OREANDA-NEWS. December 16, 2011. Staff teams from the International Monetary Fund (IMF) and the European Commission (EC) visited Riga during 28 October–10 November for discussions on the fifth and final review of the international financial support program with Latvia. Further consultations with the Latvian authorities were needed to conclude discussions due to the failure of Latvijas Krajbanka, which also had an impact on the government’s strategy for airBaltic. The teams have now reached agreement at staff level on the review.

The Latvian government's policy program aims at helping to sustain the economic recovery, enhancing the country's ability to borrow on capital markets at affordable interest rates, and bringing Latvia closer to meeting the conditions for Euro adoption on a sustainable basis, in line with its target date of January 2014.

The Latvian economy is now recovering from a severe downturn, with economic growth of 4?–5 percent expected this year. However, growth is likely to slow sharply next year, owing to the deteriorating external environment. While consumer price inflation is likely to ease next year, efforts to promote a sustainable low-inflation environment are warranted. This year’s budget deficit should come in below target, despite significant unexpected costs associated with airBaltic. Labor market conditions have improved but long-term unemployment remains high, and skill losses and skill mismatches require particular attention. Poverty rates remain among the highest in the European Union (EU). Against this background, the mission teams have continuously stressed the need to retain a sufficient level of social safety net spending.

The Latvian government will aim at a 2012 budget deficit of 2.5 percent of GDP, with a view to meeting the general government deficit criterion for Euro adoption on a sustainable basis. Although the mission teams expressed doubts about some measures in the government’s budget proposal, such as further cuts in road maintenance and reduced safety net spending, the budget should be sufficient to achieve the fiscal target. As a contingency, the government stands ready to introduce additional measures during 2012 if these will be needed to meet the deficit criterion.

In the banking sector, the government submitted its final sales strategy for the Mortgage and Land Bank to the EC on 2 November with a view to launching the orderly sale of its commercial portfolio. This step provided for the release on 21 November of another €100 million for general government financing from the funds earmarked for banking sector support.

The sale of Citadele Bank has started and the orderly resolution of Parex Bank continues, with a view to maximizing returns to the State. Following the failure of Latvijas Krajbanka, the authorities have restored access to insured deposits, and have committed to further legislative and administrative steps to strengthen financial sector supervision.

The government plans further structural reforms to promote Latvia’s competitiveness and long-term sustainable growth. It has also taken steps to improve EU structural funds absorption and has advanced, albeit with some delay, with their strategies for reforming state-owned enterprises.

Completion of this review by the EU and the IMF will unlock remaining tranches of support from both institutions, as well as credit lines from the Nordic countries and other EU countries. However, given its strong financial position, the Latvian government does not intend to draw the funds available to them upon completion of this review.

Subject to endorsement by the European Commission and following consultation of EU Member States in the course of December, a Supplemental Memorandum of Understanding (SMoU) including the policy measures agreed for completing the fifth and final review could be signed and released by January 2012, together with the Commission Staff Report.

Upon expiration of the EU's Balance-of-Payment financial assistance on 20 January 2012, Latvia will be subject to Post-Program Surveillance until a large part of the EU-funded loans are repaid, complementing the monitoring of economic and budgetary developments within the European Semester and the regular reviews of whether the criteria for Euro adoption are fulfilled.

Subject to approval by IMF management, the IMF Executive Board meeting to discuss the Fifth Review under the Stand-By Arrangement (SBA, see Press Release No. 08/345) could take place before the SBA’s expiration on 22 December 2011. After the expiration of the SBA, Latvia and the IMF will continue to maintain a constructive policy dialogue and, in accordance with Fund policy, initiate Post-Program Monitoring (PPM). Under PPM, members undertake more frequent formal consultation with the Fund than is the case under surveillance, with a particular focus on macroeconomic and structural policies.