Press Release of July 15, 2004
At its July 15 regular meeting, the Bank of Latvia's Council resolved to leave unaltered the refinancing rate and the interest rate on bank deposits with the Bank of Latvia and Lombard loans, but to increase the reserve requirement for banks and foreign bank branches from 3% to 4% (in effect as of July 24, 2004), with a view to reduce macroeconomic risks in the country and to ensure the sustainability of the current rapid economic growth.
The Council of the Bank of Latvia based its decision on the following considerations.
While the annual inflation in Latvia has shown, albeit slight, a downward trend, the strong impact of domestic demand on prices is cause for some worry. Since no slowdown is expected either in the growth of economy or in the growth of lending, high domestic demand could put the level of inflation in the country under further pressure.
High domestic demand has also caused notable deterioration of the foreign trade balance - with imports growing more steadily than exports and the current account deficit rising. Another negative tendency is the deterioration of the current account financing, which is attributable to the decrease in the backing of direct foreign investment.
The general government budget for 2004 posted a deficit of 2.2% of GDP, which is relatively high at this stage of economic development. The data on the outcome of budget revenues for May are also disappointing, and such budget expenditure due to debt will continue to increase the pressure on inflation and external imbalances, with imports growing in excess of exports.
In March 2004, the Bank of Latvia increased the refinancing rate by 0.5 percentage points (to 3.5%), aiming to minimise the effects of various macroeconomic risks (a large budget deficit, high inflation rate and external economic imbalances) on the economy. This increase, however, did not have a significant effect on the increase of the amount of loans granted, since the number of borrowers opting for loans in a foreign currency instead of lats and, consequently, the number of banks taking the so-called currency risk grew. Although an increase in the refinancing rate set by the Bank of Latvia determined a transitory rise in the rates of the lats on the market, the rates of the Latvian money market have returned to the previous level following significant inflows of foreign currency.
To reduce the domestic demand, the Bank of Latvia has increased the reserve requirement for banks by one percentage point to 4%. (The minimum reserve requirement for credit institutions is a part of deposits received from enterprises and residents or non-banks that have to be kept with the Bank of Latvia). The increase of the reserve requirement will make banks and foreign bank branches keep larger amounts of funds with the Bank of Latvia thereby reducing the resources available for lending.
The planned reduction of the reserve requirement for banks to 2% set by the EU will take place gradually in line with the minimisation of the above risks.
The current interest rates set by the Bank of Latvia are as follows:
- the refinancing rate - 3.5% 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 of 21 days and more.