1. MACROECONOMICDEVELOPMENTSREPORTAPRIL2013

2. MACROECONOMIC DEVELOPMENTS REPORTApril 2013, No 14 Latvijas Banka (Bank of Latvia), 2013Latvijas BankaK. Valdemra iela 2A, Riga, LV-1050, LatviaTel.: +371 67022300 Fax: +371 67022420http://www.bank.lvinfo@bank.lvThe source is to be indicated when reproduced.ISSN 1 691 5925MACROECONOMIC DEVELOPMENTS REPORTApril 2013

3. 2MACROECONOMIC DEVELOPMENTS REPORTApril 2013CONTENTSContentsAbbreviations 3Executive Summary 41. External Sector and Exports 61.1 External economic environment 61.2 Latvias competitiveness and commodity export growth 82. Financial Market Developments 102.1 Foreign nancial markets 102.2 The Bank of Latvias operations and credit institution liquidity 132.3 Securities market 152.4 Interest rates 152.5 Money supply 183. Domestic Demand 223.1 Private consumption 223.2 Private investment 243.3 Government expenditure and budget 254. Aggregate Supply 274.1 Industry and construction 274.2 Services 294.3 Labour market 315. Costs and Prices 356. Balance of Payments 387. Conclusions and Forecasts 407.1 Economic developments 407.2 Ination 41Statistics 43Additional Information 95

4. 3MACROECONOMIC DEVELOPMENTS REPORTApril 2013AbbreviationsCIF cost, insurance and freight at the importers borderCIS Commonwealth of Independent StatesCPI Consumer Price IndexCSB Central Statistical Bureau of LatviaEC European CommissionECB European Central BankEMU Economic and Monetary UnionESA 95 European System of Accounts 1995EU European UnionEU15 EU countries before 1 May 2004EU27 current EU countriesEURIBOR Euro Interbank Offered RateFOB free on board at the exporters borderFCMC Financial and Capital Market CommissionFRS Federal Reserve SystemGDP gross domestic productHICP Harmonised Index of Consumer PricesIMF International Monetary FundJSC joint stock companyMFI monetary financial institutionNA no answerNI no informationOECD Organisation for Economic Cooperation and DevelopmentOFI other financial intermediary (other than an insurance corporation or a pension fund)OMXR NASDAQ OMX Riga indexPMI Purchasing Managers IndexPPI Producer Price IndexRIGIBOR Riga Interbank Offered RateRosstat Federal State Statistics Service of the Russian FederationSEA State Employment AgencySJSC state joint stock companyULC unit labour costsULCM unit labour costs in manufacturingABBREVIATIONS

5. 4MACROECONOMIC DEVELOPMENTS REPORTApril 2013Executive SummaryAccording to the latest IMF projections, the global economic growth in 2013 could be fasterthan in 2012, albeit falling somewhat behind the forecast made in October 2012. Likewise,higher growth momentum is also expected in almost all major trade partners of Latvia.Moreover, with the premium on debt securities of euro area peripheral countries declining,external risks have recently been mitigated somewhat. Nonetheless, those related to slower-than-expected growth in the euro area, the political situation in Italy, problems in Cyprus andthe potential impact on the euro area from the lowered UK credit rating still persist.Notwithstanding the unstable global growth and low total external market demand, theactivity of commodity trade intensied in the fourth quarter of 2012, with exports reachingpeaks in October and November of 2012. Latvian producers continued to reafrm theirsustained competitiveness with higher export market shares in total global imports of goods.In the situation of brisker domestic economic activity due to export-generated income, theinvestment activity decreased and caused some moderation in the growth rate of goodsimports in the second half of the year. Persistently low investment activity is likely tohamper the development of production and consolidation of business competitiveness in thelong term. The inow of foreign direct investment in Latvia is continuing, and it is a positivefactor for Latvias competitiveness; at the same time, however, the inow of foreign directinvestment in manufacturing moderated towards the close of 2012.With the excess liquidity persisting, a further decline in the lats money market rateswas observed in Latvia as they approached the euro rates. Nevertheless, in January andFebruary, the movements of the money market indices no longer played a signicant rolein determining the lending and deposit rates. At the same time an improvement in theeconomic situation of exporting sectors resulted in a higher demand for corporate loans, atthe same time encouraging also the credit institutions to step up lending to non-nancialcorporations, and the loan portfolio of this sector remained stable, with the quality of loansalso improving. The annual rate of change for loans granted to non-nancial corporationsis projected to become positive in 2013. The household loan portfolio, however, will stillproceed on a downward trend, with gradual repayments of household loans for housepurchase continuing.The Latvian economy continued to develop buoyantly in 2012, achieving the highest growthrate in the EU. At the beginning of 2013, investment had an important role in supportinggrowth. Further on, private consumption became dominant, whereas in the second half of theyear net exports made a very signicant positive contribution to the GDP growth.The purchasing power of households continued to improve in 2012. This was inter aliareected by the rising spending. However, several opposing factors currently exert theirinuence on consumption. On the one hand, an increasingly larger number of householdsconrm in surveys that their welfare is improving. On the other hand, the averagetemperatures this winter were considerably lower than the ones observed a year ago whichtranslated into higher spending on heating.Investment growth continued to decelerate in 2012. The slowdown in investment growthobserved in the fourth quarter was primarily related to the fading of the resumed tendency toupgrade equipment and vehicle eet, something which had been postponed during the crisis.Manufacturing was a major positive contribution of the supply side to the annual GDPgrowth by sector in 2012, its growth being mainly driven by the expanding external demand.Although the declining output observed in January may be explained by the data volatility inEXECUTIVE SUMMARY

6. 5MACROECONOMIC DEVELOPMENTS REPORTApril 2013some subsectors of manufacturing, objective reasons lead to a conclusion that output in somesubsectors will decline in 2013. Hence the forecasts of the overall manufacturing growth in2013 are more subdued than in previous years.The decline in the unemployment rate is in line with the forecasts. Unemployment isexpected to continue on a gradual downward path in 2013. With the rate of jobseekersapproaching its natural level, the future success in unemployment reduction will depend notonly on the overall growth rate of the national economy but increasingly on the effectivenessof the employment programmes for specic groups of population and regions.Moreover, the data do not conrm the hypothesis that unemployment is declining in Latviaonly on account of individuals leaving the country. Quite on the contrary, the number ofeconomically active population is increasing and the rate of economically active populationto working-age population is expanding.As regards the employment growth in Latvia, it is among the highest in the EU. Allavailable statistical data sources of differing coverage present a similar picture, excludingthe possibility that the labour market is recovering only under the impact of short-term andtemporary factors. The majority of businesses project to increase rather than reduce thenumber of employees in all major sectors of the economy in the coming months.In January and February 2013, the annual ination continued to decelerate, reachingthe lowest level since September 2010. The overall impact of the supply side factors onthe ination dynamics remained favourable, while the contribution of demand was stillmoderate, being reected by negative annual core ination.The ination data for January and February, the currently observed drop in oil prices andthe expected Public Utilities Commissions decisions on the reduction of heating tariffs inRzekne and Riga from May and June 2013 respectively allow for quite signicant (up to1%) reduction of the average annual ination assessment for 2013.At the same time ination in Latvia might rise from the current historical low due to anincrease in electricity prices expected in the second half of the year. The assessment of theimpact of food prices could also change in the middle of the year when the rst estimates ofthe harvest of the new season are made available. On the other hand, the price monitoringcampaign launched in 2013 might act as one of the factors preventing price rises in theremaining months of the year.EXECUTIVE SUMMARY

7. 6MACROECONOMIC DEVELOPMENTS REPORTApril 2013Table 1GDP GROWTH IN LATVIAS MAJOR TRADE PARTNERSIN 2012 AND PROSPECTS FOR 2013(%)2012 2013120132Denmark 0.6 1.2 NISweden 0.8 2.2 NIFinland 0.2 1.3 NIGermany 0.7 0.9 0.6UK 0.3 1.1 1.0Estonia 3.2 3.5 NILithuania 3.6 3.0 NIPoland 2.0 2.1 NIRussia 3.4 3.8 3.7Euro area 0.6 0.2 0.2US 2.2 2.1 2.0Total global economy 3.2 3.6 3.5Sources: Eurostat, Rosstat, October 2012 (1) and January 2013 (2)World Economic Outlook (IMF).1. EXTERNAL SECTOR AND EXPORTS1. External Sector andExports1.1 External economic environmentAccording to the latest IMF projections, the globaleconomic growth in 2013 could be faster than in 2012,albeit falling somewhat behind the forecast made inOctober 2012. Likewise, higher growth momentumis expected in most trade partner countries of Latvia,with relatively stronger performance prospects forLithuania, Estonia and Russia (see Table 1).With the premium on debt securities of euro areaperipheral countries declining, external risks haverecently been mitigated. Nonetheless, those relatedto slower-than-expected growth in the euro area, thepolitical situation in Italy, problems in Cyprus and thepotential impact on the euro area from the loweredUK credit rating still persist.The GDP growth in the euro area was negative in2012, and the largest quarter-on-quarter decelerationin its pace was recorded for the fourth quarter (seeChart 1.1). Except neutral effects of governmentconsumption and net exports, the contribution ofalmost all GDP components to its quarterly growthwas negative. Even though the quarter-on-quartercontraction in Germanys GDP in the fourth quarter of2012 could be assessed as particularly destructive, therecent improved condence indicators suggest that theeconomy in Germany is returning to a more positivegrowth path.The growth in Lithuania, which is Latvias major tradepartner, is still robust, and a 0.7% quarter-on-quarterGDP increase was recorded in the fourth quarter of2012. The Lithuanian economy is positively drivenby foreign trade. Formerly, the positive impact camefrom the rapid expansion of re-exporting, whereaspresently, primarily owing to good harvest, exportsof Lithuanian products are also increasing. Labourmarket situation has also taken a turn for the better. Inthe meantime, investment, which has been halted forquite a time now, gives rise to serious concerns aboutthe further economic growth in Lithuania.In Estonia in the fourth quarter, GDP grew by0.9% quarter-on-quarter. While the increase laggedsomewhat behind the expectations, the weak externaldemand posted most signicant upside risks for thefuture economic growth. At the same time, higherChart 1.1GDP ANNUAL AND QUARTERLY GROWTH RATE IN Q42012 IN LATVIAS TRADE PARTNER COUNTRIES(%)

