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Analyst
Guolong Yu
yuguolong@Dagongcredit.com
Local currency/outlook BB/stable
Foreign
currency/outlook BB/stable
Rating time October 2010
Sovereign
Credit Rating
Rationale
Dagong assigns “BB” on both local and foreign currency of Republic of Latvia
in it sovereign credit ratings, which are based on a comprehensive appraisal of
current debt requirements, as well as the factors related to risks of debt.
Affected by the international financial crisis, the declining of government
revenues and additional aid to financial sector increased government
expenditure, and at the meantime caused a dramatic expansion of government
deficit and debt-scale. As of the end of June 2010, the central government debt
of Latvia amounted to 4.748 billion Lats, which is almost 38.91% of GDP. With
the bailout spending on financial sector, the all level governments fiscal
deficit reached 7% in 2009. The government will continue its tight fiscal
policy, under the pressure of the additional conditions of the loan assistance
from European Union and the International Monetary Fund. However, due to
recovery of the domestic economy is still un-robust, fiscal income in the short
term will be difficult to obtain substantial improvement. Meanwhile the
unconstitutional judgment on the reduction of pension expenditures resulted in
the fiscal expenditure increasing. It is expected that the fiscal deficit
will reach 8.6% of GDP in 2010, which will further increase both government
financing requirements and debt burden.
The fundamental solvency of the government has been ensured to some extent by
the aid fund from international organizations. However, as economic growth is
difficult to recover to the pre-crisis levels, and the debt burden is continuing
got deteriorated, the solvency of the government will be subject to certain
constraints in the future, mainly in the following areas:
The convergent economic philosophy of various parties provides a good
political environment for the rapid economic development in Latvia. However, the
radical fiscal tightening policies have led to a rising social pressure. In this
case, the upcoming parliamentary elections will increase the uncertainty of
economic and fiscal policies of the next government;
Declining in labor cost improved the competitiveness of export products in
the international market, and the economic rebound is on the way. However, the
situation of the rapid credit-fueled economic growth will be hardly reproduced.
The current export-led growth model is not solid due to a series of factors,
such as the European sovereign debt crisis. Besides, the domestic
unemployment remains high rates and the future of economic recovery is blur;
Capital adequacy ratio of banking system has been increased significantly
under the government intervention. However, due to the gradual increase of
non-performing loans in private sector, the asset quality of banking system
deteriorated substantially, which may further increase the financing
requirements, and make the size of government debt continuing extended;.
Thanks to the intervention of European Union and the International Monetary
Fund, Latvia maintains its fixed exchange rate system, pressures on currency
depreciation has eased a lot. With the good trend of FDI inflow and the growing
trade account surpluses, international reserves has been steadily recovered and
the pressure on foreign currency debt repayment also got reduce The
international aid funds revived investor’s confidence and reduced the cost of
local currency financing for the government. With the well performed fiscal
austerity, it is expected that the aid funds from EU and the International
Monetary Fund will be allocated as planed shortly, and will help to ensure the
government's foreign currency solvency.
Outlook
It is unlikely for Latvian to recover it economic growth to pre-crisis level.
The previous real estate-driven growth model has been proved unsustainable and
the future economic development depends on the possibility of investment being
attracted into international trade sector to establish a new economic growth
mode. Although the stability of financial sector has been restored, the previous
high ratio of private credit in the economy could result in a continuing
deterioration of asset quality and increase the pressure on the government debt
burden. Given that Latvia government strengthens the implementation of fiscal
austerity, it is likely for Latvia to obtain aids from IMF and EU constantly,
which will be conducive to the restoration of official foreign exchange reserves
and stability of Lats, and then to maintain the short-term government solvency.
Therefore, Dagong keeps a stable outlook for Latvia government’s local and
foreign credit ratings in the next 1-2 years.
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