Documentof The World Bank
FOR OMCLAL USE ONLY Public Disclosure Authorized ReportNo. 13424-LV
NEMORANDUM OF THE PRESIDENT
OF THE
INTERNATIONAL BANK FOR
RECONSTRUCTION AND DEVELOPMENT
TO THE
EXECUTIVE DIRECTORS Public Disclosure Authorized ON A
COUNTRY ASSISTANCE STRATEGY
OF THE
WORLD BANK GROUP
FOR
LATVIA Public Disclosure Authorized
AUGUST 17, 1994
Country Department IV Public Disclosure Authorized Europe and Central Asia Region
This documenthas a restricteddistribution and may be usd by recipientsonly in theperformance of theiroir cal duties.Its contents may not otherwisebe disclosedwithout World Bank autboriz2tion. Abbreviations
CAS Country AssistanceStrategy CIS Commonwealthof IndependentStates EBRD European Bank for Reconstructionand Development EDI EconomicDevelopment Institute EIB European InvestmentBank ESW Economic and Sector Work EU PHARE European Union's TechnicalAssistance Program for Eastem Europe and the Baltics EXIM Export/ImportBank FDI Foreign direct investment FIAS Foreign InvestmentAdvisory Services FSUB Former Soviet Union (12) and the Baltics G-24 Group of 24 GDP Gross domestic product IDF InstitutionalDevelopment Fund IFC InternationalFinance Corporation IMF IntemationalMonetary Fund MFN Most Favorable Nation MIGA MultilateralInvestment Guarantee Agency NIB Nordic InvestmentBank OECD Organizationfor EconomicCooperation and Development PHRD Populationand Human Resource Development SDR SpecialDrawing Rights UNDP United Nations DevelopmentProgram
Currency Equivalents (May 1994 average)
Ls 0.5644 = US$ 1.00 Ls 1.00 = US$ 1.722
Fiscal Year
January 1 - December 31 FOR OFFICIAL USE ONLY
LATVIA: COUNTRY ASSISTANCE STRATEGY Table of Contents
A. Recent Developments ...... I Background . Political Developments .1 Economic Developments. 2
B. External Environment and Economic Prospects. 6 External Environment. 6 Macroeconomic Prospects. 7 Creditworthiness and External Financial Requirements. 8
C. Development Issues and the Government's Policy Agenda. 9
D. The Bank's Country Assistance Strategy .11 Strategic Focus ...... 11 Lessons from Experience ...... 11 Lending Strategy.13 Private Sector Development .14 Public Infrastructure .15 Social Safety Net and Social Services .17 Lending Scenarios and Triggers .17 Portfolio Implementation and Management Issues .19 Technical Assistance and Aid Coordination .19 Activities of Other Development Organizations .21 IFC, FIAS and MIGA Activities .21 Collaboration with the IMF .22
E. Agenda for Board Consideration .22
Boxes
1. CountrnyProfile. 1 2. Agreements Between Latvia and Russia .. 2 3. Key Economic Indicators.. 3 4. Proposed Economic and Sector Work Program .. 13 5. Proposed Lending Program . .16
Annex
A. Key Economic Indicators .23 B. Poverty and Social Development Indicators ...... 25 C. Technical Annex...... 27
IThis document has a restricteddistribution and maybe usedby recipientsonly in theperformance of their | officialduties. Itscontents may not otherwisebe disclosedwithout World Bank authorization. Tables
1. National Accounts ...... 28 2. External Trade ...... 31 3. Balance of Payments ...... 32 4. External Capital and Debt...... 34 5. Government Budget ...... 38 6. Money and Credit ...... 39 MEMORANDUMOF THE PRESIDENTOF THE INTERNATIONALBANK FOR RECONSTRUCTIONAND DEVELOPMENT TO THE EXECUTIVEDIRECTORS ON A COUNTRYASSISTANCE STRATEGY OF THE WORLDBANK GROUP FOR LATVIA
A. RECENTDEVELOPMENTS
Background
1. An earlier limited discussion of the Bank's assistance strategy for Latvia took place on September 25, 1992, in the context of the presentation to the Executive Directors of the Rehabilitation Loan. The 1992 assistance strategy focussed on the initial steps of the country's economic reform program and the financing needs to maintain essential services and production. The present Country Assistance Strategy (CAS) expands on the discussion of the Bank's lending strategy in the context of Latvia's aspiration to re-integrate into Europe.
Box 1: Country Proffle
The Republicof Latvia is situatedon the eastern coast of the Baltic Sea, bounded by Estonia to the north, Lithuaniato the south, and Russiaand Belarusto the east. It has a 500-kilometercoastline on the Baltic Sea, along which lie the ice-free seaportsof Ventspils,Liepaja, and Riga, the capital. Latvia has an area of about 25,000 square miles (64,600 square kilometers). A little less than half the country is arable. Woodlandscover 40 percent of the territory and are an importantsource of timber. The country has very few natural resources and importsall of its natural gas and oil products, and half of its electricity needs. Industry accounts for one-thirdof GDP and employment.Agriculture accounts for 15 percent of GDP and one-sixth of employment. Latvia has a populationof 2.6 million people, of whom one-third live in Riga.
2. Latvia's aspiration to re-integrate into Europe has driven the economic reform program. This aspiration has provided a large degree of consensus among the major political groupings and allowed the country to move ahead on stabilization and the transition to a market economy. Progress in both areas has been significant: inflation declined from over 900 percent in 1992 to 35 percent in 1993, and is projected to stay well below this level in 1994; privatization of small enterprises is two-thirds completed; and price and trade liberalization are expected to be concluded by end-1994. However, full integration with the West still hinges on further development toward long-term political stability, exchange rate stability and deepening of structural reforms.
Political Developments
3. Economic reforms enjoy a large degree of consensus in Latvia's political establishment, the main issues of contention relate to two important and immediate issues for the country's long-term political stability: (i) the citizenship fate of Latvian residents who arrived in the country after 1944-45; and (ii) Latvia's relationship with Russia. The manner in which these issues are addressed could influence the speed in which Latvia is re-integrated with the West. -2-
4. Around 30 percent of Latvia's resident population are currently not recognized as Latvian citizens. The controversy surrounding their citizenship status stems from the dramatic change in Latvia's ethnic composition. In 1935 over three-fourths of the population were of Latvian origin; by 1993 this figure had dropped to 54 percent, with ethnic Russians accounting for 70 percent of the rest. The naturalization of those groups who arrived since 1944-45 is opposed by nationalist Latvians, who attempted to introduce citizenship quotas for ethnic groups. The law passed without the inclusion of such quotas as recommended by the Council of Europe.
5. Nationalist tendencies have also undermined the government's attempt to resolve some pending issues in the country's relationship with Russia. In the May 29 municipal elections, a coalition of nationalistic parties headed by the Latvian National Independence Movement won a majority of seats in the largest cities, including Riga, on a platform which opposes agreements with Russia (Box 2). These agreements had been generally endorsed by Western governments.
Box 2: Agreements BetweenLatvia and Russia
On April 30, 1994, two protocols, one on Russian troop withdrawal and another on trade arrangements, were signed by the Presidents of Latvia and Russia. The troop withdrawal agreement established that the rernaining Russian military personnel stationed in Latvia would leave the country by August 31, 1994. In exchange,retired military personnel who had lived continuouslyin Latvia until January 1992would receive residencyrights and be entitled to social benefits, althoughold-age pensions would be paid by Russia. Russia would be allowed to operate the Skrunda radar station for the next four years and have another 18 months to disassemblethe station. A separateprotocol also extendedmost favorablenation (MFN) trading statusto both countries.The treaty was ratified by Russiaon a temporarybasis, contingenton Latvian ratificationof the troop withdrawalagreement. Latvia had already ratified the MFN agreement in late-1992.
Economic Developments
Stabilization
6. Latvia launched a stabilization program in 1992, delinking its currency from the ruble zone by floating the LatvianRuble, and then replacingit by a permanentcurrency, the Lat, in 1993. This allowed the country to pursue an independentmonetary policy and reap the benefits of a prudent fiscal policy. An open trade regime and, until mid-1993, incomes policy measures (which led to a decline in real wages) also contributedto stabilization.As a result, inflationdropped steadilyfrom double digit monthly figures through October 1992, to less than 0.5 percent a month in the third quarter of 1993.
7. In the last quarter of 1993, inflation picked up as a result of monetary expansion caused by larger-than-expectedcapital inflows. This, combined with higher pensions and public sector wages, led to price increases in excess of what could be reasonably attributed to the rise in the VAT rate from 10 to 18 percent on November 1. However, after peaking at 8 percent in November 1993, the inflation rate began to decline again and was only 0.2 percent in May 1994. -3 -
8. The current account of the balance of payments has strengthened and gross official reserves totaled US$ 0.5 billion (about six months of imports) at end-1993. This favorable outcome was due to: (i) a relatively low level of imports; (ii) significant capital inflows, in part from Russia, and (iii) the good performance of service exports, most notably shipping. As part of the Bank of Latvia's policy to moderate the liquidity impact of the inflow of convertible currencies, the Lat was allowed to appreciate by about 30 percent in nominal terms and by around 85 percent in real terms against the US dollar. Since mid- February 1994, however, the Bank of Latvia has aimed at keeping the Lat stable against the SDR to maintain Latvia's competitiveness.
Box 3: Key EconomicIndicators
1991 1992 1993 1994
Real Economy
Real GDP (% change) -8 -34 -12 01 UnemploymentRate n.a. 2.3 5.8 6.52 (% of labor force)
Prices and Wages
CPI (% change) 262 951 35 93 Min. Real Wage 100 67 61 483 (1991 = 100)
Trade Flows (% of GDP)
Exports n.a. 62 42 243 Imports n.a. 79 45 333 Trade Balance n.a. -17 -2 _93
General Gov. Budget (% of GDP)
Total Revenue 37.4 28.2 33.5 n.a. Total Expenditure 31.1 28.2 32.5 n.a. Financial Balance 6.3 0.0 1.0 n.a.
1) Forecast. 2) March 1994. 3) First quarter 1994. -4 -
Structural Adjustment
9. Structural adjustment in key areas has progressed significantly: most prices have been liberalized; the trade regime has opened and privatization of small businesses, agricultural land and banking institutions is well advanced; and the government is reforming the social safety net, focussing on social benefits specifically aimed at lower income groups through better means-testing. However much remains to be done in all these areas as the following paragraphs indicate. The speed at which Latvia completes the structural reform agenda will strongly influence its integration prospects into western Europe.
10. Trade and Agricultural Policies. One of the main issues facing policy makers in Latvia is the link between trade and agricultural policies. At independence, Latvia introduced a liberal trade policy regime with low and uniform tariffs and almost no non-tariff barriers. However, the reduction in agricultural customs duties, combined with the exchange-rate appreciation that followed stabilization, resulted in a sharp increase in imports of food products from both the CIS and elsewhere. Faced with what is perceived as unfair trade practices from the East and the West, and under increased pressure to provide protection to Latvian agriculture, supporters of the agricultural lobby in the Government and Parliament pushed for the introduction of higher import tariffs on some agricultural products, mainly meat and dairy products.