8. 7MACROECONOMIC DEVELOPMENTS REPORTApril 2013electricity prices may result in a loss of householdspurchasing power and reduce the domestic demandsomewhat.The UK GDP declined by 0.3% in the fourth quarter.In part, this fall was spurred by one-off factors,yet overall, such a development was anticipated,as the recovery of the countrys economy has beenvery fragile throughout 2012. Given the continuingweakness in the UKs recovery and growth outlook,Moodys downgraded the UKs government bondrating to Aa1. This move adversely impacts theeconomic growth expectations of the UK populationand underpins depreciation of the British poundsterling.In Russia, the economy is generally developing asexpected. In early 2013, the growth continued tolose some momentum, which is conrmed by someyear-on-year shrinkage in manufacturing and risingunemployment. With Russias accession to the WTO,some tariffs were lowered or removed completely,which, in the near future, may have an adverse effecton Russias trade balance. Meanwhile in January,the business sentiment indicators in manufacturingimproved, with a likely effect of somewhat bettereconomic outlook for the country.In the fourth quarter of 2012, GDP in Poland pickedup 0.2% quarter-on-quarter. Private consumptionbecame weaker, the shrinkage in investment was notso pronounced, and net exports positively contributedto growth. Despite persistent and generally weakeconomic growth, some positive signs were surfacing.In January, retail trade data were better than expected,manufacturing was recovering, and business andconsumer condence indicators improved. ThePresident of Narodowy Bank Polski has noted that theeconomy has most likely started to revive.In the fourth quarter against the third quarter, thegrowth of Swedish GDP was unchanged, while inthe third quarter an increase was still observed. Itprimarily reected developments in the externalsector. As around 40% of Swedish exports go to theeuro area, the recession in the latter negatively affectsthe situation in Sweden as well. The data for the initialmonths of 2013 also support the assumption that sofar the growth in Sweden has been weak.In Finland, the fourth-quarter GDP contracted by0.5% quarter-on-quarter as was primarily reectedby falling exports, investment and governmentconsumption. The country raised its VAT rate with1. EXTERNAL SECTOR AND EXPORTS

9. 8MACROECONOMIC DEVELOPMENTS REPORTApril 20131 January 2013, thus adversely impacting privateconsumption; it is expected, however, that togetherwith stabilisation in income, Finland will also seeprivate consumption gradually recovering.The quarter-on-quarter GDP reduction in Denmarkwas 0.9% in the fourth quarter. It was underpinnedby contracting private consumption and weakeningexternal sector dynamics. In February 2013, however,the government of Denmark presented a plan torestore competitiveness and boost the economicgrowth, which foresees the opening of 150 000 newjobs by 2020. This could positively affect the overallsentiment in Denmark, yet the outlook for exports isstill weak, since the growth in Denmarks major tradepartners remains slow.1.2 Latvias competitiveness and commodityexport growthNotwithstanding the unstable global growth andlow total external market demand, the activity ofcommodity trade intensied in the fourth quarter of2012. With the export value reaching its peaks inOctober and November of 2012, the nominal valueof exports posted a 21.0% year-on-year increase inthe fourth quarter. The situation did not differ fromthe previous quarter: in the fourth quarter, the growthin commodity exports exceeded that in commodityimports both quarter-on-quarter and year-on-year (seeCharts 1.2 and 1.3).In the fourth quarter, Latvian producers continuedto reafrm their robust competitiveness with higherexport market shares in total global imports ofgoods. Moderation in the economic activity of theEU countries notwithstanding, the trend of exportmarket share growth in overall imports of the EU27countries was preserved; the Baltic countries, whereexport market shares were contracting for the secondconsecutive quarter, and Sweden with its marketshares contracting throughout the year, were the onlyexceptions. Meanwhile, market shares of the rest ofmajor trade partners remained unchanged or continuedto expand (see Chart 1.4).The improvements in exporters competitivenesswere driven by diversication of both output andexport markets as well as higher labour productivityand producers value added. In the fourth quarter,vegetable and food products, machinery andmechanical appliances, electrical equipmentaccounted for the largest annual growth in commodityChart 1.2EXPORTS OF GOODS(year-on-year; %)Chart 1.3IMPORTS OF GOODS(year-on-year; %)1. EXTERNAL SECTOR AND EXPORTS

10. 9MACROECONOMIC DEVELOPMENTS REPORTApril 20131. EXTERNAL SECTOR AND EXPORTSexports. A substantial increase in vegetable productexports was determined by rising grain prices in theglobal market and record-high harvests. However, itwas the real exports that dominated in overall exportgrowth in the reviewed quarter, with the formergrowing by 4.5% quarter-on-quarter and 14.5% year-on-year.In the situation of brisker domestic economic activitydue to export-generated income, the investmentactivity decreased and caused some moderation inthe growth rate of goods imports in the second halfof the year. It may be explained by entrepreneursbeing hesitant regarding external-environment-related decisions. Meanwhile, a weaker importgrowth combined with decelerating investment islikely to hamper the development of production andconsolidation of business competitiveness in thelonger term.Condence indicators released by the EC suggestthat the assessment of export order volume slightlydeteriorated in January; in the rst quarter of2013, however, the respective indicators improvednotably, while the self-assessment of producerscompetitiveness deteriorated both domestically and inand outside the EU, which is indicative of exportersfull awareness of the growing competition.The inow of foreign direct investment in Latviais continuing, and it is a positive factor for Latviascompetitiveness (see also Chapter 6). It should benoted, however, that due to the wait and see businessstances with regard to external developments theinow of foreign direct investment in manufacturingmoderated towards the close of 2012. Consequently,foreign investment was primarily made in servicesproviding branches, which require smaller fundinvestment than manufacturing enterprises. In somecases, the result is a larger number of new jobs, yet ina long-term perspective, it does not boost productionand economic growth.According to the information provided by theInvestment and Development Agency of Latviaon foreign direct investment trends in the future, anumber of positive decisions have been taken oninvestment in metalworking, engineering, electronic,logistic, food and other industries. The implementationof related projects will enhance the potential of theLatvian economy.Chart 1.4LATVIAS EXPORTS AGAINST MAJOR TRADEPARTNERS IMPORTS(moving average; Q1 2010Q4 2012; %)* Estonia and Lithuania right-hand scale.

11. 10MACROECONOMIC DEVELOPMENTS REPORTApril 20132. Financial MarketDevelopments2.1 Foreign nancial marketsIn the period from mid-December 2012 to mid-February 2013, the political and economic conditionsin euro area peripheral countries improved due todetermined implementation of the reform process insome of them and political consent obtained at theinterstate level.The ECB Outright Monetary TransactionsProgramme, announced in August and with itstechnical framework formulated in September2012, has served for the nancial market as securityassurance; even though no bond buying has takenplace under this programme as yet, it has enhancedmarket participants condence that in the event of ashock it would be possible to reduce the borrowingcosts of problem-distressed euro area countries.A preliminary agreement has also been reached onestablishing a single bank supervisory mechanismunder the ECB; a bond (debt) buyback operationhas been successfully conducted in Greece andensured the disbursement of the next tranche ofbailout funding to this country. Market participantscondence in the euro area growth outlook wasfurther strengthened by euro area banks repaying early(ahead of schedule) the ECB loans with 36-monthmaturity.Nonetheless in February 2013, when marketparticipants anxiety concerning the parliamentaryelection results in Italy intensied, the situation in theEuropean nancial markets reversed. The discussionsfocused on Cyprus, its bail-out programme, the sizeof the needed nancial support, and public debtsustainability measures. Following the election ofa new president and the formation of a new cabinetin Cyprus in March, the postponed bail-out issueresurfaced with new force. Even though around17 billion euro, which would be sufcient for bankrecapitalisation in this small economy, in Europeancontext is a relatively small-scale rescue nancing,its full disbursement would jeopardise the publicdebt sustainability. On 16 March 2013, the Cypriotauthorities and international creditors succeeded inreaching a preliminary political agreement, foreseeingan upfront one-off stability levy applicable to alldeposits, both made by residents and non-residents(as is known, citizen and company deposits from2. FINANCIAL MARKET DEVELOPMENTS

