Updated convergence programme of Latvia, 2007-2010 - Main contents

EN

Official Journal of the European Union

C 73/18

On 4 March 2008, the Council examined the updated convergence programme of Latvia, which covers the period 2007 to 2010.

Following a sustained period of high growth since the mid-nineties, Latvia's real GDP increased at double-digit rates in 2005-2007. Growth has primarily been driven by a powerful credit boom boosting private consumption and real estate investment, with net external borrowing surpassing 20 % of GDP since 2006.

Monetary conditions have been accommodative, given a high degree of euroisation in the framework of a narrowly pegged exchange rate within ERM II. Adding to the overheating from the demand side, labour shortages have contributed to the emergence of a wage-price spiral, with very high wage growth outstripping productivity, leading to the highest inflation in the EU and rapidly worsening cost competitiveness. Helped by a set of measures adopted by the authorities in spring 2007 some slowdown has become visible in the housing market and in domestic consumption, but further steps in this direction are necessary to achieve a smooth adjustment towards a sustainable growth path. In this context fiscal policy has insufficiently tackled the emerging vulnerabilities. Key to addressing internal and external imbalances will be a more ambitious fiscal stance; adherence to an appropriate medium-term budgetary framework; prioritizing public expenditure and re-examining taxation instruments to avoid demand stimulus in sectors which do not significantly strengthen the economy's medium- and long-term supply potential; and a more responsible public sector wage growth. To foster the catching-up process, structural reforms and removal of bottlenecks directed towards strengthening the supply side of the economy are needed.

The macroeconomic scenario underlying the programme envisages a soft landing with real GDP growth gradually decreasing from 10,5 % in 2007 to 6,8 % by 2010. According to the programme, domestic demand will remain the main growth contribution, although it is expected to slow significantly from 2007 to 2008. Assessed against currently available information (2), this scenario appears to be based on plausible growth assumptions. However, the envisaged deceleration of domestic demand is far from assured, and the programme's economic scenario is attended by very high risks to macroeconomic stability, including continued overheating with a substantial risk of an abrupt slowdown at a later stage. Furthermore, without a larger adjustment of aggregate demand and supply than depicted in the programme, the country's external position would not be sustainable in the longer run.

The programme's projections for inflation, which appear to be plausible, show that Latvia will be moving further away from nominal convergence at least until 2008. Moreover, uncertainties remain large due — inter alia — to ongoing volatility in energy and other commodity prices and to how the current wage-price spiral may evolve. Restraining public sector compensation is critically important for achieving a reduction in whole-economy wage growth which would be necessary to break the current cost-price dynamics and rapidly worsening cost competitiveness.

For 2007,...