Latvia—Finely Balanced for Growth

This chapter chronicles Latvia's financial experience in the wake of its severe banking crisis of 1995. Key financing issues that are likely to be faced by the Latvian authorities if the economy is to secure the rapid, investment-led growth envisaged for the run-up to EU accession are identified. The chapter concludes that investment-led real growth of 5–6 percent annually can be financed by a combination of strong foreign capital inflows and rapid, but not unsustainable, growth in bank lending, provided private sector saving rates also rise. Such a configuration, however, represents a fine balance. The Latvian economy and banking system are very internationalized and could suffer significantly in the wake of the 1998 Russian crisis. If this were to result in the movement of the government sector back into deficit, stagnation of private savings, and the tailing-off of inward foreign direct investment, then the banking sector is unlikely to be able to close the financing gap, and private investment will be curtailed. Nevertheless, the scenario discussed at the end of this chapter suggests that the economy can withstand even a relatively prolonged (2–3 year) slowdown in inward foreign direct investment without any material lowering of growth or investment. In this respect, Latvia can be described as a country with no acute external financing constraint, and any slowdown in growth is likely to come from the direct impact of the Russian crisis on the traded sectors of the economy, particularly its internationalized banking system.