12. 11MACROECONOMIC DEVELOPMENTS REPORTApril 2013Russia predominate) at Cyprus credit institutions asa solution to the public debt sustainability problem.This preliminary agreement with international lenders,and the proposed levy on deposits in particular,set off a strong domestic wave of protests andinternational repercussions. Anxiety gripped marketparticipants who thought that other euro area publicdebt distressed economies might follow suit, andtrust in the nancial and deposit insurance systemdeteriorated. Only few days passed, and the Cypriotparliament voted against the proposed terms ofthe European bailout, thus rejecting the agreementand arousing market participants concerns aboutthe countrys potential plunge into bankruptcy. Theimpact of these developments in Cyprus on the globalnancial market was negative and particularly strongfor the euro area market, where peripheral countrybond yields soared, euro depreciated and stock priceindices deteriorated, while the prices of safe assetswent up. The stock prices plummeted in the Russiannancial market as well. Finally on March 25, thePresident of Cyprus and the EU and IMF ofcialsmanaged to reach a new deal on bail-out packageterms for the Cypriot economy, which foresee theimmediate shutting down of the Popular Bank ofCyprus, the second largest bank of Cyprus, while fullycompensating (shifting to another bank) its depositsbelow 100 000 euro; in return, the amount of EU,ECB and IMF bail-out nancing for Cyprus will be upto 10 billion euro. The banks in Cyprus reopened on28 March.Meanwhile, the dynamics in the US nancial marketwas determined by the developments related to theUS federal budget and positive economic performanceconrming a gradual recovery of the housing andlabour markets as well as the entire economy.With market participants more often consideringinvesting in risky assets, stock prices in globalstock markets as well as yields on safer-deemedgovernment securities in government securitiesmarkets tended to move up. Between 15 December2012 and 15 February 2013, Japans stock marketprice index Nikkei 225 went up 29.0%, the respectiveUS S & P 500 index increased by 10.6%, but Europesstock market index DJ EURO STOXX 50 picked up3.6% (see Chart 2.1). The dynamics of yields ongovernment securities differed across the peripheralcountries of the euro area (see Chart 2.2). With thesovereign credit risk diminishing, government securityyields were on a downward trend in Portugal, Irelandand Spain, while in Italy they elevated due to theaugmenting political risk.Chart 2.1MAJOR WORLD STOCK PRICE INDICES AND GERMAN10-YEAR GOVERNMENT BOND YIELDS2. FINANCIAL MARKET DEVELOPMENTS

13. 12MACROECONOMIC DEVELOPMENTS REPORTApril 20132. FINANCIAL MARKET DEVELOPMENTSBetween mid-December 2012 and mid-February2013, the price of Brent crude oil was on an upwardtrend; later, however, it started to decline gradually.In the reference period overall, the price of Brentcrude oil, though uctuating within the range of108 and 120 US dollars per barrel, remained almostunchanged year-on-year (see Chart 2.3). The risein Brent crude oil price from December 2012 toearly February 2013 was primarily on account of oilsupply restrictions arising from geopolitical tensionswhose effects were intensied by market participantsstronger optimism. Whereas the downward trend inthe oil price since mid-February 2013 was determinedby political uncertainty, weak economic performancein the EU peripheral countries, and slower-than-expected economic growth in China. In the mediumterm, market participants anticipate booming oilsupplies from oil producers outside the OECD andconsequential downward dynamics of Brent crude oilprices.The prices of the rest of raw materials and foodproducts were rising in the period between mid-December 2012 and mid-February 2013. Thus, forinstance, with manufacturing of already existingoutput growing and innovative manufacturingexpanding in China, the demand for various metals,including also precious ones, increased. Since mid-February 2013, however, the prices of other rawmaterials and food products, similar to oil prices,have been declining. These oil, raw material andfood product price development trends determineda gradual moderation in inationary pressures in thedeveloped countries.Most market participants had expected the ECB tohold its main renancing rate unchanged at 0.75% inthe reference period (see Chart 2.4), as the euro areaination remained close to the ECB ination targetand provisional economic data suggested that theeconomic growth in the majority of core countrieswas reviving. Regarding the reference period fromDecember 2012 to February 2013, market participantsdid not anticipate, at least as strongly as before, theECB to lower the renancing rate further. Moreover,the euro area credit institutions used the option ofearly repayment of nancing borrowed under ECBDecember 2011 and March 2012 special longer-termrenancing operations with 36-month maturity. ByMarch 2013, the euro area credit institutions are likelyto have repaid the ECB a total of 235.8 billion euro or23.1% of the amount allotted under these operations.Due to the market participants expectations about theChart 2.2YIELD SPREADS BETWEEN 10-YEAR GOVERNMENTBONDS OF EURO AREA PERIPHERAL COUNTRIES ANDGERMANY(percentage points)Chart 2.3BRENT OIL PRICE AND EXCHANGE RATE OF THEEURO AGAINST THE US DOLLARChart 2.4BASE RATES(%)

14. 13MACROECONOMIC DEVELOPMENTS REPORTApril 2013euro interest rate and liquidity shrinking in the market(in connection with early debt repayment to the ECB),EURIBOR started to rise in December 2012. As thesituation in the euro area nancial market turnedout to be worse than expected, market participantsdeemed the lowering of euro renancing rate asrealistic again from the middle of February. As aresult, EURIBOR started to go down once again, withrisk-free market interest rates following suit in thereference period. Consequently, the spread betweenunsecured and risk-free euro money market interestrates remained stable between December 2012 andFebruary 2013 and did not testify to tensions in theeuro area interbank market.Against the US dollar, the euro was appreciatingfrom mid-December 2012 to mid-February 2013,i.e. in the period when market participants optimismabout euro area economic growth prospects andinclination to obtain European assets increased, thusboosting the demand for euro. However, since themiddle of February 2013, the euro has again startedto depreciate, reecting the concerns of marketparticipants about the euro area development trendsas evidenced by contracting European asset ratiosin their asset portfolios. In line with the weakeningdemand for euro-denominated assets, the demandfor the euro fell, while that for the other currenciesstrengthened.2.2 The Bank of Latvias operations andcredit institution liquidityIn December 2012February 2013 market participantssold foreign currency in the amount of 1.9 millionlats (as per transaction date) to the Bank of Latvia.With the lats exchange rate to the euro moving awayfrom the lower limit of the intervention band andapproaching the central parity, foreign currencysale subsided in the next months. Demand for latsmoderated on account of increasingly convincingsigns of the prospective joining of the euro areaand a decrease in currency in circulation followingthe household spending in December. Observationsin other EU countries during the year before theirjoining the euro area suggest that a downward trend incurrency in circulation could be expected in 2013.In the reporting period credit institution liquiditygrew by 58.3 million lats on average as a result ofa decrease in the average government lats depositwith the Bank of Latvia. Deposits of other nancialinstitutions with the Bank of Latvia also contracted.2. FINANCIAL MARKET DEVELOPMENTS

15. 14MACROECONOMIC DEVELOPMENTS REPORTApril 2013Payments to the Deposit Guarantee Fund wereused for repaying its borrowing from the Treasury,thus increasing the government revenue in lats, andwere used for covering the growing governmentexpenditure at the close of the year. At the sametime growth in currency in circulation, minimumreserve requirements for credit institutions andother international institution deposits in lats had adecreasing effect on the credit institution liquidity.The government continued to convert euro into latsin the foreign exchange market; nevertheless it sawhigher expenditure at the end of the year. In Januaryand February the redemption amount of governmentsecurities exceeded 150 million lats. At the sameperiod currency in circulation also saw a morepronounced drop than in previous years, resulting inan increase in credit institution liquidity (see Charts2.5 and 2.6).The Bank of Latvias overnight and 7-day depositfacility expanded by 38.1%, to 448.6 million latson average. The average excess reserves expandedby 32.9% (to 121.1 million lats), but this amountwas mostly concentrated in a small number of creditinstitutions. Credit institutions still had not resumedusing the Bank of Latvias liquidity-providingoperations.In the reporting period the Council of the Bank ofLatvia resolved to leave the interest rates unchanged,recognising them to be appropriate for the nationaleconomy. The latest economic developments andestimates of future developments suggested that themedium-term risks to price stability were containedand ination would remain low.With the excess lats liquidity in the money marketpersisting, the weighted average interest rate oninterbank overnight transactions shrank to 0.09%in DecemberFebruary, down from 0.11% inSeptemberNovember. Consequently, 3-monthRIGIBOR declined from 0.54% to 0.51%, and6-month RIGIBOR moved down from 1.11% to0.86%. Further decline in the lats money market ratesalso resulted from the Bank of Latvias Septemberresolution on reducing the interest rates and Latviascommitment to join the euro area. In the reportingperiod the spread between the 3-month RIGIBOR andEURIBOR was 0.30 percentage points (3 basis pointssmaller than in the previous reporting period; seeChart 2.7) and that of 6-month was 0.51 percentagepoints, recording a decline of 18 basis points.2. FINANCIAL MARKET DEVELOPMENTSChart 2.5AVERAGE BALANCES OF THE BANK OF LATVIASMONETARY OPERATIONS AND GOVERNMENT LATSDEPOSITS(billions of lats)Chart 2.6NET FOREIGN ASSETS, MONETARY BASE AND BANKOF LATVIA DEPOSIT FACILITY(average end-of-day balance; billions of lats)Chart 2.7THE LATS AND EURO MONEY MARKET RATES(%)

16. 15MACROECONOMIC DEVELOPMENTS REPORTApril 20132.3 Securities marketPrimary auctions of 12-month Treasury bills and3-year Treasury bonds were held in December2012 February 2013 (see Chart 2.8). Securitieswere supplied in the amount of 60.0 million lats;with demand 3.6 times exceeding supply, allsecurities were sold. The weighted average yield on12-month Treasury bills fell from 0.67% to 0.44%.With the demand being high, the weighted averageyield declined as a result of a larger-scale bondredemption in February providing credit institutionswith additional funds for purchasing newly-issuedsecurities. As regards 3-year government bonds, theirauctions had not been held since August 2010 whenthe weighted average bond yield stood at 5.55%; atthe auction in February it was a mere 1.39%.The quoted bid yield on Latvian government bondsdenominated in US dollars and maturing in 2021was 3.23% at the end of November, reaching 3.34%at the end of February. The quoted bid yield on theLatvian government eurobonds maturing in 2018rose from 1.88% to 2.04% over the reporting period.The above rise was related to an increase in thebid rates on securities of the developed countriesin DecemberFebruary rather than a higher riskperception associated with Latvia. The continuouslynarrowing bid rate spreads also testied to that. At theend of February the spread between the bid yields onLatvian government bonds denominated in US dollarsmaturing in 2021 and the US government bonds of thesame maturity narrowed to 184 basis points, and thespread between the bid yields on Latvian governmenteurobonds maturing in 2018 and German governmentbonds of the respective maturity was 164 basis points.At the end of February OMXR, NASDAQ OMX Rigashare price index, was 3.0% higher than at the end ofNovember, while in annual terms the increase was amere 1.3%. On the major global stock exchanges theindices posted a higher average rate of increase duringthe reporting period. In this period the developmentsof the major global stock market indices had a lesspronounced effect on the Latvian stock market due toits smaller scale and fewer investors.2.4 Interest ratesIn January and February, the movements of the moneymarket indices no longer played a signicant role indetermining the lending and deposit rates. Most creditinstitutions left the bank margins applied on top ofChart 2.8AUCTIONS OF LATS-DENOMINATED GOVERNMENTDEBT SECURITIES(millions of lats)2. FINANCIAL MARKET DEVELOPMENTS