11. The opponents of such protectionism in the Government have tried to resist and managed to postpone a decision on this matter so far. The economic reformers have argued that, as a small open economy, Latvia stands to gain from a liberal trade system. The main question is the ability of the government to muster support in Parliament for this objective.
12. As for agricultural policy, pressure to increase tariffs on agricultural imports, and to provide tax exemptions' and subsidies to farmers2 are likely to impose higher costs on urban consumers and delay the downsizing of the agricultural sector, which is probably needed. In Latvia one-third of the population lives in rural areas and 17 percent of the labor force is employed in agriculture, reflecting the prevalence of small, low productivity farms. The reformers had planned, therefore, to remove subsidies and tax exemptions as well as to reduce import tariffs, allowing the sector to adjust gradually. These measures would have to be matched with policies to mitigate the social costs of adjustment for the population that either remains in the country-side. or migrates to the cities (e.g., social assistance for retiring farmers, development of a market for urban housing, etc.). Implementation will depend on how the political situation evolves.
13. Privatization. The privatization process is well advanced in the agriculture sector. By early 1994, more than half of agricultural land had been privatized and laws governing privatization of agro- processing industries such as milk, meat, and grain had been passed. However, mainly small plants are
I For example, there is no tax on agricultural profits, no sales tax, no income tax on private farming and social security taxes for farmers are half of that of other sectors.
2 Explicit subsidies to tarmer> have heen eliminated for almost all agricultural inputs and outputs, except for bread, sugar and wood pulp. In practice. however, implicit subsidies to state enterprises remain, since they are permitted to operate at a deficit or to pa! tarmers for products months after they are procured. -5- being privatized. As with industrial enterprises, privatization of large scale processing enterprises is rather sluggish.
14. The small enterprise privatization program, which is being implemented by the municipalities, has progressed well. By June 1994, about 66 percent of small enterprises in the service and trade sectors had been sold or leased with option to buy. However, completion of this program still faces significant obstacles. The most notable are: the identification of property rights associated with the national restitution program for housing; and the requirement that new owners retain the entire workforce and maintain the same line of activities, either for the duration of the lease or a minimum time period.
15. The delay inprivatizing large enterprises was initially caused by the lack of important pieces of legislation such as the voucher and leasing laws which have now been approved. With the basic legislative framework in place, the main reason for the delay became the procedures that required the intervention and involvement of several ministries in privatization decisions, without a uniform approach. A new Privatization Law was passed in March 1994. This law streamlined the institutional mechanism for privatization. It also created a State Property Fund which will control and manage all state property including public enterprises and a Privatization Agency which will have central authority over the privatization of large enterprises. New privatization rules have been adopted which allow two privatization tracks-tenders and auctions-as well as liquidation. These recent developments are expected to accelerate the privatization process.
16. Private Sector Development. Until recently, efforts at promoting the private sector had progressed at a slow pace. In mid 1993, a business support center to train businessmen and provide information on financing and marketing was opened in Riga. A number of other centers are planned to be opened in other parts of Latvia in the near future. The Government has also established the Latvian Development Agency as a "one-stop-shop" for easy access and advisory services to foreign private investors on laws, regulations, local business conditions, and investment opportunities in the country.
17. Recent progress has also been observed in de-monopolization. The law on supervision of monopoly activities was amended in April 1993 and price and tariff boards were created to control natural monopolies, particularly in the energy and telecommunications areas. Major steps have been taken to restructure the energy sector: the oil sub-sector has already been privatized, the electricity and gas monopolies are in the process of being restructured to operate on a commercial basis, and the district heating system has been transferred to the local governments. The grain monopoly, Latvia Labibas, has been liquidated; and the telecommunications company, Lattelekom, has been privatized.
18. Banking Reform and Financial Restructuring. The Bank of Latvia's record of independence has been established and its supervisory capabilities have been substantially expanded. In parallel, privatization of the second tier of the banking system has progressed rapidly: about half of the former commercial branches of the Bank of Latvia have been privatized and the remainder have been merged into the newly established Universal Bank. The intention is to privatize this bank once it has established its viability. However, the banking system in Latvia suffers from a large portfolio of non-performing loans to enterprises. Enterprises have also accumulated substantial arrears to the Government, to their workers, and among themselves. The non-performing assets of financial institutions, estimated at about 3.5 to 4.0 percent of GDP, are concentrated in two state banks: the State Savings Bank and the Universal Bank. The government has replaced these non-performing assets with seven-year bonds as part of a restructuring scheme for these banks. -6 -
19. Labor Market and Social Safety Net. Open unemploymentin Latvia is still low considering the decline in industrial output; average unemploymentwas 6 percent in May 1994. However, there are significant discrepanciesacross regions: registered unemploymentranged from 3 percent in the capital city, Riga, to 20 percent in the eastern Districtof Kraslava. The governmentis developinga broad array of instrumentsto address the problem of growing unemployment,including active labor market policies such as retraining, job search assistance, and public works. In addition, Latvia has a comprehensiveset of transfer mechanisms, including pensions, family benefits, unemploymentcompensation, and social assistance transfers, to protect the most vulnerablegroups.
20. The main area where progress has been slower than originally anticipatedis the developmentof means-testing of the social assistance programs. Social assistance programs are mostly run by local governments and financed by local revenue and 100 percent matching transfers from the central government. This is designed to encourage local governments to meet their responsibilities.However, these programs are not well developedand there seem to be wide differencesin coverage and benefits provided by local governments. Work is still required on the implementationof these programs to improve the capacity of local administrationto cope with the present and anticipated levels of poverty.
21. Pension Reform. The pension system is also expected to be revised since the current system is under intense political pressure to increase payments to retirees. A new pension law, which is being drafted, separates the social funds from the central governmentbudget (they were consolidatedin January 1993) and gradually introducesa multi-tier pension system. The new system envisagesthe separationof basic provisions from earnings-relatedprovisions, the introductionof funded benefits, and the gradual increase in the retirement age.
22. Crime. As in neighboring countries, crime is on the rise and has become an issue of priority concern for the Latvianauthorities. The governmentis trying to address the problem by taking preventive social action and judicial and penal measures to stem the drift toward hard-core crime. Social and legal structures to deal with this problem will take some time to be established. In the meantime, the government is strengthening its capacity to enforce law and order.
B. EXTERNAL ENVIRONMENT AND ECONOMIC PROSPECTS
External Environment
23. Latvia's economic prospects will be strongly influencedby its external environment, given its size, trade orientation, limited natural resource endowment and need of external financing to support transition to a market economy. Three external factors stand out which would influence Latvia's development prospects over the next few years: (i) Latvia's integrationinto the European Union (EU); (ii) trade relations with Russia; and (iii) possible terms of trade shocks.
24. Integration into the European Union. Latvia's integrationinto the EU wouldhave strong positive effects on its economy. The EU is already Latvia's main trading partner in the West, and the recently -7 - signed free trade agreement will give Latvia better access to these markets than non-European OECD countries, most developing countries and CIS members. Moreover, the economic recovery in Europe should increase the demand for exports from Latvia, and this should encourage foreign direct investment and further weld Latvia's economic relations with Europe's. Conversely, failure to reach an agreement on long-tern guarantees of full market access to western European markets could adversely affect Latvia's growth prospects.
25. Trade Relations with Russia. Notwithstanding Latvia's integration into Europe, developments in the country could still be strongly influenced by the direction the Russian economy takes. If Russia moves toward becoming a relatively stable, open economy, Latvia could possibly acquire an important role as a commercial entrepot for an ensuing growth in Russian trade. However, if Russia were to turn inward, restricting its foreign trade, Latvia's commercial entrepot role would be limited, as would its access to inputs from the East (e.g. energy inputs).
26. External Shocks. Latvia is well-positioned to deal with terms-of-trade shocks. Its reserve position is strong and the external debt is so far small and manageable. However, Latvia's dependence on energy imports-the country imports all of its natural gas and oil products, and about half of its electricity needs-makes it particularly vulnerable to increases in energy prices. A sharp increase in energy prices from the current levels could hurt its balance of payments position and limit its ability to import needed investment goods.
Macroecononiic Prospects
27. Base Case Scenario. The most likely scenario is the continuation of the present policy performance, with a commitment to economic stabilization, as demonstrated by the solid track record of fiscal moderation and an independent monetary policy; and a coherent structural reform program, with visible progress in privatization. Under this scenario, GDP could rise by about 4.5 percent per year on average for the remainder of the decade. In the short-run, the increase in investment necessary to sustain growth would entail a surge in imports of capital goods, raising the rate of growth of imports above the expansion of exports. AsI a result, Latvia's balance of payments current account is projected to turn negative after 1994, with the deficit peaking at 4.3 percent of GDP in 1995-96 and gradually shrinking thereafter.
28. Three issues emerge in this scenario. First, the recovery's sustainability hinges on Latvia's capacity to increase exports to international markets. The share of non-FSUB exports has increased from 2 percent in 1990 to almost 50 percent in 1993. Further increase in exports to convertible currency markets should result frorn (i) improved market access under an association agreement with the European Union (EU); (ii) investment in industries with export potential (e.g., wood and furniture, food, building materials, textile and leather); and (iii) the upgrading of the quality and environmental standards of Latvian exports.
29. Second, will the country be able to maintain external competitiveness in the face of large capital inflows? Larger-than-expected capital inflows in the second-half of 1993 have led to a significant appreciation of the Lat against other convertible currencies. It is important therefore that the Latvian government (i) accelerate its privatization program, especially of large enterprises, (ii) introduce legislation aiming to reduce restrictions on property sale, and (iii) increase its reliance on market based -8 - monetary instruments, mainly governmentbonds, to finance public sector deficits; since an increase in real and financialassets would help sterilizethe impactof future capital inflows. Otherwise,real exchange appreciationwill hurt external competitiveness,despite labor costs that are, and are expectedto remain, well below northern European levels for some time at least.
30. Third, Latvia needs to raise aggregate investmentrapidly while gradually introducingmeasures to increasesavings in the long-run. Economicrecovery requires a rapid increasein investment from the very low current levels. To reach this goal, public investmentis projected to increase from less than one percent of GDP to around three percent by 1995. Foreign direct investment is expected to follow suit; however, the government should also take measures to increase the pool of savings for domestic investors. These include: (i) restricting the size of public sector deficits; (ii) maintaining positive real interest rates; and (iii) introducinga fundedtier in the pension system.
31. UpwardPotential and DownwardRisks. A combinationof factors could lead Latvia to a higher GDP growth rate: (i) the accelerationof private sector developmentand privatization, includingan active program of large enterprise reform for those enterprises that are not going to be privatized immnediately (including the impositionof hard budget constraints with resulting bankruptcies);(ii) improved public sector implementationcapacity, entailing an expeditiousdevelopment of legal and regulatory institutions; (iii) a faster pace of energy conversion that reduces the consumptionper unit of output; and (iv) a reconmmitmentto move swiftly towards a transparenttrade policy regime with low and uniform tariffs. Under this high growthscenario, the economywould recover more quickly:projected GDP growth could reach about 5-6 percent annuallyover the next half-decade.
