which bring considerable benefit to the economy.

However, such investments are incompatible with cool relations between countries. Until Latvia is accepted positively at the political level in Russia, such wide-scale investments will not come here.

– What will last year’s results for the banking industry be? Will the majority of banks still suffer losses?

At present, it is already clear that the total losses of the banking industry according to last year’s results will be less than in 2009, including due to the fact that a part of the previously made conservative accruals for loans were later re-estimated taking the actual economic situation into account.

A large role in this is played by the changing general attitude of the markets and the participants of the economic processes. During the previous years, when forming accruals for loans, the banks were guided by very negative forecasts, based on which the collaterals were re-estimated – then it seemed that the market had no bottom. Now it is clear that the bottom has been found and in some segments even a slight rise is observed. As a result, a part of the very conservative previously made write-offs and accruals have been re-estimated – this explains the lower losses of this year.

And, although in absolute figures the losses are still very serious and the issue of bad loans is still on the agenda, the situation may be regarded with careful optimism. The growth rates of the accruals are going down and the scale of problems the banks struggle with today is considerably lower than a year or two ago. Therefore, we can say that the situation in the banking sector is stable and can be forecasted. The most complicated period must be behind us.

– Will write-offs continue this year as well and how will banks act now? How will they complete this year?

In the first half of the year the write-offs will obviously continue, but at much less high rates than before. According to the results of the year, the cumulative performance of the banking sector can be either slightly negative or break even.

Having solved the current problems, some of the banks will resume crediting, but it will not be that aggressive and easily accessible as during the recent credit boom period. The banks operating in foreign markets, including Rietumu Bank, will continue the policy of attracting deposits of non-residents which is largely contributed to by the aforesaid Immigration Law.

In general, positive tendencies will prevail. Obviously, the majority of the banks, having recovered from temporary difficulties, will switch to the active development strategy again. At present all commercial banks already have clear plans of their further activities with regard to the economic situation. As for Rietumu Bank, we will continue our business activities in Russia and the CIS – the most attractive markets for us. Alongside this, we will attract foreign investments to Latvia – I think that the main prospects here are still ahead.

– Do we have to expect structural changes in our banking system? Will Scandinavian banks stay and will new foreigners come to the country?

The appearance of new players is very doubtful, at least, in the medium term. The crisis has clearly shown the small depth of our market and that there is not much place for wide-scale business projects here and mortgage loans are not the priority for the banks now.

Among foreign financial conglomerates, the largest interest to Latvia will be retained by Scandinavians who have strengthened their positions here during the recent years. The actions they undertook on recapitalisation of their affiliated companies are the evidence of their long-term plans. Thus, Scandinavians indeed will remain the chief strategic investors in the banking sector.

– As of 1 January Estonia has been the first of the Baltic countries to introduce the Euro. Is Euro adoption required for Latvia, in your opinion, and what will it give us?

The answer is clear here. The debates on whether Latvia has to join the European monetary union ended when Latvia joined the EU. We are a very small country, LVL cannot become even a significant regional currency, not to mention on some larger scales, and it is not serious to talk about ambitions of Latvia in the currency market.

Besides, the crisis has shown that a country which is a member of the “European club” has much wider opportunities for mitigating negative effects both in the banking system, and in the economy in general. Euro adoption will give us access to unlimited European resources of the Eurozone countries, will increase the attractiveness of Latvia for foreign investments due to the lack of the currency risk, will reduce this risk and the currency exchange expenses for our businesses. Therefore, we have to strive towards introduction of the Euro and to do it as fast as possible.

– What should our government focus on this year? What should they undertake in order to eventually lead the economy out of stagnation?

The time has come for Latvia, maybe with some delay, to start making plans of development, growth and implementation of its ambitions. It is necessary to finally elaborate a clear concept of the country’s development, determining the priority industries the economy will be based on.

The tactics directed to survival, reductions and cuts which we were following during the recent years must give way to growth-oriented reasoning. This does not at all mean that we have to increase the budget deficit or the state machine – the measures directed to the budget consolidation must be continued, but it should not blur the prospective plans. It is most important that the philosophy of taking decisions on the level of the government and the Saeima should be directed towards development, and not on survival. Then it will become a significant crucial point for the country.

This year must become the period of critical decisions on the issues of state ownership of commercial assets. Obviously, decisions will be taken on privatising some state enterprises and facilities.

At present, the state owns a number of companies which, in contrast to, for instance, Latvenergo or Latvijas Valsts Mezi, do not have a global strategic significance for the country: shares in Air Baltic, telecommunication operators, as well as real estate facilities. I do not think that everything should be sold, but transfer into private hands of such non-core assets will allow for attracting long-term investments and significantly reducing the budget load. Besides, for many enterprises, when they pass over to private ownership, management will become more efficient and this will bring benefit to these companies, the national economy and the residents.