17. 16MACROECONOMIC DEVELOPMENTS REPORTApril 2013the money market indices to new loans granted tohouseholds or non-nancial corporations unchanged.Nevertheless, in some lending segments the bankmargins increased in January and February incomparison with the previous months. This suggestedthat either smaller credit institutions which often grantloans to higher-risk customers at higher interest rateshave increased their activity in the particular marketsub-segment, or some larger credit institutions havetightened their pricing conditions. With the interestrates on time deposits with MFIs declining and therespective lending rates growing, the spread betweennew MFI loans and new time deposits with MFIswidened to 4.0 percentage points in February (seeChart 2.9).The interest rates on new euro loans granted tonon-nancial corporations lingered between 3% and4%. Most of the new euro loans granted to non-nancial corporations exceeded 1 billion euro (or anequivalent amount in lats). Due to this reason, thevolatile rates on those loans were the primary driversof the overall developments in the rates on new eurolending to non-nancial corporations. The interestrates on new medium-sized (from 250 thousand euroto 1 million euro or an equivalent amount in lats)euro loans granted to non-nancial corporationsremained unchanged in January and February,whereas the respective rates on small-size loans (upto 250 thousand euro or an equivalent amount in lats)slightly increased. In both non-nancial corporationlending sub-segments an upward pressure on theinterest rates was exerted by the increased activity onthe part of smaller credit institutions. This conrmsthat higher interest rates on new small and medium-sized loans granted to non-nancial corporations arean indication of a higher risk prole associated withthe new loans rather than of changes in the pricingconditions applied by credit institutions.The interest rates on new lats loans granted to non-nancial corporations were also characterised byvolatility and were highly dependent on the interestrates on large-size loans. Most credit institutionsdid not change the bank margins on lending to non-nancial corporations. Nevertheless, as some largercredit institutions re-focussed from one marketsub-segment to another market sub-segment eitherdecreasing or, as the case may be, increasing theinterest rates on loans offered in the particular sub-segment, it affected the overall borrowing costs of non-nancial corporations and the borrowing costs in eachsub-sector of lending to non-nancial corporations.2. FINANCIAL MARKET DEVELOPMENTSChart 2.9SPREAD BETWEEN INTEREST RATES ON NEW LOANSAND NEW DEPOSITS(percentage points)

18. 17MACROECONOMIC DEVELOPMENTS REPORTApril 2013In January and February, oating interest rates andinterest rates with the initial rate xation period ofup to 1 year on new euro loans to households forhouse purchase lingered roughly around the level ofDecember 2012. In the case of those particular loans,the bank margins above the 3-month EURIBOR wereslightly higher in the period from December 2012 toFebruary 2013 in comparison with the respective levelof the previous year (by 0.3 percentage point; at 3.1percentage points on average), as some major marketplayers tightened their pricing conditions and the shareof higher-risk loans in aggregate loans expanded.The bank margin on the respective householdloans for house purchase granted in lats remainedstable (2.3 percentage points in February 2013;2.4 percentage points in December 2012) and werenarrower in comparison with the one applied to euroloans. At the same time, the interest rates on newloans with an initial interest rate xation period ofover 1 year granted to households for house purchaseremained volatile which can be explained by the lackof depth in the particular market segment.Following a dive in January, the interest rates onnew consumer credit granted to households in latswith an initial interest rate xation period of over1 year returned to the level observed in the precedingmonths. The respective rates of euro loans, in turn,continued to uctuate within the interval of 6%8%(see Charts 2.10 and 2.11). Within the relativelyshallow consumer credit segment, the interest rateson new loans were largely inuenced by the changesin interest rates and the structure of new loans acrossvarious credit institutions.The interest rates on new time deposits of non-nancial corporations remained broadly unchanged:still close to zero. Considering the low level of thedeposit rates, the amount of free liquidity placed bynon-nancial corporations on time deposits in Januaryand February was again smaller than in the respectiveperiod of the previous year. In December 2012 andJanuary 2013, the interest rate on new time depositsof households made in lats increased, as creditinstitutions offered better deposit terms and conditionsto households and smaller credit institutions increasedtheir household deposits: time deposits by householdstend to be with longer maturities (6 months and1 year) and normally have higher interest rates. InFebruary, the impact of all the above-mentionedfactors faded or disappeared and the interest rates onhousehold deposits returned to a level slightly belowthe one observed in November 2012.2. FINANCIAL MARKET DEVELOPMENTSChart 2.10INTEREST RATES ON MFI SHORT-TERM LOANS INLATS*(%)* Floating interest rates and interest rates with an initial interest ratexation period of up to 1 year.Chart 2.11INTEREST RATES ON MFI SHORT-TERM LOANS INEURO*(%)* Floating interest rates and interest rates with an initial interest ratexation period of up to 1 year.

19. 18MACROECONOMIC DEVELOPMENTS REPORTApril 20132.5 Money supplyIn the rst two months of 2013, the growthof the monetary aggregates remained broadlystable, reecting the favourable macroeconomicdevelopments and the stability of the nancialmarkets. A slight drop in the money supply in Januarywas followed by a moderate rise in February, largelyresulting from an increase in deposits of non-nancialcorporations placed with credit institutions. Thegrowth of deposits by non-nancial corporationswas supported by both the recovery of the domesticconsumption as well as the income of well-performingexport sectors. Household deposits were depletedbecause of increasing consumption, whereas thehousehold preference for decreasing the proportionof currency holdings in their savings, possibly relatedto less uncertainty vis--vis the euro introductionprospects, supported an increase in those deposits. Asa result, the demand for cash decreased considerablyin the rst two months of the year. An improvementin the economic situation of exporting sectors resultedin a higher demand for corporate loans, at the sametime encouraging also the credit institutions to stepup corporate lending. The loan portfolio of this sectorremained stable. At the same time, the quality of loansimproved. As a result of the GDP growth, the ratio ofloans to GDP continued to decline reaching 65.5%(79.6% in 2011; see Chart 2.12).Aggregate money supply totalled 6.9 billion lats inFebruary, representing a 3.4% year-on-year increase(see Chart 2.13). M1, the most liquid component ofmoney supply, continued to dominate in the broadmoney M3 and its annual growth rate reached 12.3%in February (see Chart 2.14 for the developmentsof currency in circulation). As the remunerationpaid on deposits was negligible, the rise in depositsconcentrated primarily in the overnight segment:overnight deposits grew by 2.8% in January andFebruary. Deposits redeemable at notice alsoexpanded by 4.3%, whereas deposits with an agreedmaturity of up to two years contracted by 2.7%.The annual growth rate of deposits made by residentnancial institutions, non-nancial corporations andhouseholds remained moderate at 5.2% in February.Euro deposits expanded, whereas the deposits made inlats contracted, with both annual rates still remainingsimilar (4.4% and 3.5% respectively; see Charts 2.15and 2.16 for the developments in deposits). Againstthe background of growing deposits, the ratio ofdomestic deposits to loans increased from 56.0% in2. FINANCIAL MARKET DEVELOPMENTSChart 2.12RESIDENT LOANS TO GDP(%)Chart 2.13ANNUAL RATE OF CHANGE IN MONETARYAGGREGATES(%)Chart 2.14CURRENCY IN CIRCULATION(%)

20. 19MACROECONOMIC DEVELOPMENTS REPORTApril 2013December 2012 to 56.9% in February 2013. At thesame time, nancing received from foreign parentbanks continued to contract and the growth of non-resident non-MFI deposits decelerated (see Charts2.17 and 2.18).Chart 2.15ANNUAL RATE OF CHANGE IN RESIDENT DEPOSITS(%)Chart 2.16RESIDENT DEPOSIT DYNAMICS(billions of lats)Chart 2.17NON-MFI DEPOSIT DYNAMICS(in billions of lats)2. FINANCIAL MARKET DEVELOPMENTS

21. 20MACROECONOMIC DEVELOPMENTS REPORTApril 2013At the end of February, aggregate loans granted toresidents had shrunk by 0.5% in comparison withthe end of December (see Chart 2.19 for monthlychanges in lending). The annual rate of decrease inresident loans continued to decelerate and dropped to10.1% in February (or 3.7% when excluding creditinstitutions whose licences were revoked in 2012; seeChart 2.20). The loan portfolio shrank as a result of adecline in household loans (1.3% in two months). Atthe same time, loans granted to nancial institutionsand non-nancial corporations grew by 0.1% duringthis period. Loans granted in euro continued on adownward trend, whereas the loan portfolios ofother foreign currencies and the lats expanded. Theproportion of the lats loans in the aggregate domesticloan portfolio was 13.9% in February.Lending to manufacturing of fabricated metalproducts, water supply, wholesale, storage andnancial services increased in the course of themost recent months. In January, a positive lendinggrowth rate was demonstrated by agriculture andall its primary sub-sectors, some sub-sectors ofmanufacturing (manufacturing of wearing apparel,metals, fabricated metal products and paper), energysector, water supply, transportation by land and othersectors (see Chart 2.21 for changes in the structure ofthe domestic loan portfolio).The changes observed in money supply in January andFebruary reected the balanced development of theeconomy. Although household deposits could continueto shrink under the impact of certain factors, corporateaccounts will receive further inows generated by thedomestic demand and persistently well-performingexport sectors. Thus the aggregate money supply willcontinue to expand moderately in 2013. Moreover,Chart 2.18CREDIT INSTITUTION FOREIGN LIABILITIES(billions of lats)Chart 2.19MONTHLY CHANGE IN LOANS TO RESIDENTHOUSEHOLDS AND NON-FINANCIAL CORPORATIONS(millions of lats)Chart 2.20ANNUAL RATE OF CHANGE IN LOANS TO RESIDENTS(%)2. FINANCIAL MARKET DEVELOPMENTS

