OREANDA-NEWS. July 01, 2008. Ministry of Economy and Ministry of Finance estimate that Latvia's economic growth this year will reach 2-3 percent, and increase slightly in 2009, reaching 3-4 percent.

The government today took into consideration the Economy Ministry's report on the macroeconomic situation in the country.

The Economy Ministry explains that Latvia's economic development was exceeding the potential growth level from 2005 to mid-2007. This caused high inflation and a large current account deficit.

The growth pace started decelerating in the second half of 2007 due to both internal and external factors. The government's counter-inflation strategy, which was mostly aimed at curbing domestic consumption, also contributed to the declining economic development.

The financial market was first to react: commercial banks employed a more cautious mortgaging policy, interest rates increased. Households' spending structure also changed.

This caused a chain reaction: investments into housing decreased, property prices fell, retail trade turnover also dropped at the end of the last year.

The current trends show that Latvia's economic development is very sensitive to changes in domestic consumption, and such fluctuations will continue in the near future. Partly this is due to the present structure of the national economy, which is dominated by sectors oriented toward the domestic market. Therefore further changes will depend on changes in domestic demand and the factors that influence it.

It is not expected that the factors affecting domestic demand could change in the near future, therefore the demand will keep decreasing until it stabilized gradually. It is unclear whether the amount of investments will change in the near future.

On the other hand, stabilization of the situation will depend on structural reforms and their impact on the development of such national economy sectors as the processing industry.

The modest economic growth may cause problems for the government with achieving a surplus in the national budget this year, because the current situation with budget revenues is likely to continue, which especially concerns the revenue from value-added tax, the Economy Ministry warns.

The economic slowdown has not yet been reflected in employment rate, which keeps growing but is expected to start decreasing in the second half of this year.

In the next six months, when the growth of administratively regulated prices will not be as fast as it used to be until now, and the prices for food products will stop growing, inflation can decrease significantly, and the average annual inflation could be around 16 percent this year.

Latvia must take into consideration that in the future, availability of foreign capital will become limited or, in other words, it will become costlier. Latvia must also take into consideration global growth risks, which may weaken external demand and cause tougher competition on the global markets.