32. A low policy performance scenario would assume a significant deteriorationor even a reversal in governmentcommitment to economic reform. This could manifest itself in: (i) higher fiscal deficits; (ii) looser credit policies by the Bank of Latvia; (iii) a sluggishprivatization program; and (iv) slow legal and institutional reform. Under this low growth scenario, which is rather unlikely, Latvia would experience very little income recovery.
Creditworthiness and External Financing Requirements
33. Creditworthiness. Latvia's external debt, currently around 14 percent of GDP, is expected to peak under the base case scenario at 25 percent in 2000 and gradually decline thereafter. Debt service payments in terms of merchandise exports are expected to increase from 2.4 percent in 1994 to 6.1 percent by the year 1999. The World Bank's share of total debt service would not exceed 13 percent, and its share of total debt would peak at 15 percent in 2000.
34. External Financing Requirements. Under the base case scenario, external financing requirements would amount to about US$ 320 million annually on a disbursement basis over the period 1995-99. Assuming that bilateral credits remain at or about the current nominal levels, foreign direct investment and conmmercialcredits are projected to accountfor over two-thirds of Latvia's external financing. The resulting US$ 50 million average financinggap would be bridged by multilateral institutions. -9-
C. DEVELOPMENTISSUES AND THE GOVERNMENT'SPOLICY AGENDA
35. Latvia's key development challenge is to attain sustainable growth. The country's successful stabilization has brought inflation under control and strengthened the balance of payments, but economic activity bore the brunt of adjustment. Output declined by 34 percent in 1992 and at least an additional 10 percent in 1993. Open unemployment has more than doubled since end-1992 to about 6.7 percent in April 1994, while hidden unemployment could be as high as 20 percent.
36. While there are signs of recovery-the fourth quarter of 1993 witnessed significant increases in tax revenues, retail trade and industrial production-private and public investment levels are still too low. In 1993, private investment3 accounted for 15 percent of GDP, whereas public investment by the central government was less than one percent of GDP. To accelerate growth, the government's policy agenda focuses on four areas: (i) enterprise restructuring; (ii) energy conservation and the environment; (iii) investment in municipal infrastructure and intergovernmental fiscal relations; and (iv) the delivery of social services and the social safety net.
37. Enterprise Restructuring. The Latvian government is taking steps in three areas to promote enterprise restructuring. First, it has hardened the budget constraint to state enterprises. There are no subsidized lines of credit and channeling of direct credit lines provided by bilateral and multilateral organizations require that either the enterprise obtain a commercial bank guarantee or that the participating commercial bank bid competitively for the credit line. The level of interenterprise arrears in Latvia, though significant, is much smaller than in other countries of the FSUB and appears to be by and large confined to the energy sector. Second, significant progress in privatization can be expected in the second half of 1994. The framework for accelerated privatization is now substantially in place. The institutions have been streamlined, the process simplified and some of the key legislative steps have been taken. It is now largely a matter of implementation.
38. The one important exception with regard to the adequacy of the legal framework is the definition and enforcement of property rights and this is the third area of government action. Uncertain property rights are the major reason for the low level of both equity investments and term financing by the banking system. There are deficiencies in the registration of titles and other rights to property (company and land registers) and enforcement of these rights is difficult because of the lack of a developed court system. The Latvian authorities have therefore made property rights definition and enforcement their top legislative agenda item. The government is committed to a process that includes drafting legislation on property rights, strengthening the court system, developing adequate registries and expediting the processing of restitution claims. Progress in this area is expected to encourage private domestic and foreign investment. The ongoing Agricultural Development project and the proposed Enterprise and Financial Sector Restructuring project seek to support the government's efforts in both accelerated privatization and the definition and enforcement of property rights.
3 This includes inventory accumulation and investments by state enterprises that did not receive support from the budget. - 10 -
39. Energy Conservation and the Environment. The Latvian authorities have given priority to energy conservationand the environmentin their public investmentprogramming. Energy consumption in Latvia is 35 percent higher than in countries with comparable income and weather conditions. Substantialsavings can be achieved throughthe rehabilitationof existinginstallations designed to reduce leakage within the district heating networks and improve housing insulation.However, to induce energy conservation and finance the needed upgrading of energy installations, domestic prices should be increased to reflect the price of energy imports. Over the last two years local governments have been slow to set rates that reflect the full cost of supply and utility companieshave failed to enforce payments. As a result, arrears to the energy companyhave built up, measures to improve energy conservationhave been delayed, and Latvia has been forced to rely on external financingto settle part of the debt related to gas supplies from Russia.
40. The governmentrecognizes that these issues are interrelatedand need to be addressed in parallel. The government's agenda includes legislativeaction to induce local governmentsto settle arrears to the energy companiesand charge rates that reflect the full cost of service provision; define more clearly the responsibilities of central ministries, local governments and operating utilities; and enhance the local governrments'financial and managerial ability to deliver these services. This should improve energy conservation and provide the resources and the incentivesfor the necessary investment in the energy sector.
41. Inadequatewaste water treatmenthas made the Daugava and the Lielupe rivers heavily polluted, with serious implicationsfor the water quality of the rivers and the Baltic Sea. Inadequatesolid waste disposal facilities have added to localized groundwater pollution. Rehabilitationand expansion of the existing water and wastewater system, and the constructionof new sanitary landfills are therefore need to prevent further environmentaldegradation.
42. Municipal Infrastructure and IntergovernmentalFiscal Relations. Latvia has implementedan ambitious program of decentralizationof authority to local governments, restoring the more traditional government structures that prevailed during the inter-war years. Local governments have become increasinglyresponsible for the deliveryof municipalservices (including water supply, sewage treatment, solid waste management,urban transport and district heating); housing and housing maintenance; and some contribution to the provision of education, health and other social services. Decentralizationhas been motivated to some degree by increased fiscal pressure at the center and the desire to transfer expenditure responsibilityto local governmentswhile at the same time constrainingfunding. However, in large part decentralizationreflects a genuine commitmentto deepeningthe democraticprocess and to increasingaccountability and efficiency by shifting provision of services to the local level.
43. Within the context of decentralization and devolution of expenditure responsibility to local governments, the municipal finance framework takes on increased importance as a key determinant of local governments' ability to deliver the services for which they are now responsible. Therefore, the government's agenda includes an ambitious package of legislation designed to clarify expenditure responsibilities and tax assignments, improve the structure of local budgets and the regulation of municipal enterprises, and establish principles for revenue equalizationand determinationof local fees. Taken together, this package is expected to provide the basic framework for a relatively stable and transparent system of expenditure and revenue assignment, and allow the local government to assume their new responsibilities. - 11 -
44. Social Services and the Social Safety Net. The transition to a market economy is being accompaniedby a decline in real incomes, leaving some groups of the population below socially acceptableminimum living standards. As indicatedin para. 20, the governmenthas used a broad array of instrumentsto mitigate this problem. The implementationof the various social assistanceprograms, however, faces two problems. First, means-testingof the programs is not well developed. Second, local governmentshave little experiencein the managementof social services, whichwere providedpreviously through enterprises.
45. Inadequateattention to maintainingsocial servicesand improvingthe quality of human capital can undermine public support for market reforms and damage the foundations of growth. Therefore, in addition to addressing the immediatesocial safety net issues, the governmenthas also started to direct attention to the long-term issues in health and education: access, quality and cost. The government's agenda aims at rationalizingthe existingsystem to reduce duplicationand incorporateprivate provision of services.
D. THE BANK'S COUNTRY ASSISTANCE STRATEGY
Strategic Focus
46. As indicated, Latvia has achieved significantsuccess in stabilizing its economy and initiating structural reforms and the Government is now setting the stage for resumed economic growth by deepeningthe structural reforms to completethe transitionto a market economy. The Bank's assistance strategy has shifted accordingly, from supporting stabilizationand early structural policy measures to assisting the Government in deepeningstructural reforms and promotingprivate and public investment. Priority will be given to: (i) private investmentpromotion by easing constraintsand opening new areas for private sector activity; (ii) ensuringan adequate level of public infrastructureservices to facilitate a supply response, improve energy conservation, support nascent municipal governments and address pressing environmentalconcerns; and (iii) streamlining and strengtheningthe social safety net and the delivery of social services.
Lessons from Experience
47. The experience from the Bank's first two years of operation in Latvia has highlighted the following considerations:
(i) Importance of Economic and Sector Work. The success of the Bank's policy dialogue and lending strategy depends to a large extent on the quality and timely disseminationof its economic and sector work. The Bank's first Country Economic Memorandumpublished in 1993 has been highly regarded and widely read in Latvia and, together with subsequentmore focussedPolicy Notes, has provided an excellentbasis for a very fruitful policy dialoguewith the Latvianauthorities. The recentlycompleted Public Expenditure Review (PER) has been instrumental in engaging the government in a dialogue on budget planning and investmentstrategies and priorities. In line with the recommendations of the report, the Latvian authorities have established a public investment programming unit. The document also provides guidance to the Bank's investmentlending and is helping to mobilize assistancefrom other sources, in addition - 12 -
to assistingthe governmentfocus its public investmentpriorities. The AgricultureSector Review was also very well received and highlightedthe need for a comprehensivesector strategy designedto assist the emergingprivate farming. This is being supported by the ongoing Agricultural Developmentproject.
(ii) Implementation Capacity. A major factor that limits the pace of economic reform is the government'slimited capacityto formulateand implementpolicies and programs. Latvia, despite having a highly skilled and motivated manpower mainly in technical fields, still lacks some of the structures and skills needed for the transformation to a market economy. For instance, preparation of some projects in the pipeline is taking longer than expected because of the need to define and strengthen managerial and financial responsibilitiesof central ministries, local governmentsand operating utilities. Bank operations, therefore, have to factor in this reality and the associated need for technical assistance.
(iii) Other Donors. A large number of bilateral and multilateral donors are active in Latvia. The Nordic countries are involved in a number of sectors, providing both financialand technicalassistance. Other European countries, either bilaterallyor through the European Union, Japan, Canadaand the United Statesalso have significantprograms. EBRD, EU PHARE, EIB, NIB and other multilateral organizationsalso have growing programs. Bank operations, therefore, have been dovetailed with those of the other donors.
48. Based on these lessons, the followingprinciples have been developedto guide the Bank's country assistance strategy for Latvia:
(i) Design of Economic and Sector Work. Future ESW will be designedto continuethe open dialogue, contributeactively to project design, and help promote project ownership and efficient implementation.The review of the public expenditure envelope and the public investmentprogram is plannedas a continuousprocess, with data regularly shared and discussedamong governmentand donors. The proposed EconomicUpdate will focus on inter-governmentalfiscal relations, which is a matter of primary concern to the government and is directly relevant for several Bank operations in energy, municipal services, and social protection. Likewise, the proposed FY96 Country Economic Memorandum will include a poverty assessment and address cross-cutting issues in enterprise reform, labor markets, and the social safety net. Other proposed sector work (Box 4) would provide a basis for continuingpolicy dialogue and project design.