22. 21MACROECONOMIC DEVELOPMENTS REPORTApril 20132. FINANCIAL MARKET DEVELOPMENTSTable 2MONETARY AGGREGATES(quarterly gures are averages)Outstanding amountas percentage of M32013 IIAnnual growth rates (%)2012 2013Q1 Q2 Q3 X XI XII Q4 I IIM1 70.9 15.5 12.9 14.5 15.9 8.0 10.9 11.6 13.3 12.3Currency in circulation 14.8 28.8 23.6 19.7 18.0 12.4 4.1 11.5 1.0 0.7Overnight deposits 56.1 11.9 9.9 13.1 15.3 6.8 13.0 11.7 17.1 16.3M2 M1 (= other short-term deposits) 26.8 20.9 15.0 16.2 16.9 3.5 11.0 10.5 12.9 13.7Deposits with an agreed maturity ofup to 2 years 23.5 20.9 15.1 17.0 17.9 3.4 12.0 11.1 15.5 16.5Deposits redeemable at notice of upto 3 months 3.3 20.4 14.7 8.4 7.0 4.3 1.7 4.3 11.9 13.1M2 97.7 0.3 1.5 2.6 3.7 4.4 3.8 4.0 4.7 3.7M3 M2 (= marketable instruments) 2.3 42.8 28.1 25.3 27.9 53.5 29.2 17.4 29.1 8.3M3 100.0 0.9 1.1 3.0 4.0 5.1 2.8 4.0 3.7 3.4Credit to residents 8.2 10.8 11.0 10.6 10.0 9.4 10.0 9.3 9.6Credit to general government 12.3 15.5 15.5 11.1 0.5 14.2 1.2 9.0 2.5Credit to the private sector 8.0 10.6 10.8 10.5 10.5 10.4 10.5 10.1 9.9Loans to the private sector 9.0 11.5 11.4 11.0 10.9 10.6 10.8 10.4 10.1Longer-term financial liabilities(excluding capital and reserves) 43.3 18.5 12.1 4.6 5.0 53.2 20.9 52.4 50.1Source: the Bank of Latvia.Chart 2.21STRUCTURE OF CHANGES IN THE DOMESTIC LOANPORTFOLIO(millions of lats)following the nal decision about Latvia joining theeuro area, an additional supporting factor for a rise indeposits will be the opportunity to convert non-cashcurrency into euro easier, at the same time decreasingthe use of the cash currency. Movement towardsjoining the euro area will also gradually increase therole of the euro in the structure of money supply.For the time being, the demand for corporate loans,particularly for investment in exporting businesses,will increase. Credit institutions have also conrmedthat such businesses can rightfully apply for loans;therefore, there is a potential for further recoveryof corporate lending. As a result, the annual rate ofchange of corporate loans will most likely returnto a positive territory in 2013. The household loanportfolio will proceed on a downward trend, withgradual repayments of household loans for housepurchase continuing.

23. 22MACROECONOMIC DEVELOPMENTS REPORTApril 20133. Domestic DemandThe GDP of EU27 and the euro area contracted by0.3% and 0.6% respectively, whereas the Latvianeconomy continued to develop buoyantly in 2012,achieving the highest growth rate in the EU (5.6%;see Chart 3.1). Just a year ago, with a roughly thesame growth rate Latvia was the third fastest growingeconomy in the EU.Exports, investment and private consumptioncontributed equally to GDP growth in 2012, yet theirparticular dynamics changed over the year. At thebeginning of 2012, investment played an importantrole in supporting growth. Further on, privateconsumption became dominant, whereas in the secondhalf of the year net exports made a very signicantpositive contribution to the GDP growth (see Chart3.2).In the fourth quarter, the leading position in terms ofdevelopment was occupied by exports: its impressivegrowth rate of 8.4% contributed 4.7 percentagepoints to the GDP growth. Imports of goods andservices expanded at a considerably lower rate incomparison with exports (by 1.0%); therefore, thepositive contribution of net exports amounted to4.0 percentage points.Although the growth of private consumption at 4.2%was twice as low as that of exports, its contributionto the annual changes of the GDP was relatively large(2.8 percentage points) as consumption remained asizeable component accounting for 69% of the realGDP.The growth of the gross xed capital formationdecelerated in comparison with the beginning of theyear, nevertheless contributing 1.2 percentage pointsto the GDP growth.The negative contribution of inventories (2.9percentage points) still dampened the GDP growthsignicantly, yet the effect of the changes ininventories gradually faded.3.1 Private consumptionThe purchasing power of households continued toimprove in 2012. This was inter alia reected by therising spending. Moreover, the private consumptiongrowth accelerated notably in the second quarter.Retail trade followed a slightly different path inChart 3.1CHANGES IN GDP(at constant prices; %)Chart 3.2CONTRIBUTION TO ANNUAL CHANGES IN GDP(demand side; percentage points)3. DOMESTIC DEMAND

24. 23MACROECONOMIC DEVELOPMENTS REPORTApril 2013the course of the year: steeper growth of the salesvolumes (particularly, of the demand for consumernon-durables) was observed with a one-quarter lag(i.e. in the third quarter; see Chart 3.3).The growth of consumption decelerated slightly at theturn of the year. In the fourth quarter, consumptionexpanded by 0.6% quarter-on-quarter and by 4.2%year-on-year (see Chart 3.4). The growth could remainmoderate also in the rst quarter of 2013, althoughseveral opposing factors currently exert their inuenceon consumption.With the average wage and salary as well as theincome of self-employed and the employmentnumbers on a rise, the disposable income ofhouseholds is also growing. An increasingly largernumber of households conrm in surveys that theirwelfare is improving (see Chart 3.5). Nevertheless, theaverage temperatures this winter were considerablylower than the ones observed a year ago whichtranslated into signicantly higher spending onheating. The deterioration of the consumer and retailtrade condence in February was most likely directlyrelated to the growing housing expenditure whichhad a negative effect on the purchasing power ofhouseholds and their spending habits in points ofsales, thereby dampening the prots earned by salesbusinesses.The decline in the numbers of customers, however,does not apply to all points of sales. The demand formotor vehicles has been rising in the most recentmonths. In January and February, the number ofcars newly registered with the Road Trafc SafetyDepartment increased very signicantly (see Chart3.6). This increase was achieved primarily on accountof cars registered in the ownership of physical personsand produced more than two years ago. Car purchaseswere nanced mainly by previously-accumulatedsavings. The number of cars purchased on a basisof leasing agreements has also increased graduallyin the course of the recent years. At the same time,households continue decreasing their debt obligations,hence further shrinking of loans, including loans forpurchasing consumer goods, can be observed.Low ination will also act to support a more rapidrecovery of consumption in 2013. Considering thatthe heating season will be over and the observedprice rises are negligible, the increases in wages andsalaries will result in an almost equal improvement ofthe purchasing power.Chart 3.3INDICATORS CHARACTERISING CONSUMPTION(consumer condence, net responses; 2010 = 100; percentagepoints)Chart 3.4CHANGES IN GDP AND PRIVATE CONSUMPTION(year-on-year; %)Chart 3.5CONSUMER CONFIDENCE AND UNDERLYINGFACTORS(net responses; percentage points)3. DOMESTIC DEMAND

25. 24MACROECONOMIC DEVELOPMENTS REPORTApril 20133.2 Private investmentInvestment growth continued to decelerate: in thefourth quarter of 2012, investment increased by 3.3%quarter-on-quarter and by 4.2% year-on-year. Thisshould be viewed as a rather moderate growth ratein comparison with the beginning of 2012, when thequarterly rate amounted to 12.6% and the annual ratereached 39.0%.The slowdown in investment growth was primarilyrelated to the fading of the resumed tendency toupgrade equipment and vehicle eet, something whichhad been postponed during the crisis. The imports ofcapital goods (mechanical appliances and electricalequipment as well as transport vehicles) contractedsignicantly (see Chart 3.7). Nevertheless, the importsof capital goods resumed growth in the fourth quarter.The structure of non-nancial investment suggeststhat the contribution of public administration andpublic services (education, health) expanded inthe fourth quarter of 2012, the same as every year;nevertheless, it was smaller than in the previousyear. Therefore, it can be concluded that privateinvestment is growing at a higher pace (see Chart 3.8).Investment in transport and storage continues to growdynamically (see Chart 3.9).In the coming years, investment could increase, withits rate of growth even accelerating in 2013. This isalready conrmed by the rising number of vehicleregistrations in January and February. The nancingconditions are also favourable: an impressiveimprovement of prots, relatively low borrowingrates, availability of EU funding. The plannedintroduction of the euro will also make the businessenvironment more attractive to foreign investors.Chart 3.6NUMBER OF VEHICLES NEWLY-REGISTERED WITHTHE ROAD TRAFFIC SAFETY DEPARTMENT(thousands)Chart 3.7INDICATORS CHARACTERISING INVESTMENT(2010 = 100; %)Chart 3.8CONTRIBUTION OF PRIVATE AND GOVERNMENTINVESTMENT TO GDP(%)3. DOMESTIC DEMAND

