The banking crisis...
Banka Baltija, Latvia's biggest bank, with over 200,000 private depositors, was declared insolvent and put under Bank of Latvia administration on May 23, 1995. The bank was declared bankrupt on December 12, 1995 after the initial problem was uncovered by Cooper's and Lybrant during audits earlier in the year. Ernst & Young later discovered 200 million lati ($365 million) in losses to be unrecoverable and the bank was soon after declared bankrupt. Although Latvia limited compensation to 500 lati per personal saver, the increased expenditure by the state budget raised the budget deficit from approximately 2% to 4% of GDP. (World Bank, 1995). The bank failure contributed to a weak economy, decreased GDP, decreased industrial production. Latvia responded to the crisis by "withdrawing the right to take deposits from a number of banks, hiring international auditors to conduct regular inspections, requiring that banks' quarterly balance sheets be published in the government newspaper no later than a month after the quarter's close, improving cooperation between the police and the bank, and passing new banking legislation which makes it more difficult for offshore banks to be bank shareholders and sets requirements for minimum equity capital, liquidity, and other banking indicators" (World Bank, 1995).
These developments are a result of a number of deficiencies common to the banking system of transitional economies. "Banks tend to lend extensively to their own shareholders who have no intention of paying them back, lending is extremely concentrated in a specific type of activity ( the financing of import-export transactions and transit transactions), and banks borrow money on exchange rate risk.". (EIU, 1995). Problems also arise due to the deficient legal base and the absence of specific key institutions in the economy. "Absence of a recourse for banks in dealing with enterprises who are not current on their loans forces banks to roll over credits rather than foreclose on the enterprise.".(EIU, 1995). Significant progress has been made in the restructuring and privatizing of former commercial branches of the Bank of Latvia, including the establishment of the Universal Bank of Latvia from a merger of 21 former Bank of Latvia branches. With the assistance of the World Bank, a rehabilitation and privatization program was initiated two years ago for the Universal Bank of Latvia. The government has also rehabilitated the State Savings Bank for privatization. A number of banks are connected to the Society of Worldwide Interbank Telecommunications (SWIFT), an international funds transfer system, and banks are beginning to introduce credit and debit cards and cash-advance services to clients.
Statistics related to structural reform (see tables at end of paper)...
In the 1980's, Latvia's economy grew at a fairly high rate, with the GDP averaging 3.9% a year in 1989. The GDP decline started in 1990 and reached a peak in 1992 of 33.8%, mainly due to Russian energy supply shortages (EIU, 1995). The biggest GDP decline in 1993 was in the construction sector, with output falling 65%, mining followed with a 60% decline, and manufacturing 40%. Services recorded a 7.6% fall. Agriculture and forestry remained fairly stable, fluctuating slightly around 23% in 1992 and 1993. The energy sector shrunk from 6.3% to 2.2% in 1993. The largest sector of the economy is currently the service sector which accounts for 48.6% of the GDP in 1993 (EIU, 1995).
The IMF currently estimates that approximately three-fourths of the population works in the material sector due to the shift from away from industries and into services. Unemployment has risen steadily with the biggest job losses being in the state sector. In April 1994, 6.6% of the workforce was officially registered as jobless, the highest rate in the Baltic region. The employment figure understates the true level of joblessness, as many workers are on unpaid leave, or on short-time work, or are underemployed (EIU, 995).
The government has ended the policy of wage indexation which was in place until the middle of 1992. The government has also introduced a wage tax to penalize enterprises which raised salaries in excess of government guidelines. In 1993 real wages rose by 6.8%, followed by a 32% drop in 1992, with wages in industry up by 8.2% (EIU, 1995).
Inflation accelerated sharply as Latvia gradually liberalized prices and removed subsidies. Annual average inflation went from 124.5% in 1991 to 951.2% in 1992 (EIU, 1995). The rate peaked in November 1992 with an inflation rate of 1,445% (EIU, 1995). One of the countries greatest successes has been bringing inflation under control through tight monetary policy which included high interest rates. By the end of 1993, inflation remained close to 35%. Rising food costs are attributed as the main factor in continued high inflation (EIU, 1995).
