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Opening Speech by the Minister of Finance of Latvia Oskars Spurdzins

Conference "The Sustainable Development of the Latvian Economy: Issues, Risks, Solutions"
September 19, 2005
Riga, Latvia

Opening Speech by the Minister of Finance of Latvia Oskars Spurdzins

Ladies and Gentlemen!

It is a great pleasure for me to make my remarks at a moment when Latvia's economic development has reached unprecedented growth rates. Today, sixteen months following Latvia's accession to the European Union, it is obvious that our country, formerly a timid candidate, has become a "Tiger" – not only in the context of the Baltic area, but on the scale of the European Union. This fact is reflected in the sustained growth rate of gross domestic product (GDP): 9.5% in the first half of 2005, as compared with the respective period of 2004. It must be noted that GDP increased by 7.4% and by 11.6% (in the first and second quarters of 2005, respectively), evidencing the highest GDP growth since Latvia regained independence. We should be proud of that!

Thus a certain apex has been reached in the development of the Latvian economy and our task is to maintain this situation as long as possible. May our economic "tiger" never tire and have the strength to reach new apexes! Thus the Bank of Latvia's invitation to try to assess for how long our economy can develop at the current dynamic pace is most welcome. This issue is also important for me as the Minister of Finance as sustainable development of the Latvian economy will determine when our country reaches the average standard of living common to the EU Member States. The Latvian public is eager to see this objective attained, and it seems to have been one of the major arguments for supporting Latvia's accession to the EU determined by the citizens' positive vote in the referendum two years ago.

What is it that currently most impairs the growth rate of the Latvian economy? An exhaustive one-word reply cannot be given to this question as maintaining the high growth rates depends on a number of conditions. Among them, further dynamics of inflation ratios is a significant factor.

As we all know, after a several year period of low inflation the year 2003 was marked by a trend of more vigorous price rise, increasing substantially during 2004. In August 2004, the 12-month inflation rose as high as 7.8%, remaining the highest among the EU Member States for a year and declining to 6.1% in August 2005.

However, it should be taken into account that a comparatively high inflation is a side-effect of high GDP growth rates.

As regards Latvia's goal of introducing the euro in 2008, I consider that we should give it up only if the attaining of this goal becomes clearly impossible. I still believe that Latvia can reduce inflation at least by half and inflation at around 3% would be only a logical outcome, given the current buoyant economic growth. In any case, even if we join the euro zone a year later, such mobilisation will be an efficient means for increasing our economic stability.

In this respect, I am concerned about the large energy price fluctuations worldwide and the fuel price dynamics. Under such circumstances our intentions to curb the rise of inflation rapidly via Government resolutions may very well come close to nil. It is a global problem requiring a global solution, and Latvia should show initiative in trying to find one, as the problem exerts a more or less substantial impact on each of the 25 EU Member States.

In this context, a problem specific to Latvia is an utterly insufficient competition not only in energy supply, but also in many other areas, resulting in monopolisation of the goods and services market, thus diminishing producers' profit and increasing consumer costs throughout the economy. The situation is most critical in the fuel market and food retail trade and the consumer price rise in these segments exerts a substantial pressure on inflation.

Drafting the 2006 government budget, the Latvian Government is planning for a budget deficit of no more than 1.5% of GDP next year (0.18% less than was planned for 2005). I consider a further reduction in government spending impossible for two reasons.

First, Latvia must not reduce the intensity of spending the EU Structural Funds in 2006, which is the final year in a three year cycle and should become the most intense period of spending the EU Structural and Cohesion Funds, which has been undesirably sluggish. So far only about 19% of the total Structural Fund financing for 2004–2006 and only about 13% of the total Cohesion Fund financing have been spent. Latvia cannot afford to lose these funds without investing them in the economy, therefore the Ministry of Finance of the Republic of Latvia, the managing authority for the EU Structural and Cohesion Funds, will strengthen monitoring and, if necessary, initiate decisions on reallocation of funds from inefficient projects to those capable of spending the EU Funds.

Second, the Government must not fail to compensate social groups for the escalating price rise, and we must not, not even for a moment, postpone the declared wage increase in several sectors, otherwise Latvian schools will have to be opened not only in Ireland. Given the current demographics, it simply must not happen and the Government should at least endeavour to stop the "brain drain" of intellect and skilled workers from Latvia.

In the capacity of the Minister of Finance, I would desire a more vigorous rise in the central government budget rather than cutting down Latvia's budget expenditure. I wish the same for every Latvian household and business: to earn more rather than spend less and at the same time be very realistic regarding one's financial capabilities, especially when assuming credit liabilities.

The state's ability to increase revenue this year has been evidenced by the fact that in the first eight months of 2005 the State Revenue Service (SRS) has collected 365 million lats or 27.3% more than in the same period last year.

I am convinced that the restructuring of SRS and aligning of natural persons' income monitoring will result in the Treasury losing less funds than has been the case.

However, I believe that incomparably greater opportunities for increasing the state revenue and thereby contributing to the country's welfare are provided by expanding the economic activity of Latvia's residents, with increasingly more people starting an active business. Businesses pay taxes and the more businesses we have the more taxes will be collected by the state and thus its opportunities for solving urgent social problems will increase. Currently we have three times fewer enterprises per 1 000 inhabitants in Latvia than in Western European countries, thus there exists an enormous potential for increasing our country's economic capacity.

Instead of the current boom of consumer credit, I would rather see a boom of new business enterprises. Both the politicians and relevant governmental institutions should ensure that Latvia attains the level of the "old" EU Member States in this area as well.

As regards loan structure, I propose to evaluate the opportunities for diverting the majority of loans to the production sector rather than consumption. Also, an opportunity for allocating higher tax relief on investment to promote the development of businesses rather than simply "spending" one's earnings, should be evaluated.

I think that in the case of lending, loans for profiteering from real estate should be scrutinised very carefully due to the fact that price adjustments will be possibly made in selected real estate segments and loan interest rate increases cannot be excluded in the long-term, thus causing problems for the majority of households in Latvia.

This prospect can be avoided, if Latvia attains the demand and supply balance at the macroeconomic level. The best way of accomplishing it would be to expand production and exports. Although lately exports tend to grow more rapidly than imports, the share of industry in total GDP growth remains comparatively modest.

As I have already indicated, promotion of production and exports is closely related to the reluctant establishing of new companies and slow drawdown of the EU Structural Funds.

Apparently environment for starting business in Latvia is not adequate for the majority of general public to change their employee status to that of entrepreneurs.

The country should promote this environment in the near future as well as ensure an opportunity for all future legal entities to acquire the necessary business education. I am convinced that we will gain knowledge and new ideas for the economic development also at the conference hosted today by the Bank of Latvia. Therefore I wish its participants success in their work and sustainable development to the Latvian economy!

Thank you.