26. 25MACROECONOMIC DEVELOPMENTS REPORTApril 20133. DOMESTIC DEMAND3.3 Government expenditure and budgetAccording to the ofcial information by the Treasury,the decit of the consolidated general governmentbudget estimated on a cash ow basis amounted to13.9 million lats or 0.1% of the forecast GDP in therst two months of 2013 (see Chart 3.10).The consolidated general government budget revenuecontinued to grow in the rst two months of 2013 (seeChart 3.11), increasing by 5.6% in comparison withthe respective period of the previous year. Tax revenueexpanded by 7.2%, primarily on account of thepersonal income tax and social insurance contributioncollections (a rise of 9.0% and 10.3% respectively),conrming the continued strength of the economicdevelopment. The observed decline in the VATcollections by 1.4% year-on-year can be explained bythe effects stemming from the reduction of the tax ratefrom 22% to 21%. Inows of the EU funding (foreignnancial assistance revenue) expanded by 3.6%.In January and February 2013, the consolidatedgeneral government budget expenditure grew by9.0% over the respective period of the previous year(see Chart 3.12). The increase was determined by arise in non-capital expenditure by 7.6%, with boththe current expenditure as well as expenditure onsubsidies and grants contributing signicantly at thebeginning of 2013. Capital expenditure increased by38.4% in the rst two months of 2013 in comparisonwith the respective period of 2012, primarily onaccount of larger local government investment.The general government debt stood at 5 781.5million lats (35.4% of the GDP projected in 2013;5 652.0 million lats at the end of 2012) at the end ofChart 3.9NON-FINANCIAL INVESTMENT BY SECTOR(% of total non-nancial investment)Chart 3.10ACCRUED BALANCE OF THE CONSOLIDATEDGENERAL GOVERNMENT BUDGET BY LEVEL(billions of lats)Chart 3.11SELECTED TAX REVENUE(JanuaryFebruary; millions of lats)

27. 26MACROECONOMIC DEVELOPMENTS REPORTApril 2013February 2013. The increase was primarily explainedby changes in the applied methodology: short-termdeposits of local governments and businesses withthe Treasury were added to the general debt. Lookingpast the effect of methodology changes, the generalgovernment debt decreased by 81.2 million lats sinceDecember. The domestic debt shrank by 96.6 millionlats as a result of maturing government securities,whereas the external debt grew by 15.3 million lats onaccount of the US dollar appreciation.3. DOMESTIC DEMANDChart 3.12RATE OF CHANGE IN CONSOLIDATED GENERALGOVERNMENT BUDGET EXPENDITURE(year-on-year; %)

28. 27MACROECONOMIC DEVELOPMENTS REPORTApril 20134. Aggregate Supply4.1 Industry and constructionIn the fourth quarter of 2012, the value added ofmanufacturing at constant prices recorded a year-on-year rise of 6.2%. At the same time, the value addedof manufacturing (seasonally adjusted) increasedin the fourth quarter by 1.3% in comparison withthe previous quarter (see Chart 4.1). Hence in thefourth quarter manufacturing was one of the majorpositive contributors to the annual GDP growth in thebreakdown by sector (0.8 percentage point), as wasthe case in the previous quarters.Expansion of manufacturing in the fourth quarter wasattributable to a quarterly rise in the manufacturingof chemicals and chemical products (15.5%),basic pharmaceutical products and pharmaceuticalpreparations (16.6%), fabricated metal products(2.8%) as well as wood and articles of wood andcork (2.8%). At the same time, a declining volume ofoutput in manufacturing of metals (7.4%), computers,electronic equipment and optical products (10.1%),motor vehicles, trailers and semi-trailers (8.5%) andrepair and installation of machinery and equipment(3.6%) had an adverse impact on the increase inmanufacturing (see Chart 4.2 for the annual changesin industrial output).The turnover in manufacturing at current pricesreported a year-on-year rise of 9.1% in the fourthquarter of 2012, of which an increase of 3.2% on thedomestic market and that of 16.9% on the externalmarket. This is again conrmed by the fact thatexpanding external demand is the major contributorto the manufacturing growth. It should be noted,however, that the increase in external demand is moremoderate than the rise in manufacturing turnover,pointing to a higher competitiveness of Latviasmanufacturing and new markets.Industrial condence indicator aggregated by the ECfor the fourth quarter was 1.7 points higher quarter-on-quarter. The above development was primarilyattributable to a more positive assessment of theorder volume by the manufacturers. At the sametime, the assessment of stocks has remained negative(manufacturers point to insufcient stock levels),which, along with the assessment of the order volume,conrms a further growth of the sector.Production capacity utilisation projected for therst quarter of 2013 rose to 72.1% (see Chart 4.3).Chart 4.1DYNAMICS OF MANUFACTURING OUTPUT(at constant prices; %)Chart 4.2ANNUAL INDUSTRIAL OUTPUT CHANGES IN Q4 2012(working-day adjusted; %)Chart 4.3PRODUCTION CAPACITY UTILISATION INMANUFACTURING(%)4. AGGREGATE SUPPLY

29. 28MACROECONOMIC DEVELOPMENTS REPORTApril 2013Chart 4.4GROWTH-RESTRICTIVE FACTORS INMANUFACTURING(% of replies from respondents)Situation differed notably by subsectors. Productioncapacity utilisation remained high in manufacturingof wearing apparel (74.6%), wood and articles ofwood and cork (78.4%), fabricated metal products(72.3%) and furniture (74.5%). At the same time, lowproduction capacity utilisation was observed in themanufacturing of beverages (58.9%), non-metallicmineral products (60.7%) and chemicals and chemicalproducts (64.3%). A notable predictable fall inproduction capacity in manufacturing of metals has tobe noted as well from 77.9% in the fourth quarter of2012 to 61.0% in the rst quarter of 2013.Businesses still reported the limited demand to bethe major growth-restrictive factor (36.0% of thetotal number of respondents; see Chart 4.4) in therst quarter of 2013; however, the value of theabove indicator persistently follows a downwardpath. Rather many respondents (29.0%) identiedno substantial growth-hampering factors at the time.The above is the indicators highest indication sincethe commencement of the data collection in 2004.A decreasing number of respondents pointed to labourshortage (8.0%) or technical problems (8.1%) andonly 4.3% of respondents indicated access to fundingto be the primary growth-restrictive factor.The manufacturing data for January were negative.The output volume fell by 3.6% in comparison withDecember 2012, while the annual growth rate wasclose to zero. Such data contradict other industrialindicators slightly; hence the produced output volumein manufacturing is most likely expected to grow inthe coming months. Although the declining outputobserved in January may be explained by the datavolatility in some subsectors of manufacturing,objective reasons lead to a conclusion that output insome subsectors will decline in 2013.The volume of output may decline in those sectorswhere output is related to the stagnating EUconstruction market (wood industry, manufacture ofbasic metals, etc.). The output of fabricated metalproducts and motor vehicles, trailers and semi-trailers is also likely to decline due to the stagnatingEU automotive industry. The year is expected to berelatively favourable, as regards the manufacturingof food products, electrical equipment, chemicalproducts, basic pharmaceutical products andpharmaceutical preparations and computers, electronicequipment and optical products. Hence substantialgrowth in manufacturing is still forecast in 2013(about 5%), albeit more subdued than in the previousyears.4. AGGREGATE SUPPLY

30. 29MACROECONOMIC DEVELOPMENTS REPORTApril 2013In the fourth quarter, the value added of theconstruction sector recorded a year-on-year rise of9.3%. A quarter-on-quarter increase in the value addedof the construction sector was 3.5%. The contributionof the construction sector to the annual GDP growthwas 0.6 percentage point. In the fourth quarter,construction output at current prices rose by 16.2%year-on-year. Engineering structures (9.3 percentagepoints), including the construction of motorways,streets and roads, ports and blocks of industrialbuildings (see Chart 4.5), accounted for the majorcontribution to the annual increase. Construction ofindustrial production buildings, museums and librarieswas the largest contributor to the segment of non-residential buildings (4.0 percentage points). At thesame time, residential buildings contributed rathermoderately (2.9 percentage points) to the expansionof construction, with the apartment houses accountingfor the primary contribution.The construction condence indicator assessed by theEC deteriorated by 7.6 points in the fourth quarter.It was underpinned by a deteriorating assessmentof the overall volume of orders and employmentexpectations. The construction condence indicatordeteriorated, most likely, on account of two factors.First, compared with the previous years, weatherconditions of the current winter are very unfavourablefor the performance of construction works. Second,the information about a smaller amount of fundingthat might be allocated for the road construction in thecoming years was released in mass media. This is alsoconrmed by the replies of the builders to the surveyquestion about the growth-restrictive factors: the lackof demand and weather conditions were mentioned asthe main constraints in the fourth quarter of 2012.The construction condence indicator improvedsomewhat in the rst two months of 2013. Sectorexperts acknowledge that the construction sector willreport growth in 2013, albeit lower than in 2012.Access to funding (both budget funding and EUfunding) that has remained approximately the same asin the previous year supports the above trend. Thus,private funding will mostly contribute to the growth ofthe construction sector in 2013. Hence the segmentsof residential buildings and some non-residentialbuildings (industrial structures, commercial buildingsand warehouses) should expand.4.2 ServicesIn the fourth quarter, the value added of theservices sector at constant prices recorded a year-Chart 4.5CONTRIBUTION OF SOME TYPES OF CONSTRUCTIONTO THE ANNUAL CONSTRUCTION GROWTH ATCURRENT PRICES(percentage points)4. AGGREGATE SUPPLY

