Latvia, a small economy (2.7 million people) about the size of Ireland, has a centuries-old tradition in trade as a gateway between East and West. Since Latvia regained its independence it has fastly re-established its role in the transit of goods, benefitting from ice-free ports, a strong transport and communication infrastructure and the 19th largest fleet in the world.

In 1991, a comprehensive programme of transformation, from a centrally planned to a market-based economy was started. The first phase of the transformation is now largely complete - market forces determine prices and external trade, and a relatively stable macroeconomic environment has been achieved.

First priority in economic policy: stability

Inflation has been substantially reduced in Latvia and comes close to single-digit levels. In 1996 inflation rate was 13.1 per cent (12-month index), which is low by transitional economy standards.

Latvia's success in the field of stabilisation has been internationally recognised. In 1996 Standard and Poors assigned a 'BBB' long-term foreign currency debt rating to Latvia, one of the highest among the countries in transition. Together with an 'A' rating for long-term local currency debt, these reflect Latvia's success in establishing market-based reforms.

Economic growth and privatisation

Accession to WTO is expected to improve terms of trade and create a more favourable basis for investment.

Great attention is also being paid to the free Baltic market, the creation of which was completed at the beginning of 1997. The three Baltic states recognised the necessity of closer co-operation long ago as local markets are too narrow for successive development of companies. A free trade agreement on trade in industrial goods has been in effect since April 1994. The liberalisation of the market for agricultural goods took more time due to differences in agricultural policies applied by the Baltic states.

Full economic transformation is directly linked to European integration. The Baltic integration with Europe has gradually deepened and the Baltics applied for EU membership in 1995. The large and high-income territory of Europe was an attractive market for the Baltics, and being part of Europe was an important political goal after years under Soviet rule.

Privatisation

Tax system

Latvian tax legislation provides for flat and unified tax rates thus balancing interests of the business sector and the state, eg, the law on VAT, stipulates standard VAT rate being 18 per cent of taxable value of supplies of goods and services. No tax applies to exports, international transportation, banking, financial or insurance services. Also corporate and personal income taxes are fixed at a relatively low level of 25 per cent that does not hinder private initiative.

Tax legislation in Latvia does not anticipate a higher level of taxation on imported products than that imposed on similar domestic products, which demonstrates the neutrality of the tax system.

The government pays particular attention to the harmonisation of indirect tax legislation with that of the EU as this has the largest impact on the balanced development of trade relations. Though the present tax system basically complies with respective EU Directives (eg, Sixth VAT Directive), further work is being done within the framework of the PHARE programme to ensure the full compliance with EU regulations.

A new customs law to come into force in July of 1997 complies with the requirements of the EU Customs Code. An improvement in customs procedures in the Baltics within the framework of the PHARE programme will make the business environment in the region more favourable.

Banking

One very important factor ensuring stability of the system and predictability of the policy is the independence of the Bank of Latvia, which is safeguarded by law.

The years 1995/1996 were years of consolidation of the banking sector and now this is represented by 34 banks. Increased profitability of banks, strengthened capital base and a better quality of banks assets testify to the stabilisation of the Latvian banking sector. In 1996 the number of banks that were allowed to take private persons' deposits - core banks - increased from 13 to 15. Supervision of these banks is especially thorough and, besides the examinations carried by the Bank of Latvia's examiners, special targeted examinations are carried out for the Bank of Latvia by international accounting firms present in Latvia: Arthur Andersen, Coopers and Lybrand, Deloitte and Touche, Price and Waterhouse and KPMG Latvia in order to obtain a second opinion on potential problem areas.

Banking sector legislation has been considerably strengthened, according to EU directives and now some prudential requirements applicable to the banking sector are even stricter than required by respective directives (eg, this is true for the capital adequacy ratio). It is very important to note that prudential rules are rigorously enforced by the Bank of Latvia, which excludes the possibility of volatility in the banking sector.

Following a dramatic reduction in the level of inflation and the Bank of Latvia's refinancing rate, lending interest rates continue to fall, now being at the 15 to 20 per cent level. The downward trend in interest rates is also influenced by the increasing presence of foreign banks, strengthening competition in the sector. Foreign banks are enjoying domestic treatment.

The stability of the financial system is guaranteed by the strict monetary policy applied by the Bank of Latvia, strict supervision of the banking sector, the government's commitment to fiscal deficit (for the year 1997 a zero financial deficit for Central Government was approved).

Developing securities market

In year 1995 the law 'On Securities' was adopted which was recognised by the World Bank as one of the best Securities Laws in Central and Eastern Europe. The same year Parliament accepted the law 'On Securities Market Commission', thus establishing an independent Securities Market Commission.

It is now two years since the Latvian Central depository and the Riga Stock Exchange were included in the Latvian securities market structures.

In order to establish a common Baltic securities market a co-operation agreement was signed between the Latvian and Estonian Central Depositories at the beginning of 1997. The same agreement will be signed with Lithuanian Central Depository later this year.

Latvian securities market legislation provides for strict investor protection principles which are rigorously enforced both by Riga Stock Exchange and the securities market commission. Investor interests are protected through strict information requirements imposed on capital market operators (companies issuing securities and mediators), other prudential requirements to be observed by market participants, as well as strict supervision of the financial situation of companies, the shares of which are publicly traded.

Transparancy of market operations is ensured through daily issues of Stock Exchange Bulletins.

Information related to capital market is also published in business newspapers. All the updated information on issues of securities, quotations of the securities on RSE, information on company balance sheets, whose shares are in public circulation and other important information, can also be obtained through the Internet, which is vital for decision making.

A well established securities market structure as well as progress in the privatisation process has boosted development of the equity market.

The capitalisation of the stock exchange market increased from US$30 million at the end of 1995 to $150 million at the end of 1996, now (end of March) being $335 million (seven per cent of GDP). The total value of the market (shares and government bonds) is 11 to 12 per cent of GDP.

The highest daily turnover at the Riga Stock Exchange registered so far was $1 million.

Though the securities market in Latvia does not have any official stock price index, the increase in share prices is obvious: for many companies it was five to 12 times higher.

Taking into account the scheduled privatisation of strategic companies (gas, oil, shipping, electricity company), capitalisation of the RSE will increase at least to $900 million by the end of 1997.

Roberts Zile started his career at Latvia's Agriculture Economics Institute where he undertook scientific research work as a postgraduate using a correspondence course. He has been an editor at Avots publishing company. He then had the post of the division chief at Latvia's Institute for Agrarian Economics. He still works at the State Parliament where he is Head of the Budget and Finance (Taxation) Committee and supervised the development of the state budget without a deficit for 1997. In 1997 Roberts Zile was promoted to the position of Minister of Finance in the Latvian Government. He has been a participant of many international conferences and seminars. He is the author of many publications on the issues of property rights and agrarian policy in the USA, Australia, Norway, Finland, Austria, Hungary, Slovak, Germany. He is a representative of Latvia in the research projects of some international organisations (FAB, OECD, the European Commission ACE programme)