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Standard & Poor’s Ratings Services has raised its long-term foreign currency sovereign credit rating on the Republic of Latvia to ‘A-‘ from ‘BBB+’. At the same time, the ‘A-‘ long-term local currency and ‘A-2′ short-term foreign and local currency sovereign credit ratings on Latvia were affirmed. The outlook is stable.
“The upgrade reflects sustained improvements to Latvia’s economic structure in the context of EU accession, as well as solid medium-term growth prospects,” says Standard & Poor’s credit analyst Remy Salters. “The equalisation of the foreign and local currency ratings also reflects our belief that Latvia is firmly on track for EMU membership.”
The country is expected to join the Eurozone by 2008 at the latest, which will minimize the potential negative impact of balance-of-payments pressures and the country’s external debt position. Until that time, weak external liquidity and relatively low wealth will remain key constraining factors for the rating.
The ratings on the republic are supported by a track record of sound macroeconomic management and favourable fiscal indicators, and the authorities’ firm commitment to deepening market-based reforms. This consistent macroeconomic policy mix safeguards the sustainability of the fixed exchange rate regime and promotes robust output growth. Recent rapid credit growth, however, warrants close monitoring of developments in the banking sector, which is heavily dependent on non-resident deposits.
Latvia’s fiscal flexibility is significant, with general government debt estimated at 16% of GDP in 2004 and the public sector in a net external creditor position. Moderate general government deficits of about 2% of GDP will keep the debt ratio at less than 18% in the medium term.
The ratings on Latvia remain constrained by weak external financial liquidity, low levels of economic development, and lingering governance problems. The current account deficit in 2003 represented 9.2% of GDP, with less than one-half financed by net foreign direct investment. In addition, the gross external financing gap is still very high, at about 420% of official foreign exchange reserves in 2003.
“In the medium term, a continuation of the economic restructuring process, together with the maintenance of a prudent fiscal stance and sustained real economic convergence with more highly rated sovereigns, will be key to rating improvements,” says Salters. “Conversely, policy slippage jeopardizing eligibility for Eurozone membership by 2008 could lead to downward pressure on the foreign currency ratings.”