31. 30MACROECONOMIC DEVELOPMENTS REPORTApril 2013on-year increase of 4.1%. The overall contributionof the services sector to the annual GDP growthwas 2.8 percentage points (see Chart 4.6 for thechanges in the value added of the main types ofservices). Wholesale and retail trade (1.6 percentagepoints), information and communication services(0.4 percentage point) and professional, scientic andtechnical services (0.3 percentage point) accounted forthe major positive contribution.In the fourth quarter, retail trade turnover declinedmoderately quarter-on-quarter (by 0.5%), followingthe accelerated increase in the third quarter, whilethe annual rate of increase remained relatively high(6.7%). In the rst half of the year the demand formotor vehicles shrank, whereas in the second halfof the year the above sector resumed growth. Hencein the fourth quarter the overall retail trade turnover,including the sale of motor vehicles, expanded by1.1% quarter-on-quarter (see Chart 4.7) and by 5.5%in comparison with the fourth quarter of 2011.In the fourth quarter, the value added of the transportand storage sector increased merely by 1.1% year-on-year (see Chart 4.8 for the annual changes in freightturnover in the major areas of transportation). Thevalue added of the sector decreased by 0.9% quarter-on-quarter (seasonally adjusted data). Since the annualrate of increase moderated notably, the contributionof the transport and storage sector to Latvias GDPgrowth also shrank substantially (to 0.1 percentagepoint). Such dynamics of the transport sector hadalready been projected, with low capacity of thesector and some problems associated with the lack ofdemand for the transportation services pointing to theabove development.The volume of cargoes loaded and unloaded atLatvias ports in the fourth quarter recorded an overalldecline of 4.0% year-on-year. It was the rst quarterconrming a negative annual growth rate since mid-2010. The shrinking volume of cargoes loaded andunloaded at Ventspils port (by 16.9%) was the primarydriver of a negative annual rate of increase. Cargoesloaded and unloaded at Riga port also decreasedmoderately (2.6%), while the annual growth rateremained high at Liepja port (54.7%).The volume of freight transported by rail in the fourthquarter recorded a 17.6% year-on-year decrease.The overall drop in the volume of rail freight wasattributable to the shrinking transportation to and fromthe ports by 17.8%. The volume of cargo transit alsodeclined notably (45.3%).Chart 4.6CHANGES IN VALUE ADDED OF MAIN TYPES OFSERVICES(year-on-year; seasonally adjusted data; %)Chart 4.7BREAKDOWN BY QUARTERLY CHANGES IN RETAILTRADE(percentage points)Chart 4.8ANNUAL CHANGES IN FREIGHT TURNOVER BY THEMAIN TYPES OF FREIGHT TRAFFIC(%)4. AGGREGATE SUPPLY

32. 31MACROECONOMIC DEVELOPMENTS REPORTApril 2013In the fourth quarter, the volume of roadtransportation shrank by 7.1% year-on-year. Thisdevelopment was attributable to narrowing roadtransportation in domestic trafc (9.1%), whileinternational trafc recorded an increase (4.0%).However, the share of domestic transportation washigher regarding the structure of road transportation,consequently the overall annual increase in roadtransportation remained negative. At the same time,the freight turnover, expressed as tonne-kilometres(the volume of transported freight multiplied by adistance in kilometres), picked up by 7.3%, suggestingthat the distance of the transported freight increasedsubstantially in the fourth quarter of 2012. The abovedata are likely to explain the difference between thegrowth rate of the rail freight volume and that ofcargoes loaded and unloaded at ports (the volume ofrail freight shrank more notably than that of cargoesloaded and unloaded at ports).According to preliminary data for the rst quarterof 2013, the annual rate of increase in the volume ofcargoes loaded and unloaded at ports and that of railfreight has remained negative. This suggests that adecline in the demand for freight transportation in theregion affected the performance of the sector at thebeginning of 2013. In March, however, the freezingof the northern part of the Baltic Sea might contributepositively to the operation of ports, with some freightows being diverted to Latvias ports.4.3 Labour marketDecline in unemployment was consistent with theBank of Latvias forecast: according to the CSBslabour survey data, the average rate of jobseekers was14.9% of the economically active population in 2012(a year-on-year decline of 1.3 percentage points). Theannual decline was similar at the end of 2012 as well,with the rate of jobseekers reaching 13.8% (see Chart4.9) in the fourth quarter. Unemployment is expectedto continue on a gradual downward path in 2013. Withthe rate of jobseekers approaching its natural rate(the average 15-year rate of jobseekers amounts to12.7%), the future success in reducing unemploymentwill depend not only on the overall economic growthrate, but also increasingly on the effectiveness of theemployment programmes provided for particulargroups of population and regions.The degree of mismatch between the demand for andsupply of labour has remained broadly unchangedin comparison with the period prior to the economic4. AGGREGATE SUPPLYChart 4.9REGISTERED UNEMPLOYMENT RATE AND THAT OFJOBSEEKERS(%)

33. 32MACROECONOMIC DEVELOPMENTS REPORTApril 20134. AGGREGATE SUPPLYoverheating. The Beveridge curve, reecting the jobvacancy and unemployment ratio, gradually returns tothe level of 2004 (see Chart 4.10).Moreover, the data do not conrm the hypothesisthat unemployment is declining in Latvia only onaccount of individuals leaving the country. Quiteon the contrary, the number of economically activepopulation increases and the rate of economicallyactive population to working-age populationis expanding. Although an increasing numberof economically active population is a positivephenomenon and reects the populations higherexpectations for nding a job, it should be takeninto account that the above leads to a deterioratingunemployment statistics in the short term. Had thenumber of economically active population not risen inthe last two years, the rate of jobseekers would havebeen close to 11% currently (see Chart 4.11).Employment growth in Latvia is among the highestin the EU. All statistical data sources of differingcoverage that are available present a similar picture,excluding the possibility that the labour market isrecovering only under the impact of short-term andtemporary factors. Thus, for instance, according to theCSBs labour survey data, the number of the employedpersons rose in the fourth quarter of 2012 by 25.6thousand year-on-year. The State Revenue Servicedata point to a similar increase, which contrary to thelabour survey excludes the grey economy: the numberof employees paying their social security contributionshas risen by 23.0 thousand over the year.The data ofthe national accounts also conrm the fact that theemployment has grown on account of the number ofemployees: employees (22.3 thousand) accountedfor the majority of the total rise in the number ofemployed persons (24.5 thousand over the year).According to the CSBs business survey data, thenumber of occupied posts was 36.5 thousand higherin the country in the fourth quarter of 2012 than a yearago, driven by the developments in private sector.Employment expectations of businesses haveimproved notably over the last three months, rebuttingthe concerns that the process of new job creationmight cease. The majority of businesses project anincrease rather than a decrease in the number ofemployees in all major sectors of the economy in thecoming months (see Chart 4.12).In January 2013, the registered unemployment raterose by 0.4 percentage point (to 10.9%) on accountof short-term factors. The traditional indicatorChart 4.10BEVERIDGE CURVE: NUMBER OF UNEMPLOYEDPERSONS REGISTERED WITH THE SEAAND THAT OFVACANCIES(in thousands)Chart 4.11IMPACT OF THE DYNAMICS OF THE NUMBER OFECONOMICALLY ACTIVE POPULATION ON THE RATEOF JOBSEEKERSChart 4.12DATA FROM BUSINESS SURVEYS ON THE PROJECTED3-MONTH EMPLOYMENT DYNAMICS(net responses; percentage points)

34. 33MACROECONOMIC DEVELOPMENTS REPORTApril 20134. AGGREGATE SUPPLYof seasonality in January (0.2 percentage point)was accompanied by the impact of legislativeamendments: the disbursement of unemploymentbenet was extended up to nine months irrespectiveof the length of service since January 2013, hencea number of individuals who had lost their job atthe end of 2012 postponed the registering of thestatus of unemployed until the beginning of 2013.Uncommon decline in the registered unemploymentrate in November and December 2012 (by0.2 percentage point) also points to the impact oflegislative amendments. In February, the registeredunemployment rate stood at 10.9%, however, theabove rate is expected to follow a downward path inspring and reach one-digit level during 2013.The annual rate of increase in the average monthlygross wage and salary remained stable (4.0%) in thefourth quarter of 2012. However, the real net wageor the purchasing power of a wage rose ever morerapidly (by 2.5% over the year; see Chart 4.13).Declining ination was the primary contributor to theabove development.Rising wages and salaries continue to be attributableto the labour productivity growth (see Chart 4.14),and hence no risks to price stability and economiccompetitiveness emerge. The EC data suggest thatthe number of businesses that single out the labourshortage as the main constraint for business growthhas stabilised below 10% (see Chart 4.15). It iseven less than in 20022004 and reects a normalequilibrium situation, fostering investment inowsand at the same time also labour productivity growthrather than an accelerated further rise in wages insteadof labour productivity growth due to the labourshortage.Overall, a moderate increase in the average wageof the employed persons in 2012 (3.7%) was partlyattributable to the fact that high unemployment ratecontributed to higher output, since new employeeswere paid a lower wage than the average wage andsalary of the enterprise, thus leading to a deterioratingaverage wage statistics. As unemployment rateis gradually moving closer to the natural rate ofunemployment, businesses will nd it more difcult toenhance employment rapidly and will have to channelmore funds into the labour productivity growthfostering investment. This would also be the basisfor a more buoyant rise in remuneration which mightrange between 4% and 5% in 2013, without creating asubstantial inationary pressure in the economy.Chart 4.13ANNUAL CHANGES IN THE AVERAGE MONTHLYNOMINAL AND REAL WAGE FOR FULL-TIME JOB(%)Chart 4.14REAL WAGE AND SALARY AND LABOURPRODUCTIVITY INDICES(Q1 2005 = 100; seasonally adjusted data)Chart 4.15THE RATE OF BUSINESSES WHO FIND LABOURSHORTAGE THE MAIN OBSTACLE FOR BUSINESSGROWTH(%)

35. 34MACROECONOMIC DEVELOPMENTS REPORTApril 2013The CSB has revised upwards the compensation ofemployees gure for the rst half of 2012, whilerevising downwards the above gure for 2011. HenceULC follow a gradual upward trend and are notablylower than in 2008 (see Chart 4.16).4. AGGREGATE SUPPLYChart 4.16ULC INDEX(Q1 2000 = 100; seasonally adjusted data)