(ii) Quality at Entry. To increasethe likelihood of success of Bank operations, efforts will continueto ensurequality throughproject preparationand borrower ownership. This entails (a) supporting institutionaland managerial capacity for project implementation through the use of IDF and other TA funding sources; (b) keeping projects straight forward and avoiding organizational complexity; and (c) conducting specific project implementationworkshops and public information functions to help promote efficient implementationand project ownership. The Bank will continue to rely heavily on its Resident Mission in this endeavor. - 13 -
(iii) Bank's Role in Aid Mobilizationand Coordinationof TechnicalAssistance. In view of the presence of many donors in Latvia, the Bank will continue giving considerable attention to coordinating activities at three levels. First, the Bank will continue participating in the broad G-24 framework for aid mobilizationand technical assistancecoordination. Second, the Bank will continue to take the lead and participate in informal workshops among technicalstaff at the sectoral level. Third, at the project level, the Bank will actively seek and accommnodatecofinancing partners, particularly grant sources of technical assistance financing. In addition, the Bank will keep close contact with the major bilaterals and internationalorganizations in order to coordinate areas of emphasis for lending. Since Latvia, understandably,prefers to use grants or concessionalfunding for technical assistance, the Bank will need to continue devoting considerable efforts to work with the government and donors to match technical assistance requirementswith available concessionalsources. In the case of the EBRD, agreement has been reached to coordinate closely either through formal cofinancing arrangements for large projects, or by independentlyfinancing complementary smaller investments.
Box 4: Proposed Economic and Sector Work Program (FY94-97)
FY94 FY95 FY96 FY97
Public Economic Update: Country Public Investment Expenditure Intergovernmental Economic Review (Update) Review Fiscal Relations Memorandum
Agriculture Sector Financial Markets Energy Sector Education and Review Study Review Training Note
Policy Notes: Forestry and International Fisheries Note Trade. Enterprise and Financial. Sector Reform. Social Policies.
Lending Strategy
49. OngoingOperations. The Bank's first loan to Latvia, the RehabilitationLoan (US$ 45 million), focussed on support for the early implementationof economic reform and financing critically needed imports. The project is proceedingwell. As of June 1994, about 93 % of the loan has been committedand - 14 - two-thirds disbursed. An associated loan from the Japanese EXIM Bank (US$ 35 million equivalent), which the Bank is administering,was signed in November 1993, became effective in April 1994 and is expectedto be implementedexpeditiously.
50. The Bank's second loan, an Agricultural Development project (US$ 25 million) is designed to promote the developmentof private agriculture, particularly through the provision of credit to private farmersand privatizedagro-industrial enterprises. This project is also assistingthe Governmentof Latvia in implementingland reform, privatizationand registration,in cooperationwith EU PHARE and Sweden. Implementationis off to a promising start.
51. Future Lending. Proposed lending for the next several years under the Base Case scenario assumes: (i) a continued commitment to economic stabilization, and (ii) a coherent structural reform program. The proposed program is designedto financeon averageto projects per year to meet demands in several sectors (Box 5). The thrust of the program is designed to assist Latvia address the main issues outlined in the government's well-conceivedpolicy agenda.
Private Sector Development
52. The Bank's strategy to support private sector developmentin Latvia aims at developingthe legal and institutionalframework for private sector activity; and addressingproblems in the interfacebetween enterprises and the financial sector. The focus on the legal and institutionalframework stems from the perception that uncertainproperty rights are a major reason for the low level of both equity investments and term financing by the banking system; while attention to the interface between enterprises and the financial sector is based on the intimate interdependenceof these two sectors.
53. Legal and InstitutionalFramework. The Bank's strategy in assisting Latvia develop a legal and institutionalframework that meets the demandsof a market economytakes into account the presence of other donors (mainly EU PHARE, UNDP and several bilateral organizations). Instead of providing across-the-boardsupport, Bankassistance will focuson interventionsin conjunctionwith specificprojects, or selected use of the InstitutionalDevelopment Facility (IDF). Areas where such assistance would be targeted include: (i) property rights, as in the agriculture loan; (ii) contract law, where there has been already some input from IDF financedtechnical assistance; and (iii) efficient institutionalarrangements in key sectors (e.g., energy and municipal development)through specificoperations.
54. Enterprise and Financial Sector Restructuring. Bank support for enterprise and financial sector restructuringis expectedto focus on two broad types of activities: targetedtechnical assistance to enhance efficiency in production and financial intermediation;and financial support to private sector activities. The ongoing Agricultural Developmentproject is assisting the governmentin implementingland reform and the privatizationof state processingand distributionmonopolies. It has also mobilizedgrant funding for technical assistance in land reform, registration, cadastre and legal reform. The proposed Enterprise and Financial Sector Restructuring project is designed to support-and accelerate-the Government's mediumand large enterpriseprivatization program, and institutionalstrengthening of the bankingsystem. The project is comprised of three components: (i) a credit line to finance investment and related permanentworking capital needs of newly-privatizedand other private sector enterprises; (ii) institutional development financing, providing technical assistance for the design and completion of privatization transactions, and technicalassistance for the restructuringof the state-ownedbanks; and (iii) financing - 15 -
for the modernizationof the domesticpayments and clearingsystems including the purchase of computer hardware and software.
55. Direct financial support to private sector activitiesthrough lending operations is designed as a catalyst,and is likely to remain modest in viewof the presenceof other donors. The ongoingAgricultural Developmentproject is providing credit for private farmers and privatized agro-industrial enterprises whichundertake capital investmentdesigned to improveefficiency. The proposedEnterprise and Financial Sector Restructuringproject will encouragebanks to undertakeinstitutional strengthening measures, and is supportedby the establishmentof a Swedishfund to improve the capitalizationof some banks and by a World Bank credit line. The combinationof strengthenedbanks, increasedsources of long-term funds and enhancedability to assess credit and projectrisk, is expectedto increasethe availabilityof long-term financingfor newly-privatizedand other private sector enterprises.
Public Infrastructure
56. Latvia has a well-developedinfrastructure at the national level with little need for expansion at this stage. Roads, railways, ports, power supplyfacilities, many hospitalsand educationalinstallations are operating well below capacity. However, over the last couple of years, budgetary constraints forced the public sector to defer maintenanceand rehabilitation. Therefore, key infrastructure capacity in energy, transport, water and sewage requires rehabilitation not only to permit better use of existing installations,but also to address pressing environmentalconcerns. The Bank's assistancein rehabilitation and modernizationof key infrastructurecapacity is designed to: (i) improve energy conservation, (ii) support nascent municipal governmentsand (iii) address environmentalproblems.
57. Energy Conservation.Latvia importsall of its natural gas and oil products, and about half of its electricity needs. In 1993, these imports accountedfor approximately22 percent of GDP and 40 to 45 percent of total imports (US $400 million). This reflectsboth the country's shortage of domesticenergy supplies and inefficiencies in energy production and use. A cross-country comparison indicates that Latvia's energy consumptionfor heat and hot water productionand delivery is 2 to 3 times higher than Western countries with similar size and weather conditions. Substantialsavings can be accomplished, therefore, by renovating existingenergy installations.
58. The Bank will support effortstoward energy conservationthrough a relativelysmall and targeted first round lending operationthat could lay the ground for larger repeater projects in the future. Specific support through the proposed EnergyRehabilitation project will include:technical assistance to introduce a new institutional and regulatory framework for the energy sector; and investment financing for rehabilitatingand restructuringdistrict heating systems4 . Bank assistance in this area will also consider other donors' activities: EBRD assistance to Latvia Gas and the Daugava Hydropower System; EU PHARE support to institutionalreform; and bilateral involvementin project preparation.
4 This includes: leakage abatement and insulation improvements to reduce wastage within the district heating network; and efficiency improvements for municipality owned boilers, including conversion to local fuels. - 16 -
Box 5: Proposed Lending Program
US$ Million
FY95 Enterpriseand Financial Sector Restructuring 35 Energy Rehabilitation 30
Total 65
FY96 (S) Environment 4 Health and Social Protection 30
Total 34
FY97 (S) Enterpriseand Finance 11 35 (S) MunicipalDevelopment 20
Total 55
FY98 (S) Agriculture H 50 (S) Transport 20
Total 70
Total FY95-98 224
Annual Average FY95-98 56
S = Standby
59. Municipal Governments. The local governments in Latvia have been given considerable responsibilities in the provision of services such as water, sewage, solid waste disposal, urban transport, road maintenance, housing, street lighting and internal security. As a result, local governments account for 27 percent of all public expenditure budgeted for 1994. The Bank will assist local governments in providing municipal services, including housing, urban transport, solid waste disposal, water and sewerage. The proposed Municipal Services Development project would provide financing for priority investments in some of these areas; and technical assistance to the central and municipal governrments in budget and investment planning. - 17 -
60. EnvironmentalConcerns. Water and air pollution in Latvia decreased substantiallyafter 1991, as a result of the sharp decline in industrialoutput. However, there is still localizedgroundwater pollution in areas next to solid and hazardouswaste disposal sites, contaminationof drinking water supplies that require rehabilitation of water and sewerage infrastructure, and untreated wastewater discharges into rivers and the Gulf of Riga. Thus, in addition to projects in energy conservation,solid waste disposal, water and sewerage,which have a clear environmentalimpact, the Bank's lending program also includes an environmentalmanagement project designedto restore and enhance the water quality in the town of Liepaja and improve coastal zone environmentalmanagement. This is one of several small projects identifiedunder the Baltic Sea Joint ComprehensiveEnvironmental Action Programme.
Social Safety Net and Social Services
61. The Bank's assistance strategy in the area of social protection and delivery of social services receives special attention from our economicand sector work. The FY95 Economic Update will focus on intergovernmentaltransfers and the associatedissue of local governmentcapacity to provide social assistanceand deliver social services. The FY96 Country EconomicMemorandum will includea povery assessment and address cross-cutting issues in enterprise reform, labor markets, and the social safety net. In addition, the review of the public expenditureenvelope for the social sectors is planned as a continuous process, with data regularly shared and discussed among governmentand donors.
62. Social Safety Net. On the social safety net, the Bank strategy is to monitorthe social dimensions of adjustmentand provide advice to ensure a fiscallysustainable system of cash transfers. The Bank has mobilized technical assistance for the design of householdbudget surveys, which help monitor living standards, and for pension system reform, that should assist in limitingcurrent expenditures.The new householdbudget surveys are expectedto be completedby 1995. A new pension law is currently being drafted, which envisages the separationof basic provision and earning-relatedpensions. The draft also proposes the introductionof funded benefits, a gradual increase in the retirementage from the current levels, and the deletion of automaticindexation clauses from the permanent law. Once this proposal is passed, the policy dialogue is expectedto focus on assistingthe governmentin refining the social safety net and further policy implementation.
63. Social Services. The proposed lending program includes a health services project designed to support local governments improve the cost-effectivenessand delivery of these services. The project would support: (i) technical assistance and training in areas such as health promotion and education, health care financingand budget allocationreform; (ii) program developmentfor secondary and primary health centers; and (iii) planning and implementationof closing, consolidationand renovationof tertiary hospitals. There are no plans for involvementin educationat this stage, however, since immediateneeds are being supported by other donors.