Trade and Investment Regulations...
Latvia overhauled the tariff regime in 1992, and created a Tariff Council to monitor processes and establish directives. Import tariffs were applied in 1992, with the overall system favoring domestic industry and agriculture. The rates change regularly depending on policy, however the tariff for imports fluctuates between 15% and 20% depending on country status. Tariffs can be up to 45% on goods that can be produced locally (EIU, 1995). With the Baltic Free Trade Agreement, which came into effect in April 1994, Latvia retained export tariffs on limestone, raw hide, scrap metals, and timber, in a continued effort to stand behind domestic industry.
Foreign investment is regulated by the Foreign investments in Latvia law which came into effect in November 1991. Latvia has focused on a number of areas which need foreign investment. These include wood and timber processing industries, the energy sector, agro-industrial machinery, textile production, and modernization of transport systems. Incentives in the law include a two year holiday from the profit tax for foreign investors with a stake of more than 30%, followed by a 50% reduction in following years (EIU, 1995). In January of 1993 the minimum investment level was set at $50,000. Growth in foreign investment has been dramatic, with over 3, 800 companies from over 80 countries coming to Latvia. In 1993, Latvia attracted approximately 7% of its GDP from direct foreign investment (EIU, 1995).
Privatization of land, housing, and enterprises...
Privatization vouchers are being used in the privatization of land, housing, and medium and large scale enterprises. The distribution of vouchers began in 1993, and is based on the recipients number of years in Latvia and their citizenship status. Restitution of land to its former owners is open to both residents and foreigners. This first phase of voucher distribution has proceeded quickly, with numbers jumping from 4,000 at the end of 1989, to 57,500 at the end of 1993. The second phase, restitution of ownership rights, has proceeded at a much slower pace. The Land Registry became fully operational in 1994, and has spent the past several years dealing with over 300,000 claims (EIU, 1995). The process of land restitution and privatization has proceeded most rapidly in rural areas, which is covered by different laws. The law on urban land reform restored ownership rights to former owners regardless of citizenship. Claims for restoration of land ownership rights were submitted to local governments. Privatization of apartments was accomplished by giving priority to existing tenants and then opening the rest to a public sale. Foreign investors were not allowed to purchase housing.
In 1994 the Parliament created, through the adoption of laws, the Latvian Privatization Agency and the State Property Fund. Both agencies are independent, although they are supervised by the Ministers of Economy and Finance, respectively. The State Property Fund is responsible for all state-owned enterprises. The agency is responsible for the monitoring of enterprise operations using standard commercial criteria. "The State Property Fund oversees the corporatization and restructuring of the enterprises, along with the appointment of their boards.".(IMF, 1995). The agency also is responsible for overseeing the privatization of the Latvian Universal Bank and the State Savings Bank. The agency receives income from enterprises, and uses some of theses funds to reinvest in the structuring of other enterprises. Public utilities have remained state owned, and it is unlikely that they will be privatized. (IMF, 1995).
The Latvian Privatization Agency is a nonprofit state-owned company. "Under privatization laws, the privatization of state enterprises can be initiated by anyone who submits a proposal to this agency.".(IMF, 1995). The Latvian Privatization Agency submits proposals to the Cabinet. After Cabinet approval of the proposal, the State Property Fund transfers the enterprise to the Privatization Agency, who announces the initiative to seek privatization of the enterprise and proposals. The Latvian Privatization Agency uses auctions, corporatization, and liquidation methods for privatization. Revenues from the privatization go to the agency to cover expenditures. The remainder goes to funds within local and state government.
The Latvian Privatization Agency has been criticized by some consultants as being slow-paced and selling companies off too cheaply. Privatization was sped up in 1994 due to goals of the Latvian Privatization Agency, in hopes of privatizing 200 companies a year and 75% of all state enterprises by the end of 1996. In addition to the privatization of land, enterprises, and banks, the government set up a number of institutions to provide support to small businesses. The centers are nonprofit organizations which provide information, counseling, and training for small to medium sized firms.
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