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S&P cuts Latvian outlook to negative on growing risks

Standard & Poor's lowered Latvia's outlook to negative from stable as the Baltic state's economic growth, the fastest in the European Union, is threatened with a „hard landing.”

Without curbing domestic demand, the country has „an escalated risk of a hard landing, which would have adverse effects on the long-term growth potential of the Latvian economy,” Standard & Poor's said in a statement yesterday. At the same time, it affirmed its long-term A- and its short-term A-2 sovereign credit ratings.
Latvia, a former Soviet republic, is struggling to keep inflation at bay, prevent an overheating loan market and adopt the euro as a surge in wages and investment following its 2004 membership in the European Union pushed economic growth a preliminary 11.9% in the Q4, the seventh three-month period in which growth exceeded 10%. The quick growth has widened the current-account deficit, the broadest measure of trade in goods and services, to more than 20% of GDP for 2006, S&P said.
The economy's growth is not „due to balanced and sustainable development.” To avoid the crash, the government will have to implement „urgent and effective policy responses,” S&P said. Since most loans are taken out in foreign currency, Latvian monetary policy is „effectively powerless” in slowing demand.

Without government action, risk will increase and the sovereign ratings would be lowered over the next 12 months, the credit agency said. The Latvian government „in the near future will take serious steps toward balanced economic development after it produces a detailed analysis,” Finance Ministry spokeswoman Daiga Reihmane said in an e-mailed press release after the S&P report. A task force will give their recommendations to the government by March 1, Reihmane said in the statement.
The Baltic country may not adopt the euro before 2013, the credit agency said, citing high domestic demand and rising prices for natural gas. Should the economy slow after a „hard landing,” adopting the euro could be more difficult as „weaker revenue income would increase the fiscal deficit,” the report said. Latvia's economy grew as demand for imports reached a record and inflation remained above an annual average of 6% for three years in a row. The current-account deficit rose to 24.2% of GDP in the Q3. (Bloomberg)