Lending Scenariosand Triggers
64. Base Case. Latvia's commitmentto economic reform, as assumed in the base case, is closely linked to its aspiration to re-integrateinto Europe, and, therefore, it is not likely to change in the near future. However, this realization still hinges on: (i) the conversion of most of the specific duties to equivalent or lower ad valorem tariffs, avoiding tariff increaseson agriculturalimports and maintaining an open trade policy regime; (ii) rapid implementationof the privatizationprogram for large enterprises, - 18 - starting in the second half of 1994; (iii) restructuring of enterprises not to be privatized immediately, encompassing measures to address the problem of inter-enterprise arrears; (iv) legislative action to induce local governments to set energy tariffs at levels that reflect full cost of service provision; (v) definition and enforcement of property rights, including the drafting of appropriate legislation, strengthening of the court system, developing adequate registries, and expediting the processing of restitution claims and land titling; (vi) rationalization of social expenditures and the reform of the pension system by increasing the retirement age and developing a complementary funded pension scheme.
65. Failure to achieve progress in one or more of these areas would influence either the size of particular projects or their inclusion in the program. For instance, headway in the large enterprise privatization program and property rights reform is fundamental not only for the timely implementation of the current Enterprise and Financial Sector Restructing project, but would also affect future Bank operations in this area. Moves toward setting energy tariffs at levels that reflect the full cost of service provision, and toward resolving the problems of inter-enterprise arrears in the energy sector, are essential conditions for the Bank's lending operations in that sector. Progress in pension reform is important for the preparation of the proposed Health and Social Protection project. And maintaining an open trade policy regime is key for the Bank's current and future operations in agriculture.
66. Low case. Dissension among the country's main political groupings could, however, delay economic recovery. Under this scenario, the government could be forced to yield to pressures to (i) increase public spending beyond prudent levels and compromise the stabilization program; (ii) either impose quantitative trade restrictions or raise specific tariffs on imports; and (iii) slow down privatization and property rights reform. Factional politics could also lead the government to neglect some of the social dimensions of transition and not focus sufficiently on the social programs. Such pressures would make it very difficult for the government to sustain tight fiscal and monetary discipline.
67. A low policy performance scenario would, therefore, be triggered by an abandonment of the stabilization program and/or a slowdown in structural reform. Should such an unlikely development take place, annual commitments of Bank loans would drop to about $25 million and concentrate on projects whose success would not depend critically on a robust macroeconomic environment (e.g., environment, maintenance of infrastructure). On the other hand, ESW would be intensified in order to underpin a deeper and broader level of policy dialogue in favor of rejuvenating the reform effort.
68. High Case. The high case for Latvia would involve the substantial strengthening and acceleration of the economic reform agenda and would imply a high degree of political consensus. In general the measures would not be different in kind from those carried out in the base case, but they would differ in degree and speed. For the high case for example, we would require a stronger commitment to the openness of the economy, with a quicker movement to low tariff levels. Enterprise restructuring would proceed more rapidly. There would also need to be quick movement to full cost recovery for public services at the municipal level, combined with targeting of social expenditures to protect those most seriously affected by the increased costs. Perhaps most important of all would be the much more evident commitment of the Latvian government towards a shift in its role in the economy towards regulation and monitoring and away from the direct provision of goods and services. It is a prerequisite for the high case of course, that macroeconomic stability would be maintained. - 19 -
69. Since foreign investors and export credit agencies would be likely to increase their activities in Latviaunder this highpolicy performancescenario, the Bank may not need to increaseits lendingvolume but would be ready to do so, if needed, up to about $76 million in annual commitments, i.e., a $20 million average increase in annual commitments. In this instance, it may be possible to provide Bank guaranteesdesigned to elicit additionalprivate capital flows and for projects in the pipeline to move faster to about three projects a year. The latter would probably entail an even larger level of cofinancingthan under the base case scenario.
Portfolio Implementationand ManagementIssues
70. Latvia is a new borrower and therefore the preparationand supervisionof projects are likely to be rather resource intensive. Over the next few years, the country and the Bank will learn more about each others policies, guidelines and procedures. There are two issues likely to affect project implementationand managementwhich the Bank is currently addressing:
71. On-lendingArrangements. Several Bankprojects, particularlyin municipaland social services, will rely on implementing agencies at the local level. Rules for on-lending arrangements to pass funds through to local authorities, including terms and conditions on which this will be done, are at an embryonic stage. As part of project preparation, therefore, the Bank is paying particular attention to this.
72. Procurement. Latvia, as other countries undergoing economic transformation, does not have a procurement law, nor the traditions of competitive bidding. Since timely procurement is essential for the efficiency of Bank-supported operations, the Bank has taken the initiative to assist the government in its efforts to establish national public procurement regulations. This assistance includes: (i) an assessment of the current proposals for a national procurement law; (ii) assistance in designing of institutions necessary for implementation and monitoring of the new regulations; and (iii) identification of training needs. In addition, the Resident Mission will provide advice on project procurement and follow-up on training where needed.
Technical Assistance and Aid Coordination
73. Technical Assistance. A significant share of the Bank's support to Latvia in these first years of economic transition has come in the form of targeted technical assistance in the areas of: public sector management and legal organization; budgeting and public investment programming; trade policy and custom administration; statistics reporting and forecasting; and external debt reporting and risk management.
74. The technical assistance on public sector management focussed on aid coordination and public investment programming. Bank recommendations were helpful to the government's decision to consolidate the functions of aid coordination under a single entity in the Ministry of Finance designed to (i) seek foreign aid and match it with the country's requirements; (ii) review proposals for technical assistance to avoid duplication, waste and the risk of long term dependency; (iii) assure that open and competitive procurement procedures are followed in aid-assisted projects; and (iv) establish a comprehensive and detailed aid record, monitor aid disbursement and prepare disbursement forecasts. With the assistance of the World Bank, the Government has also established a public investment programming unit in the Ministry of Economy to strengthen the management of public investment through evaluation and selection - 20 - of investmentprojects and to direct resources to investmentactivities that support macroeconomicand sectoral strategies.
75. The Bank has also assisted the governmentin preparingbtradepolicymeasures and in mobilizing technical assistance for customs administration. The analysis of trade related measures allowed the governmentto review the import tariff regime and begin moving towards a low uniform tariff structure whichhas been supportedby an IMF StandbyAgreement. Technical assistance on customs administration provided the provisions necessary for the introductionof a duty exemption/drawbackscheme and steps for the effective merger of customs and tax administration.
76. Since Latvia is a relativelynew recipient of foreign currency loans the Bank has also coordinated technical assistance on debt reporting and management. This assistance is designed to allow Latvian officials to properly account for the existing debt obligations and to understand the importance of matching the currency and interestbasis of their revenues and expenses;thus reducing the financial risks of foreign borrowing financial risks.
77. The combinationof limited skills in specific areas needed for the transformation to a market economy and the well-educatedand highly motivatedmanpower in Latvia yields high returns to targeted technical assistance. The Bank's assistance strategy envisions, therefore, selected intervention increase the bureaucracy's expertise in areas such as public investmentprogramming and trade policy analysis. Moreover, throughthe EconomicDevelopment Institute (EDI) the Bankwill continueproviding assistance in the form of seminars and training courses in areas such as market economics, regulation of energy enterprises and social expenditureplanning.
78. Resource Coordination. As indicatedin para. 46 above, in view of the presence of many donors in Latvia, the Bank will continue giving considerableattention to coordinatingactivities at three levels. First, in the broad G-24 framework for aid mobilizationand technicalassistance coordination; second, in informal workshopsamong technicalstaff at the sectoral level, and third, at the project level, through promoting cofinancing,particularly grant sources of technicalassistance financing. In addition, the Bank will keep close contact with the major bilaterals and internationalorganizations in order to coordinate areas of emphasis for lending.
79. In the first two years of Bank assistanceto Latvia, the Bank welcomedconsiderable participation by bilateral and multilateral donors in project preparation and implementation.For the Rehabilitation Loan, the Government of Sweden provided advisors to assist in procurement and disbursement and the Japanese Export-ImportBank cofinanced an additional US$ 35 million. The Agriculture Development project received support from EU PHARE and Sweden in the form of technical assistance for land reform, land privatization, land registration and cadastre surveys. Several projects under preparation involve active j5articipationby other agencies. For instance:
(i) The proposed Enterprise and Financial Sector Restructuringproject will involve co- financingfrom the governmentsof Sweden and Switzerland. It has also receivedsupport for project preparationand implementationfrom the JapanesePHRD and the governments of Denmark and Sweden. - 21 -
(ii) The proposed Energy Rehabilitation project has received support from the Japanese PHRD for preparatory technical assistance and institutional capacity building.
(iii) The proposed Liepaja Environment project is expected to receive grant cofinancing from the govemments of Sweden and Finland, and EU PHARE.
(iv) The proposed Health and Social Protection project has already received support from Japan's PHRD fund for technical assistance and project preparation.
(v) The proposed Municipal Services Development project has received financial support for project preparation from Japan's PHRD and for feasibility studies from the government of Denmark. The project may receive additional support from EU PHARE and Denmark in the form of funding for feasibility studies and cofinancing project subcomponents.
In addition, considerable support in the form of bilateral financing of specialists is being provided to the Regional Mission by the Nordic donors.
Activities of Other Development Organizations
80. Planned activities of other development organizations are highly complementary to the Bank's assistance strategy. EBRD's program for 1994-95 includes an equity investment in the Latvian Investment Bank, the rehabilitation of the Daugava Hydropower Installations and the Riga Water and Sewerage Systems. The European Union's areas of priority funding are energy, transport and the environment; and the EU PHARE will be financing technical assistance for the public investment programming unit. The Nordic Investment Bank (NIB) is considering a lending facility for medium and small enterprises, and project financing in transport and the environment; while the European Investment Bank (EIB) has expressed interest in funding investments in telecommunications, transport, environment and energy. The UNDP will be active in public administration reform and govemance, social assistance and the protection and promotion of human rights.
IFC, FIAS and MIGA Activities
81. Latvia joined the IFC in September 1993. IFC expects to support the privatization and modernization process of local enterprises so that they can become internationally competitive, particularly those that can attract foreign technical partners in joint venture undertakings. At the moment, IFC is considering financing projects in the construction materials, garment and wood and lumber industries. In addition, IFC has taken a 2.5 percent equity participation in the recently privatized Latvian telecommunications company; a first step to assist firms by providing technical assistance for the privatization process when requested and by providing financial support to privatized enterprises that show promise of becoming internationally competitive. At the request of the Government, FIAS undertook an initial diagnostic assessment of the environment for foreign investment and provided specific recommendations in this area. Latvia has signed and ratified the MIGA convention. Latvia will now be eligible for non-commercial risk guarantees on new foreign investments, and for specific promotional and advisory services. - 22 -
Collaboration with the IMF
82. The Bank has worked closely with the IMF on issues relating to the relationship between structural reforms and stabilization, and in particular, on trade policy and the design of the social safety net. The Rehabilitation Loan was approved almost simultaneously with the first IMF stand-by agreement with Latvia, and entailed strong collaboration between the two institutions in assisting the government in its economic reform program outlined in the Memorandum of Economic Reform Policies. More recently, Fund staff participated in the Public Expenditure Review.
