Investment climate in Latvia

Dr Roberts Zile
Minister of Finance

Latvia has achieved significant political and economic stability, the importance of which cannot be over-emphasised as a factor influencing investment location. With the restoration of independence in 1991, we declared our orientation towards the western democracies, and in 1995, submitted an application for membership to the European Union (EU). Irrespective of the wide political spectrum, there is, in principle, agreement on this issue between parties represented in the Latvian Parliament.

The Government recognises that foreign investment is essential and that it can act as a catalyst for the development of the national economy. Therefore, Latvia will make every effort to satisfy the needs of foreign investors. We can offer foreign businesses a stable macroeconomic framework, a stable and convertible currency pegged to the SDR, and a liberal foreign exchange regime. To secure the stability of economic development, the Government has accepted a non-deficit budget for the coming years.

Latvia's attraction as a destination for foreign direct investment (FDI) was reinforced by the fact that Standard and Poor's granted it an A-rating for long-term debt in its national currency, and a triple B rating for long-term debt in foreign currencies. It was thus placed ahead of Greece, Poland and Hungary as an investment location. Also, the Moody's credit agency was issued the country long-term credit rating of Baa2, which means that Latvia is among those countries in which investments can be safely made.

Not only is our Government determined to improve the business climate for investors, but also, the legislature is supportive of business and investment. The implementation of reform measures has been successfully intensified in the current legislative period. The most notable improvements concerning foreign investors include a move towards a free land market, the capitalisation of debts of form state enterprises under privatisation, the introduction of laws on free ports and free economic zones (FEZs), as well as the relaxation of visa regulations for long-term residents. The basic legal principles governing foreign investment in Latvia are in the l99l 'Law on Foreign Investment', and in subsequent amendments to this law. This Law defines the basis for the promotion, protection and guarantee FDI in Latvia. The Law grants the foreign investor the right to establish company, to terminate his investment, to receive national treatment, to free repatriate profits after the payment of due taxes and other charges, and protects the foreign investor from future legislative changes. In addition, it affords the investor a certain degree of protection against nationalisation and other measures which may adversely affect his property rights.

1997 was a successful year in the Latvian economy. Fiscal discipline observed, and the Bank of Latvia continued to implement strict monetary policy. This allowed Latvia to reduce inflation to a one digit level. This year Latvia has lower inflation than the other two Baltic States, Poland and Hungary.

Gross Domestic Product (GDP) growth rates in the first three-quarters of 1997 suggested that overall GDP growth in 1997 would turn out to be at approximately six per cent.

As a result of more rapid privatisation, the proportion of the private sector in the economy has continued to grow. In 1997 the private sector represented approximately 62 per cent of GDP, and when the privatisation process is completed, the private sector will dominate the overall added value structure of the country.

Medium-term forecasts state that GDP growth over the next several years will average five to six per cent per year. The inflation rate will continue to decline gradually. It is expected that investment growth rates will exceed GDP growth rates over the next few years, which means that investment, as a share of GDP, will grow.

After relatively limited flows of FDI to Latvia immediately after the beginning of transition, it did improve in 1994, when net inflows were equal to 4,2 per cent of the GDP - the second highest ratio of all Central and Eastern European transition economies. By the year 1997, the cumulative volume of FDI reached around 520 million lats.

In the last six years the Baltic States have shown an improvement in attractiveness in terms of the increase in cumulative FDI per capita between 1992 and 1996 - FDI per capita in Estonia increased by 13 times, while in Latvia it rose by more than 19 times. Thus Latvia started to attract FDI relatively later than the other European countries in transition (CEECs), but at higher rate per capita - in fact in 1996 Latvia was ranked fourth in attracting cumulative FDI per capita ($310), while accounting for the second highest rate of net FDI inflow as a share of GDP (4,2 per cent in 1996, down somewhat from 5,5 per cent in 1995). These figures are encouraging for further consolidation of this positive trend, provided that macroeconomic and microeconomic conditions improve attractiveness for FDI.

By February 1997 there were 7123 registered companies in Latvia, with the foreign capital coming from 92 countries. Most of the investments in Latvia are small in value, but there are same large FDIs. This has contributed to a sectoral concentration of investments, since these larger investments are in transport and telecommunications. The biggest investors are Cable and Wireless from Great Britain and Finnish Talcum, which formed consortium Tilts Communications with around 177 million US investments in the sector of communications. The great percentage of investment made by Russia is associated with a share of the Russian Government in the Joint Venture LatRosTrans, which deals with the management of the oil pipeline going through the territory of Latvia. A significant investment has recently been made by companies from Singapore, Chile and Nolay.

Since 1996, the FDl has tended to expand within the sectors of industry and transportation, as well as in the real estate of Latvia. These trends are also expected to continue in 1998. The Latvian Government estimates that the largest amounts of investment will occur during the 1997-98 privatisation. Purchase of 32,5 per cent of the stock company Latvijas Gaze by the German consortium Ruhrgas/Preussen Elektra and Russian enterprise Gazprom should provide an investment of around $55 million. The gradual increase in portfolio investment is expected to continue more rapidly, due to the fast capitalisation of the securities market in Latvia, the good credit rating of the country, and a raising interest of institutional investors into the Latvian market.

There are many positive reasons for investing in Latvia. The country has a favourable location as a 'bridge' to Russia, with easy port access and relatively well-equipped port infrastructure. FEZs have been created in the three main ports. Considering the smallness of the domestic market (there are only 2,6 million inhabitants), Latvia could become a base for exports to the Commonwealth of Independent States (CIS). Its proximity to CIS countries, in particular Russia, provides favourable conditions as a base for exports, with a large consumer market across the border, but without the 'country risks' and 'commercial risks' that an investor might actually experience in Russia.

Latvia is favourably located near the centre of the Baltic Rim. Subsequently, it could also become more active in economic integration with the Nordic countries around the Baltic Sea (CBSS), within the perspective of increasing cross border linkages among the countries of this area.

Another reason for investing in Latvia is low-cost and well-qualified labour forces. In Latvia the average salary, while higher than in Russia, is lower than in the Czech Republic or Hungary. At the same time, the level of skills and education is, on average, good; in other CEECs re-training is required to gain market knowledge and new skill profiles. However, this comparative advantage could gradually be eroded, because of the progress made in the catching up process which could be played out positively over the medium-term. The skill and qualification aspect are also a comparative advantage in relation to order developing countries, which have lower costs but unskilled labour (as in China and India).

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