36. 35MACROECONOMIC DEVELOPMENTS REPORTApril 20135. Costs and PricesIn January and February, annual ination continued todecelerate, reaching the lowest level since September2010 (0.3%; see Chart 5.1). The overall impact of thesupply side factors on the ination dynamics remainedfavourable, while the contribution of demand wasstill moderate and reected by negative annual coreination.Unusual for January, in the rst month of the yearmonthly deation (0.2%) instead of a consumer pricerise was observed. January is mostly the month wheneither increases of indirect taxes or new tariff plansof goods and services with administered prices takeeffect, resulting in the price lists of goods and servicesoffered for consumption of different other sectorsreviewed due to cost pressures. This did not happen inJanuary 2013, when not only the prices of the wearingapparel and footwear (as a result of seasonal sales)but also (unusual for January) those of natural gas andheating energy decreased (see Chart 5.2).In January, the sales of the wearing apparel andfootwear slightly exceeded the historically observedlevel, with the monthly decline in prices reaching7.4%, thus suggesting that the contribution of demandon the rising prices of goods is still moderate. Asthe inuence of this factor was less pronounced thanusually in February, such price changes are probablyrelated to the peculiarities of the regional market, i.e.in Estonia, February historically is already the monthof the new seasonal goods with the typical price rise,while in Latvia seasonal sales is still in progress.Products from Estonia have already been sold on theLatvian market over a longer period time; however,this year most of the seasonal clearances in the Latvianmarket were made in January. The trading strategyis likely to have changed slightly also in autumn of2012 as a result of the international trade chains of thewearing apparel entering the Latvian market.At the same time, monthly deation was drivenby administrative prices in January as the averagemovements of oil product prices of the preceding ninemonths had facilitated lower natural gas and heatingtariffs for consumers respectively. In February,heating tariffs declined further as the price of naturalgas delivered to business customers (including manyproducers of heating energy) changes every month,but the natural gas price for household consumptionhas been set for half a year and was reduced morerapidly already in January.Chart 5.1CHANGES IN CPI BY COMPONENT(percentage points)Chart 5.2IMPACT OF ENERGY AND FOOD PRICE CHANGES ONANNUAL CONSUMER PRICE INFLATION(percentage points)5. COSTS AND PRICES

37. 36MACROECONOMIC DEVELOPMENTS REPORTApril 2013Following a temporary rise in February (it waspartly triggered by the improving assessment of theeconomic growth in major global economies, forinstance, China), global oil prices (see Chart 5.3)tend to return to a lower level. The average level ofoil prices in the rst two months of 2013 remainedsimilar to that of the corresponding period of theprevious year, but the value of the US dollar waslower than the average level observed in January andFebruary 2012, and this helped to maintain a moderateprice level of some energy resources in lats.The average global price level of the main food andagricultural products (see Chart 5.4) has also recordeda downward trend since October 2012. The risingprices of dairy products and oils and fats (affectedby the limited supply and harvesting difcultiescaused by rain) are currently being offset by thefalling prices of sugar (the decrease could persistaccording to the current assessment by the Food andAgriculture Organisation of the United Nations assugar production has reported an increase not only inthe traditional sugar-exporting countries) as well asthe declining prices of cereal products, mainly wheat.The wheat price drop was triggered by the favourablenew harvest forecasts in the US.The price changes for services with non-regulatedprices were not unusual. Following a drop in theprices of communication services observed in thefourth quarter of 2012, these prices did not start toreturn to the previous level due to competition, buta rise in the prices of tourism services (an increaseof 4.8% in February) is evident quite often in thisseason and is related both to the willingness to enjoythe tourism offers in warm countries and the seasonalkinds of winter sports when weather conditions arestable and favourable for winter sports.The cost factors already mentioned moderate pricesof resources and raw materials (i.e. mainly energyand food prices) allowed the producer price levelto remain fairly stable, and the data for January andFebruary suggest that the producer prices of goodssold on the domestic market and increasing at a lowerrate than those of exported goods ensure domestic costcompetitiveness, without triggering a rise in consumerprices. Data on the changes in the real effectiveproducer price dynamics-based exchange rate of thelats provide evidence that the competitiveness ofLatvian producers on the external market improvedin 2012, although the dynamics of this ratio wasless stable than the changes in the real effectiveconsumer price dynamics-based exchange rate of theChart 5.3OIL PRICES ON GLOBAL MARKET(lats/barrel)Chart 5.4GLOBAL FOOD PRICES(average monthly indicator of 20022004 = 100)5. COSTS AND PRICES

38. 37MACROECONOMIC DEVELOPMENTS REPORTApril 2013lats. However, a decrease in the production costs ofenergy resources determined by external factors aswell as the domestic methodology for the calculationand determining of administered tariffs might have apositive effect on the cost competitiveness also in therst months of 2013.The actual ination data for January and February,the current drop in fuel prices and the expectedPublic Utilities Commissions decisions on a declinein heating tariffs in Rzekne and Riga from Mayand June 2013 respectively, on the one hand, allowfor signicant reduction of the average inationassessment in 2013; however, it is currently difcultto estimate the impact of some factors, and they canexert pressure on the price rise in the second half ofthe year (see Chart 5.5). This is mainly related to theindirect effect of the expected rise in electricity prices:the mandatory procurement component of electricityrates for business customers is expected to increasealready in April, whereas for households along withthe possible liberalisation of the electricity market, inautumn. The amount of the mandatory procurementcomponent announced in February had an effect onthe consumer expectations: despite ination abating,the expectations of households of a more moderateaverage price rise than in the preceding 12 monthsdeclined (Chart 5.6).The assessment of the impact of food prices couldalso change in the middle of the year when the rstestimates of the harvest of the new season (mainlygrain and potatoes) are made available. The pricemonitoring campaign launched in anticipation ofthe introduction of the euro, with its rst resultsalready being published and available to consumersfor comparison on the web site of the Ministry ofEconomics is one of additional factors that mighttemporarily prevent price rises in several popularconsumer goods and services. By acquiring new datain the course of time, it will be possible to establishwhen the so called psychologically attractive (endingwith 9) or convenient (ending with 0 and 5) prices inlats will tend to change to become psychologicallyattractive and convenient in euros.Chart 5.5HICP AND HICP AT CONSTANT TAX RATE(January 2008 = 100)Chart 5.6ANNUAL INFLATION AND INFLATION EXPECTATIONS(%)5. COSTS AND PRICES

39. 38MACROECONOMIC DEVELOPMENTS REPORTApril 2013Chart 6.1CURRENT ACCOUNT OF LATVIAS BALANCE OFPAYMENTS AND ITS COMPONENTS(% of GDP)Chart 6.2GROWTH RATE OF EXPORTS AND IMPORTS OF GOODSAND SERVICES(year-on-year; %)Chart 6.3FOREIGN DIRECT INVESTMENT IN LATVIA(% of GDP)6. Balance of PaymentsThe current account decit of Latvias balance ofpayments was 259.9 million lats or 1.7% of GDPin 2012 (see Chart 6.1). It was driven by a declinein foreign trade decit in goods and services andthe growing amount of current transfers received.Preliminary data for January 2013 suggest that thecurrent account, in line with the forecast, still recordsa small decit (36.5 million lats).In 2012, the goods and services foreign trade decitdecreased, amounting to 467.3 million lats or 3.0%of GDP. Growth in exports of goods and services wasmore rapid than that in imports (see Chart 6.2). Theincrease in exports of goods was affected by one-offfactors (a good grain harvest) and improved long-term competitiveness (a rise in labour productivityand producer value added). Exports of servicesalso continued to grow. Although a downslide intransportation services was observed at the closeof the year, exports of transportation services of alltypes have increased for the year overall. Rises werealso recorded in information and computer, travel,construction and communication services provided tonon-residents.The decit of the income account increased to239.1 million lats or 1.5% of GDP in 2012. Againstthe background of the development of the Latvianeconomy, both the dividends received by foreigndirect investors and reinvested earnings increased.At the same time, the ow of EU funds was themajor factor affecting the increase of the surplus inthe current transfers account (to 446.6 million latsor 2.9% of GDP) and the capital account (to 458.7million lats or 3.0% of GDP) of Latvias balance ofpayments. In 2012, overall 836.3 million lats werereceived from EU funds.The nancial account recorded a decit of 216.6million lats or 1.4% of GDP in 2012. The issue ofthe Latvian government bonds (2.25 billion USdollars) and the repayments of the IMF loan (810.5million lats) contributed to major nancial ows inthis account. Although credit institutions continuedrepaying their long-term liabilities, their short-termliabilities grew, hence no net capital outow wasobserved in the private sector.In 2012, the inows of foreign direct investmentin Latvia amounted to 540.1 million lats (3.5% ofGDP) including 145.6 million lats (3.4% of GDP;see Charts 6.3 and 6.4) in the fourth quarter. Already6. BALANCE OF PAYMENTS

40. 39MACROECONOMIC DEVELOPMENTS REPORTApril 2013in November 2012, the international rating agenciesStandard & Poors and Fitch Ratings, in February2013 Rating and Investment Information and inMarch Moodys raised Latvias credit rating, thuspointing to the stable improvement of the economicsituation and future foreign direct investmentopportunities.Chart 6.4NET FLOWS OF FOREIGN DIRECT INVESTMENT(millions of lats)6. BALANCE OF PAYMENTS

41. 40MACROECONOMIC DEVELOPMENTS REPORTApril 20137. Conclusions andForecastsIn 2012, Latvias economic growth rate remained highdespite the adverse developments observed in theglobal markets and major trade partner states. Thus,the concerns expressed previously about the potentialslowdown in growth did not materialise.In 2013, the