E. AGENDA FOR BOARD CONSIDERATION
83. Three issues in the assistance strategy are highlighted for the particular attention of the Executive Directors:
(i) The Base Case Scenario and Triggers. The CAS focuses on the base case scenario which is the most likely given the broad political support that economic reform enjoys in Latvia. This support makes it highly unlikely that Latvia will slip into the low policy performance scenario. On the other hand, Latvia's limited implementation capacity for the time being makes it rather unlikely that the high policy performance scenario can be reached in the next couple of years or so. Therefore, actions necessary for the realization of the base case are presented in paras. 62-63 for the Board's consideration.
(ii) Non-lending outputs. A large share of the Bank's support to Latvia in these first two years of economic transition has come in the form of targeted technical assistance and resource coordination; the former as part of ESW, project preparation and direct technical advice, and latter either through the G-24 framework or at the project level. The Bank's assistance strategy for the next couple of years still envisions a role for the Bank in providing these non-lending outputs, although the Latvian Government is expected to play the central role in the efforts to follow up the Paris meeting on Public Expenditures, with the Bank and other donors assuming a supporting role. Although these non-lending outputs entail additional costs for Bank operations, they are an integral component of the Bank's developmental assistance.
(iii) Sectoral coverage. The Bank's assistance program covers a wide range of sectors. This is designed to respond to the government's keen interest in having the Bank as a development partner across the board and to serve the objective of greater resource mobilization from several sources. This is particularly the case in the first years where assistance is required simultaneously on many fronts. Once reforms are consolidated, the Bank is likely to concentrate on repeater projects in key sectors such as enterprise and finance, municipal services, energy, environment and agriculture. The strategy is to start with smaller, less-complicated projects, and later focus on more comprehensive and complex operations in these key sectors. Should the Bank focus on a narrower lending program from the outset?
Lewis T. Preston President - 23 -
Latvia - Key Economic Indicators Annex A P. 1 ot
Actual Estimated Projected Indicator 1992 1993 1994 1995 199
National accounts (% GDP at current market prices) Gross Domestic Product 100.0 100.0 100.0 100.0 100. Total consumption 82.8 81.7 84.4 84.0 83., Gross domestic fixed investment 20.3 16.1 19.4 21.4 22. Government investment 1.5 0.8 2.0 3.0 3.a Private Investment (includes increase in stocks) 18.8 15.3 17.4 18.5 19. Exports (GNFS) 67.8 52.2 43.3 44.4 45. Imports (GNFS) 70.8 50.0 47.0 49.8 50. Gross domestic savings 17.2 18.3 15.6 16.0 17. Gross national savings 24.2 22.4 15.7 16.1 16. Memorandum items Gross domestic product (US$ million at current prices) 1,306.0 2,337.5 3,266.5 3,617.9 4,007. Gross national product per capita (US$, Atlas method) 2,611.4 2,031.4 .. Real annual growth rates (%) Gross domestic product at market prices -10.0 0.0 4.0 4. Gross domestic income -7.5 -1.1 3.4 3. Real annual per capita growth rates (7c) Gross domestic product at market prices -10.2 -0.2 3.8 3. Total consumption -9.7 4.5 3.7 1. Private consumption -8.3 5.8 4.1 1.. Source: Latvian authorities and Bank estimates. - 24 - Latvia - Key Economic Indicators Annex A p.2 of 2
Actual Estimated Projected Indicator 1992 1993 1994 1995 1996
Balance of payments (US$m) Exports (GNFS) 885.0 1,220.5 1,413.2 1,606.3 1,825.7 Merchandise 697.0 1,000.0 1,190.4 1,376.8 1,588.2 Imports (GNFS) 925.0 1,169.3 1,536.1 1,803.3 2,040.2 Merchandise 883.0 1,133.8 1,496.0 1,756.6 1,987.6 Resource balance -40.0 51.3 -122.9 -197.0 -214.5 Net current transfers (including official current transfers) 74.0 41.0 0.0 0.0 0.0 Current account balance (after official capital grants) 51.0 148.7 -121.7 -193.5 -217.0 Net private foreign direct investment 43.0 50.0 60.0 75.0 83.0 Long-term loans (net) 22.0 172.0 75.7 126.2 187.8 Official 22.0 170.0 14.3 58.8 88.1 Private 0.0 2.0 61.4 67.4 99.8 Other capital (net, including errors and omissions) -100.0 0.0 0.0 0.0 0.0
Change in Net Reserves (- = increase) 1/ -16.0 -370.7 -14.0 -7.7 -53.9 'Jemorandumitems Resource balance (% of GDP at current market prices) -3.1 2.2 -3.8 -5.4 -5.4 Real annual growth rates (1992 prices) Merchandise exports -14.6 11.0 11.0 10.8 Merchandise imports -11.8 21.1 11.0 7.4 r-ublic finance (% of GDP at current market prices) 2/ -rent revenues 28.1 33.4 31.6 31.8 32.1 irrent expenditures 26.7 31.7 31.5 32.4 32.8 Current account surplus-(+) or deficit (-) 1.4 1.8 0.1 -0.6 -0.8 Capital expenditure 1.5 0.8 2.0 3.0 3.0 F(--eign financing 0.0 0.8 3.4 2.5 2.7 Mlonetary indicators Broad Money/GDP (at current market prices) 25.0 31.8 Price Indices (1992=100) Merchandise export price index 100.0 167.9 180.1 187.6 195.4 A. rchandise import price index 100.0 145.5 158.6 167.8 176.7 Nierchandise terms of trade index 100.0 115.4 113.5 111.8 110.6 Real exchange rate index (1992 = 100, USD/Lats) 100.0 200.1 279.6 291.9 303.3 Consumer price index (% growth rate) 71.2 22.6 6.1 7.2 GDP deflator (% growth rate) 74.3 24.4 6.5 6.5 Excluding use of IMF resources Gencral government Source: Latvian authorities and Bank estimates. -25 - Annex B p. I of 2 Latvia Most SamwregionlAncome group Ncr Laratsingiltyear recent Lsirope Lower- higher Unit of eutimte A Central middle- income Indicator measure 1970-75 19JO045 1987-92 Asia incone group Priority Poverty Indicators POVERTY Upper poverty line local curr...... Headcountindcx % of pop. .. 5 Lower poverty line loci curr. .. .. Headcount index % of pop. .. .. I GNP per capita USS .. 1,930 .. .. 3,870 SHORT TERM rNCOME INDICATORS Unskilled urban wages local curr...... Unskilled rural wages Rural terms of trade Consumer price index 1987.100 ...... Lower income Food' Urban Rural SOCIAL INDICATORS Public expenditure on basic social services % of GDP .. 8.0 Gross enrollment ratios Primary % school age pop...... 107 Male Female Mortality Infant mortality per thou, live births 24.0 19.0 17.4 30.0 45.0 40.0 Under 5 mortality .. .. 21.0 38.0 59.0 51.0 Immunization Measles % agegroup ...... 82.0 DPT ...... 73.8 Child malnutrition (under-5) Life expectancy Total years .. 70 69 70 68 69 Female advantage .. 9.0 11.0 8.6 6.4 6.3 Total fertility rate births perwoman 2.0 2.1 1.8 2.2 3.1 2.9 Maternal mortality rate per 100,000 live binhs .. 25 57 58 Supplementary Poverty Indicators
Expenditures on social security % of total govt exp...... Social security coverage % econ. activepop...... Access to safe water: total %of pop...... 85.6 Urban ...... 94.3 Rural ...... 73.0 Access to health care
Population growth rate GNP per capita growth rgte Development diamond b 6+ (annual average, percent) (annul average, percent) 4J 10 p Life expectancy
2 T _ O ^ l l l l | GNP Gross
.2... -10 ~~~~~~~~~~~~~~~~~~~~~~~~Accessto safewater 1970-75 1980-85 1987-92 1970-75 1980-85 1987-92 m Latvia , Latvia - Lower-middle-income Lower-middle-income
3 a. See the technical notes, p. 89. b. The development diamond, based on four key indicators, shows the average level of development in the country compared with its income group. See the introduction. 26 - ~ ~~~~~~AnnexB p. 2 of 2
Latvia Most Same region/ncome group Nexi Latest singleyear recent turape Lower- higher Unit of eetimate & Central middle- Income Indicator measure 1970-75 1980-85 1987-92 Asia income grolup Resources and Expenditures HUMLANRESOURCES Population(m,re=1I992) thousands .. 2,621 2,640 495,241 942,547 477,960 Age dependencvratio ratio 0.53 0.56 0.66 0.64 Urban % of pop 71.0 63.3 57.0 71.7 Population growth rate annual % .. 0. -0.8 0.5 1.4 1.6 Urban ... .4.8 2.5
Labor force (15-64) thousands 1.395 1,350 ... 181,414 Agriculture % of labor force .. .18 16 Industry .. 38 '31 Female . .58 46 36 29 Females per 100 males Urban number Rural NATURAL RESOURCES Area th,ou.sq. kmn 64 50 24,165.06 40,697.37 2 1,836.02 Density pop per sq. km 413 20.4 22.8 21.5 Agricultural land 0/ of land area ... .41.7 Change in agricultural land annu al % . . 0.3 Agricultural land under irrigation I'l 9.3 Forestsand woodland thou sq. km Deforestation (net) annual%0 . ENCOME Household income Share of top 20% of households %of income Share of bottom 40% of households Share of bottom 20%,'of households EXPEN'DITURE Food %of GDP 19.8 Staples 3,6 Meat, fish, milk, cheese,eggs 8.9 Cereal imports thou metric tonnes .. 45,972 74,924 49,174 Food aid in cereals 195 1,639 4,054 282 Food production per capita 1987 100 ... .109 Fertilizer consumption kg,/ha ... .68.8 Shareof agriculture in GDP % of GOP 20.8 24.0 ... 8.! Housing %ofrGDP 4.7 Average household size persons per household 3.1 Urban Fixed inivestment housing of GOP 4.9 Fuel akndpower % of GOP 1.0 Energy consumption per capita kg of oil equiv . 3,190 1,882 1,649 Households with clectricity Urban % of household.s Rural Tr2nsport and communication % of GOP .. 6.2 Fixed investment: transport equipment . .. 10.3 Total road length thou km . 27 58 INVESTNIENT IN HUMIAN CAPITA'L Health Population per physician persons 200 378 Population per nurse Population per hospital bed 72 134 516 385 Orail rehydyration therap>,(under-5) %,of cases ... 54 Education Grossenrollment ratio Secondary of scr'oo>age pop .. 53 Fema]e Pup I-teacher ratio primary pupilsper tcacher . 26 25 Pupii-teacher ratio secondary Pupils reaching grade 4 Soof cohon' 71 Repeaterrate primary 0. of totlz enroll II Illiteracy % of pop (agn IS-) 14 Femalc %oof fern (age I 5-) 17 Nev,spapercirculation per thsou pop 100 117 9, orldt Bank, IntecmationalEconomics D.epartmnent,April 1994 - 27 - Technical Annex p. 1 of 13
Technical Note
1. The attached tables present the base case scenario for Latvia's medium-term prospects and financial requirements. The assumptions for the base case are presented in the section of the main report on External Financial Requirements and Economic Prospects. Assumptions about exogenous factors such as the London Inter-Bank Offer Rate and international inflation are as established by the Bank's Planning Assumptions Committee and circulated in May 1994.
