Press release of November 17, 2005
At its November 17 regular meeting, the Bank of Latvia's Council resolved to leave unaltered the refinancing rate and interest rates on bank deposits with the Bank of Latvia and Lombard loans; however, the reserve ratio for banks and branches of foreign banks was raised from 6% to 8% (the resolution will take effect on December 24, 2005) to facilitate macroeconomic stability as a precondition for further growth of the national economy.
The resolution is based on the following economic development considerations:
In October 2005, the annual inflation reached 7.6%, a high of the last twelve months. This increase partly resulted from the rising prices of energy (fuel, gas) on the global markets, affecting the price level also in Latvia. The Bank of Latvia's analysis suggests, however, that the high inflation rate in Latvia has increasingly been driven by the strong domestic demand. Over the last few months, the effect of inflation expectations has also become more pronounced, making the inflation process management more difficult.
In view of the inflation developments of recent months as well as the expected rise in several administered prices (e.g. higher heating tariffs in Riga) by the end of the year, the Bank of Latvia raises its average annual inflation forecast for 2005 to 6.7%.
One of the most essential driving factors of domestic demand is the persistently intensive lending policy pursued by banks. The currently observed rapid lending growth, approaching 60% of the annual growth in September, cannot be maintained in the longer term. There is a growing concern that lending increasingly boosts consumption rather than the production capacity: at present, the annual growth of mortgage loans exceeds 90% whereas industrial credit has been growing 30% on average.
The Bank of Latvia would like to emphasize yet again that in the current microeconomic circumstances the governmental institutions must take resolute measures to secure further economic growth that would be balanced and sustainable. In view of the limited effect of interest rates in Latvia after the lats peg to the euro, the Council of the Bank of Latvia has resolved to increase the applicable bank minimum reserve ratio from 6% to 8%, at the same time pointing to the limitations of the monetary policy decisions under a fixed exchange rate regime and the need for a stricter fiscal policy.
Under the conditions of rapid economic growth and high inflation, fiscal policy should be aimed at reaching a completely balanced budget, allocating the additionally collected tax income for containing budget deficit rather than financing additional expenditure.
We remind that the current interest rates set by the Bank of Latvia are as follows:
– the refinancing rate – 4.0% per annum;
– the interest rates on bank deposits with the Bank of Latvia:
– 2.0% per annum for 7-day deposits,
– 2.25% per annum for 14-day deposits;
– the interest rate on Lombard loans:
– 5.0% per annum for loans with maturity of up to 10 days,
– 6.0% per annum for loans with maturity from 11 to 20 days,
– 7.0% per annum for loans with maturity 21 days and more.
The minimum reserve ratio is one of the monetary policy instruments of the central bank, and its further increase implies greater costs involved in attracting deposits and other short-term capital for banks, thus affecting their lending capacities. The raise of the bank minimum reserve ratio from 6% to 8% is expected to result in an increase of 135–145 million lats in the minimum reserve requirement.
To ensure stabilisation of the macroeconomic situation, the Bank of Latvia raised the minimum reserve ratio on August 24 in 2005 (from 4% to 6%) and on July 24 in 2004 (from 3% to 4%); as of January 24, 2005, it has included bank liabilities to foreign banks and foreign central banks in the minimum reserve base, with a view to achieving equal conditions for bank competition, given the diverse sources of funds attracted by Latvian banks.
The bank minimum reserve requirement is calculated as a definite percentage of deposits of companies and private persons (resident financial institutions and non-financial corporations and households, to be more accurate) and of securities issued by banks to be held with the Bank of Latvia; the amount of this requirement must be maintained as a monthly average. The compliance with the minimum reserve requirement is assessed within the maintenance period from the 24th day of a month to the 23rd day of the next month.