2. The model is a simple LOTUS-based RMSM that has been modified to include the basic elements of the public sector account and GDP expenditures. Since Latvia has pursued a prudent fiscal policy during the last three years, the base case assumes that conservative fiscal policies will continue and that the deficit remains manageable. The model does not provide projections for the monetary sector. Commercial sources are projected to account for two-thirds of Latvia's external financing requirements over the period 1995-99. The share of the international financial institutions including the Bank and the IMF will remain about 15 percent of total disbursements throughout, and official bilateral sources will decline from about 20 percent of total to less than 6 percent in 1999. With foreign exchange reserves of about six months of imports in the projection horizon, Latvia is easily able to fulfill its debt service obligations; the supplemental table on debt rescheduling and reductions in debt and debt service, is therefore, unnecessary. - 28 - Technical Annex p. 2 of 13
Table 1: Latvia - NationalAccounts Part A: Current Price Data (millions of Lats) Base Case Projection Per capita GNP: S 1,930 (1992) Midyear population: 2.6 millions Actual Estimated Projected 1991 1992 1993 1994 1995 1996 1998 2002 Gross domestic product 143.3 1.005 1,575 1,960 2,171 2,404 2,978 4,657 Net indirect taxes 4.2 GDP at factor cost 139.1 Imports (GNFS) 36.5 712 788 922 1,082 1,224 1.504 2,035 Exports (GNFS) 50.5 681 823 848 964 1,095 1.396 1,969 Resource balance 14 -31 35 -74 -118 -129 -108 -66
Total expenditures 129.3 1,035 1,541 2,034 2.289 2,533 3,086 4.722 Total consumption: 81 832 1,288 1,654 1,824 1,996 2,396 3.583 Government 14.7 171 249 303 329 368 483 738 Private 66.3 660 1,039 1,350 1,495 1,628 1,913 2,845 Gross domestic investment 48.3 204 253 380 465 537 690 1,139 Government .. 15 13 39 65 71 89 140 Private .. 189 241 341 401 466 601 1,000 Memorandum items: Domestic saving --- 62.3 173 288 306 347 408 582 1,074 Net factor income .. 13 38 1 2 -2 -23 -69 Net current transfers .. 57 28 0 0 0 0 0 National saving 62.3 243 354 307 349 407 559 1,004 Optional details for RMSM-X: Net indirect taxes 4.2 Indirect taxes 12.4 Subsidies 8.2 Part B: Constant Price Data (millions of local currency units, 1992= 100) Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002 Gross domestic product 1,005 904 904 940 978 1,068 1,298 Exports (GNFS) 681 629 681 739 801 943 1,184 Imports (GNFS) 712 627 757 841 904 1,010 1,200
Total consumption expenditures: 832 752 788 819 836 850 933 Govemment 171 145 144 148 154 171 192 Private 660 607 643 671 682 679 741 Total investment expenditures 204 150 192 224 245 284 381 Terms of trade (IT) effect 0 25 15 10 8 -6 -22 Gross domestic income 1,005 930 919 951 986 1,062 1,276 Domestic savings (TT adjusted) 173 177 131 132 150 212 342 - 29 - Technical Annex p. 3 of 13
Table 1: Latvia - National Accounts (continued) Part C: Value Added by Sector (sectoral shares in percent) Base Case Projection Actual Estimated 1991 1992 1993 Agriculture 21.9 17.2 14.9 Industry, of which 45.2 35.3 31.6 Mining 0.2 0.2 0.1 Manufacturing 35.7 28.2 21.9 Services 32.9 47.5 53.5 Total 100 100 100 Part D: Long-Term Growth Rates (Average annual growvthrates are calculated from constant price data.)
Actual Estimated Projected 1991 1992 1993 1994 1995 1996 1998 2002 Gross domestic product at market pric -8.3 -33.8 -10.0 0.0 4.0 4.0 5.0 5.0 Agriculture -2 -29 Industry of which -8.3 49.3 Manufacturing Mining Services -11.8 -15.1 ImportsofGNFS 43.9 8 -11.9 20.7 11.1 7.5 4.7 4.2 Exports of GNFS -32.2 14.9 -7.6 8.3 8.5 8.5 8.8 5.9 Total expenditures -17.8 -31.0 Total consumption -23 -34.9 -9.6 4.7 3.9 2.1 -0.7 2.5 Government -15.1 -0.6 2.2 4.3 5.2 0.1 Private -8.1 6.0 4.3 1.6 -2.1 3.1 Gross domestic investment -9.7 -25.7 -26.4 28.1 16.4 9.6 9.9 6.0 Government -49.5 165.0 57.5 4.7 7.6 6.2 Private -24.7 20.9 11.7 10.4 10.3 6.0 Memorandum items: Capacity to import -3.9 6.4 7.6 8.0 7.6 6.1 Gross domestic income -7.5 -1. 1 3.4 3.7 4.0 5.2 Gross national income -6.5 -3.3 3.5 3.6 3.6 5.1 Gross national product -9.0 -2.3 4.1 3.8 4.6 4.9 Gross domestic savings 15.1 -32.6 2.5 -25.9 0.2 13.9 28.3 13.4 Gross national savings -11.5 -38.7 0.6 12.6 26.7 13.4 Population -0.4 -1.9 0.2 0.2 0.2 0.2 0.2 0.2 Labor force -1.0 .. 0.9 1.2 1.4 1.4 1.5 1.7 Gross domestic product per capita -10.2 -0.2 3.8 3.8 4.8 4.8 - 30 - Technical Annex p. 4 of 13
Table 1: Latvia - National Accounts (continued) Part E: Annual Growth Rate (Annual growth rates are calculated from constant price data.) Base Case Projecton Actual Estimated Projected 1991 1992 1993 1994 1995 1996 1998 2002 Gross domestic product at market pric -8.3 -33.8 -10.0 0.0 4,0 4.0 5.0 5.0 Agriculture -2 -29 Industry -8.3 49.3 Services -11.8 -15.1 Gross domestic income -7.5 -1.1 3.4 3.7 4.0 5.2 Consumption -23 -34.9 -9.6 4.7 3.9 2.1 -0.7 2.5 Investment -9.7 -25.7 -26.4 28.1 16.4 9.6 9.9 6.0 Population 0.2 0.2 0.2 0.2 0.2 0.2 Per capita: Gross domestic product at market prices -10.2 -0.2 3.8 3.8 4.8 4.8 Total consumption -9.7 4.5 3.7 1.9 -0.9 2.3 Private consumption -8.3 5.8 4.1 1.4 -2.2 2.9 Part F: Price Indices (national accounts deflators: 1992=100) Actual Estimated Projected 1991 1992 1993 1994 1995 1996 1998 2002 GDP Deflator 100 174 217 231 246 279 359 Import (GNFS) 100 126 122 129 135 149 170 Export (GNFS) 100 131 125 130 137 148 166 Total Expenditures Consumption . 100.0 171.2 209.9 222.8 238.8 281.7 383.8 Investment 100.0 169.0 197.9 208.1 219.1 243.1 299.3
Source: Latvian authorities and Bank staff estimates. - 31 - Technical Annex p. 5 of 13
Table 2: Latvia - External Trade A: Volume, Value, and Prices Base Case Projection Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002 VolumeIndices 1992 = I 00 Total merchandiseexports (FOB) 100.0 85.5 94.8 105.3 116.6 141.8 182.5 Value Current Prices (US$ rmillions)
Merchandise exports: Total merchandiseexports (FOB) 697 1,000 1,190 1,377 1,588 2,067 2,958
Volume Indices 1992 = 100
Total merchandiseimports cif 100.0 88.2 106.8 118.5 127.4 142.2 169.0 Value-CurrentPrices (US$ millions) Merchandiseimports: Total merchandiseimports cif 883 1,134 1,496 1,757 1,988 2,444 3,309 US$ Price Indices 1992=100 Terms of trade: Merchandiseexport prices 100.0 167.9 180.1 187.6 195.4 209.1 232.6 Merchandiseimport prices 100.0 145.5 158.6 167.8 176.7 194.7 221.8 Merchandiseterms of trade 100.0 115.4 113.5 111.8 110.6 107.4 104.9 B: Trends in NonFactorServices
Base Case Projection
Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002
Volume Indices 1992=100: Exports of nonfactorservices 100.0 118.0 119.2 120.4 121.6 126.5 142.3 Imports of nonfactorservices 100.0 85.0 96.1 109.5 120.4 136.6 162.9
USS Price Indices 1992= 100: ExporTsof nonfactorservices 100.0 99.4 99.4 101.4 103.9 109.4 121.3 Imports of nonfactorservices 100.0 99.4 99.4 101.4 103.9 109.4 121.3 Source: Latvian authoritiesand Bank staff estimates. - 32 - Technical Annex p. 6 of 13
3: Latvia - Balance of Payments
Case Projection Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002
Exports of GNFS: 885 1,221 1,413 1,606 1,826 2.327 3,282 1. Merchandise (FOB) 697 1,000 1,190 1,377 1,588 2,067 2,958 2. Nonfactor services 188 221 223 229 238 260 325
Imports of GNFS: 925 1,169 1,536 1,803 2,040 2,507 3,392 1. Merchandise (FOB) 883 1,134 1,496 1,757 1,988 2,444 3,309 2. Nonfactor services 42 35 40 47 53 63 83
Resource Balance -40 51 -123 -197 -214 -180 -109
Net factor income 17 56 1 3 -3 -39 -116 1. Factor receipts 21 70 52 67 68 74 91 2. Factor payments - 4 13 51 63 70 113 207 a. Total interest paid (DRS) 0 4 36 41 39 63 113 b. Interest arrears c. Other factor payments 4 9 15 23 31 50 94
Net current transfers: I. Current receipts 74 41 0 0 0 0 0 a. Workers' remittances b Other current payments 2. Current payments 0 0 0 0 0 0 0
Current account balance: I Before official capital grants 51 149 -122 -194 -217 -219 -225 2 Official capital grants 0 0 0 0 0 0 0 3 After official capital grants 51 149 -122 -194 -217 -219 -225
Long-term capital inflow n.e.i.: I Direct investment 43 50 60 75 83 101 110 Net long-term (LT) borrowing (DRS)- a. Disbursements 22 172 76 126 188 257 377 b. Repayments 0 0 0 0 0 42 193 Other LT inflows (Net) 0 0 0 0 0 0 0
Total other items (net): I Net Short-term (ST) 0 0 0 0 0 0 0 a. Interest arrears b. Other net ST capital - Capital flowsn.e.i -80 0 0 0 0 0 0 Errors and omissions -20 0 0 0 0 0 0
*hangein net reserves: -16 -371 -14 -8 -54 -98 -70 ojidcates increase) Net credit form IMF 36 81 58 -3 -24 -37 -11 Reserve changes n.e.i -52 -452 -72 -5 -30 -61 -59 Escrow account - 33 - Technical Annex p. 7 of 13
Table 3: Latvia- Balanceof Payments(continued)
Base Case Projection Actual Estimated Projected 1992 1993 1994 1995 1996 1998 20
J. As shares of GDP (current US$): 1. Resource balance -3.1 2.2 -3.8 -5.4 -5.4 -3.6 -1 2. Interestpayment(LT+IMF+ST) 0.0 0.2 1.1 1.1 1.0 1.3 1 3. Current account balance (See F.l.) 3.9 6.4 -3.7 -5.3 -5.4 -4.4 -2 4. LT capital inflow (See F.2. + G.) 5.0 9.5 4.2 5.6 6.8 6.4 3 5. Net credit from the IMF 2.8 3.5 1.8 -0.1 -0.6 -0.7 -U
K. Foreign exchange reserves: 1. Net reserves (excluding gold) 108 479 493 498 528 655 9 2. Gold (end-year London Price) 3. Gross reserves (including gold) 156 608 680 685 715 842 10' 4. Gross reserves (in months of imports) 1.4 4.9 3.7 3.2 3.0 3.0 3
L. Exchange rates: 1. In nominal terms - (LCU/US$) a. Primary (official) rate - Annual average 0.769 0.674 0.600 0.600 0.600 0.600 0.6t End-of-year b. GNP conversion 0.769 0.674 0.600 0.600 0.600 0.600 0.6X 2. In real terms - (base 1992 = 10() a MUV (PAC estimates) 100.0 99.4 99.4 101.4 103.9 109.4 121 b. Index real exchange rate (US$/LCU) 100.0 200.1 279.6 291.9 303.3 326.8 379
M. Memorandum item: GDP (current US$M) . 1,306 2,337 3.266 3,618 4,007 4,963 7,7( Source: Latvian authorities and bank staff estimates. - 34 - Technical Annex p. 8 of 13 Table 4: Latvia - ExternalCapital and Debt (USS millions at current prices)
Base Case Projection Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002
A. Disbursements Public and publicly guaranteed 22 172 76 126 188 257 377 1. Official creditors: 22 170 14 59 88 91 111 a. Multilateral - 0 45 14 19 47 68 86 Concessional ...... of which IDA ...... Nonconcessional 0 0 0 11 30 30 30 of which IBRD 0 45 14 8 17 38 56 b. Bilateral - 22 125 0 40 41 23 25 Concessional Nonconcessional 22 125 0 40 41 23 25 2. Private creditors: 0 2 61 67 100 167 266 a. Bonds b. Commercialbanks c. Other private Private nonguaranteed ...... Total from long-term loans 22 172 76 126 188 257 377 IMF purchases 36 81 58 0 0 0 0 Net short-term capital 0 0 0 0 0 0 0 Total disbursements(LT+IMF+ST) 58 253 134 126 188 257 377
B. Repayments Public and publicly guaranteed 0 0 0 0 0 42 193 1. Official creditors: 0 0 0 0 0 16 49 a. Multilateral- 0 0 0 0 0 4 28 Concessional ...... of which IDA ...... Nonconcessional 0 0 0 0 0 0 9 of which IBRD 0 0 0 0 0 4 19 b. Bilateral - 0 0 0 0 0 12 21 Concessional Nonconcessional 0 0 0 0 0 12 21 2. Private creditors: 0 0 0 0 0 26 144 a. Bonds b. Commercial banks c. Other pnvate Private nonguaranteed ...... Total from long-term loans 0 0 0 0 0 42 193 IMF repurchases 0 0 0 3 24 37 11 Total repayments 0 0 0 3 24 79 204 - 35 - Technical Annex p. 9 of 13 Table 4: Latvia - External Capital and Debt (USS millions at current prices)
Base Case Projection Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002
C. Net disbursements Public and publicly guaranteed 22 172 76 126 188 215 185 1. Official creditors: 22 170 14 59 88 75 62 a. Multilateral - 0 45 14 19 47 64 58 Concessional ...... of which IDA ...... Nonconcessional 0 45 14 19 47 64 58 of which IBRD 0 45 14 8 17 34 37 b. Bilateral - 22 125 0 40 41 11 4 Concessional ...... Nonconcessional 22 125 0 40 41 11 4 2. Private creditors: 0 2 61 67 100 141 123 a. Bonds b. Commercial banks c. Other private Private nonguaranteed 0 0 0 0 0 0 0 Total from long-term loans 22 172 76 126 188 215 185 IMF net 36 81 58 -3 -24 -37 -11
D. Interest Public and publicly guaranteed 0 2 27 28 27 56 111 1. Official creditors: 0 2 27 24 19 30 50 a. Multilateral - 0 0 3 4 6 13 31 Concessional ...... of which IDA ...... Nonconcessional 0 0 3 4 6 13 31 of which IBRD 0 0 3 4 5 8 19 b. Bilateral - 0 2 24 20 13 17 20 Concessional ...... Nonconcessional 0 2 24 20 13 17 20 2. Private creditors: 0 0 0 4 8 26 61 a. Bonds b Commercial banks c. Other private Private nonguaranteed ...... Total from long-term loans 0 2 27 28 27 56 111 IMF charges 0 3 8 13 12 8 2 Net short-term capital 0 0 0 0 0 0 0 Total interest (LT+IMF+ST) 0 4 36 41 39 63 113 - 36 - Technical Annex p. 10 of 13
Table 4: Latvia- External Capitaland Debt (USS millions at current prices)
Base Case Projecion Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002
E. External debt (DOD) Public and publicly guaranteed 22 194 270 396 584 1,057 1,912 1. Official creditors: 22 192 206 265 353 504 787 a. Multilateral - 0 0 0 11 41 101 198 Concessional ...... of which IDA ...... Nonconrcssional 0 0 0 11 41 101 198 of which IBRD 0 45 59 67 84 144 300 b. Bilateral - 22 147 147 187 228 259 289 Concessional .. Nonconcessional 22 147 147 187 228 259 289 2. Private creditors: 0 2 63 131 231 553 1,125 a. Bonds b. Commercial banks c. Other private Private nonguaranteed 0 0 0 0 0 0 0 Total from long-term loans 22 194 270 396 584 1,057 1,912 IMF 36 117 175 172 148 69 16 Net short-term capital 0 0 0 0 0 0 0 Total DOD (LT+IMF+ST) 58 311 445 568 732 1,127 1,928
F. As share of total DOD (LT+IMF+ST, in %) Public and publicly guaranteed 38 62 61 70 80 94 99 1. Official creditors: 38 62 46 47 48 45 41 a. Multilateral- 0 0 0 2 6 9 10 Concessional of which IDA Nonconcessional 0 0 0 2 6 9 10 of which IBRD 0 14 13 12 11 13 16 b. Bilateral - 38 47 33 33 31 23 15 Concessional Nonconcessional 38 47 33 33 31 23 15 2. Private creditors: . 0 1 14 23 32 49 58 a. Bonds b. Commnercialbanks c. Other private Private nonguaranteed Total from long-term loans 38 62 61 70 80 94 99 IMF 62 38 39 30 20 6 1 Net short-term capital 0 0 0 0 0 0 0 Total DOD (LT+IMF+ST) 100 100 100 100 100 100 100 0 0 0 0 0 0 0 G. Percent of total long-term DOD on concessional terms with variable interest rates - 37 - Technical Annex p. 11 of 13 Table 4: Latvia - External Capital and Debt (US$ millions at current pnces)
Base Case Projection Actual Estimated Projected 1992 1993 1994 1995 1996 1998 2002
H. [BRD and related ratios IEBRDDS/exports 0.0 0.0 0.2 0.3 0.3 0.5 1.1 IBRD DS/public DS 0.0 0.0 9.1 9.9 7.6 8.2 11.9 Pref creditor DS/public DS 0.0 62.7 32.7 45.2 65.9 43.0 22.7 Share of IBRD portfolio 0.0 17.8 10.7 6.0 9.0 14.7 14.8
1. Debt-to-exports ratios Long-term debt/exports 2.4 15.0 18.4 23.7 30.8 44.0 56.7 IMF credit/exports 4.0 9.1 11.9 10.3 7.8 2.9 0.5 Short-term debt/exports 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total DOD/exports 6.4 24.1 30.4 34.0 38.7 46.9 57.2
J. Debt-to-GDP ratios Long-term debt/GDP 1.7 8.3 8.3 10.9 14.6 21.3 24.6 IMF creditlGDP 2.8 5.0 5.4 4.8 3.7 1.4 0.2 Short-term debt/GDP 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total DOD/GDP 4.4 13.3 13.6 15.7 18.3 22.7 24.8
K. Debt-service-to-exports ratios Public and publicly guaranteed 0.0 0.1 1.9 1.7 1.4 4.1 9.0 Private nonguaranteed 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total long-term 0.0 0.1 1.9 1.7 1.4 4.1 9.0 IMF 0.0 0.2 0.6 0.9 1.9 1.9 0.4 Short term (interest only) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Total debt service 0.0 0.3 2.4 2.6 3.4 5.9 9.4
L. Interest burden ranos LT+IMF+ST interest/GDP 0.0 0.2 1.1 1.1 1.0 1.3 1.5 LT+IMF+ST interestVexports 0.0 0.3 2.4 2.4 2.1 2.6 3.4 Source: Latvian authorities and Bank staff estimates. - 38 - Technical Annex p. 12 of 13
Table 5: Latvia - Government Budget (millions of Lats at current prices)
Base Case Projection Acntal Estimated Projected 1992 1993 1994 1995 1996 1998 2002
Direct taxes 179 352 329 349 388 482 754 Indirect taxes 65 169 229 274 307 378 591 Nontax receipts 38 6 61 67 75 92 144 Total current revenues 282 527 619 690 771 953 1,490
Interest on external debt 0 0 0 5 8 17 37 Interest on domesuc debt 0 11 5 8 11 17 27 Other current transfers 157 299 385 440 494 600 824 Subsidies 0 0 0 0 0 0 0 Consumption 110 188 227 250 276 337 575 Total current expenditures 268 499 617 702 789 971 1,464
Budgetary savings 14 28 3 -12 -18 -18 26
Capital revenues 0 0 0 0 0 0 0
Capital transfers 0 0 0 0 0 0 0 Budgetary investment 15 13 39 65 71 89 140 Total capital expenditures 15 13 39 65 71 89 140
Total deficit financing incl net lending 8 -9 87 74 87 107 113 External capital grants 0 0 0 0 0 0 0 External borrowing net 0 12 67 55 65 78 67 Monetarv system credit (net) 3 0 2 0 0 0 0 Other domestic borrowing (net) 5 -21 18 20 22 30 47
Memorandum item: Primary deficit incl net lending 8 -21 82 62 67 74 49 Source: Latvian authorities and Bank staff estimates. - 39 - Technical Annex p. 13 of 13
Table 6: Latvia - Money and Credit (millionsof Lats at current prices)
Base Case Projection Actual Estimated 1991 1992 1993
A. Annual flows Net international reserves 107.0 126.6 Net domestic credit 82.4 158.8 To government budget 6.5 5.0 To other official entities To private sector 75.9 153.8 Total assets and liabilities Money and quasimoney 152.9 215.3 Net other liabilities
B. End-of-year Stocks Net international reserves 0.0 107.0 233.6 Net domestic credit 27.0 109.4 268.2 To government budget -12.4 -5.9 -0.9 To other official entities To private sector 39.4 115.3 269.1 Total assets and liabilities Money and quasimoney 94.2 247.1 462.4
Source: Latvian authorities and Bank staff estimates.