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Briefing No 10
Latvia and the Enlargement of the European Union

The views expressed in this document are not necessarily those held by the European Parliament as an institution.


II. POLITICAL SITUATION

a) Recent history

During the middle ages, Latvia was occupied by changing foreign rulers who were interested in the country's strategic location for commerce and its largely ice-free coastline. Most of Latvia came under Russian domination in 1771 under the Treaty of Nystad. Eastern Latgale became part of Russian territory the following year as a result of the first partition of Poland, while the Third Partition, in 1795, added the Duchy of Courland to the Russian empire. The Latvian independence movement gained momentum after the 1917 Russian revolution, although full independence was only achieved in 1922 when the Latvian nationalist government under Karlis Ulmanis succeeded in evicting first Bolshevik and then German troops. Independence proved short-lived: the Treaty of Non-Aggression between Germany and the Soviet Union of 23 August 1939 placed the Baltic Republics within Moscow's sphere of influence.

Soviet troops entered the country on 17 July 1940, and Latvia was effectively annexed after rigged elections resulted in an administration that called for the country's admittance into the Soviet Union. Germany took control of Latvia in 1941, following its invasion of Germany, but the soviet Red Army expelled the Nazi forces in 1944 and regained control. Latvia's economy, infrastructure and political life were then integrated into the Soviet system, including industrialisation of the economy and the collectivisation of agriculture. The Communist Party of Latvia (LCP) exercised a complete monopoly on power and all other political parties were banned. After Stalin's death, the Krushchev era ushered in a brief spell of decentralisation from Moscow, followed by a further clampdown. National consciousness resurfaced during Brezhnev's rule, focussing mainly on environmental issues and the revival of Latvia's cultural traditions.

Latvian dissidents became more outspoken as a result of Mikhail Gorbachev's policies of glasnost and perestroika after 1985, but were strongly resisted by the conservative, Russian-dominated LCP led by Boris Pugo. Mr Pugo moved to Moscow in September 1988 and was replaced by the comparatively liberal Janis Vargis. The following month, the Latvian Popular Front (LTF) held its inaugural congress. The Latvian National Independence Movement (LNNK) was formed around the same time. In July 1989, the Latvian Supreme Soviet declared Latvian sovereignty and economic independence.

In elections in 1990, the LTF won a majority of seats in the Supreme Soviet, then renamed the Supreme Council, and declared the 1940 Soviet annexation illegal by voting to reinstate the 1922 constitution. An LTF leader, Ivars Godmanis, became prime minister. Under pressure from conservatives in Moscow, Mr Gorbachev sent paratroopers from the Soviet Ministry of the Interior to storm the Riga Press House on 2 January 1991, and the Ministry of Internal Affairs on 20 January, leading to disturbances in which four people were killed. A referendum held on 3 March 1991 produced a 73.7% vote in favour of independence, comfortably above the two thirds majority that Moscow had stipulated before secession. The atmosphere changed after the abortive coup against Mr Gorbachev in August 1991 (in which Mr Pugo was one of the plotters), giving Latvia the freedom later that month to ban the LCP. The State Council of the Soviet Union formally recognised Latvia's independence on 6 September 1991.

The LTF-led government which took office after independence rapidly lost popularity as recession gripped the country. The party itself was also riven by splits, and its demise was almost complete by June 1993, when Latvia held its first post-independence election. The largest number of seats was won by Latvia's Way, a right-of-centre party established earlier in the year, led by Anatolijs Gorbunovs. It formed a coalition government with the Farmers' Union (LFU), representing agricultural interests. Valdis Birkavs', a leading member of the LFU became prime minister; another party member, Guntis Ulmanis - the nephew of the inter-war leader, Karlis Ulmanis - was elected president by the Saeima the following year. However, since then government coalitions have been unstable, with negotiations on a government after the 1995 election particularly tricky.

b) Institutions

The present constitution, adopted on 21 August 1991, is a revised version of the inter-war constitution of 15 February 1922. The legislature is the 100-seat unicameral Saeima, Latvia's parliament before the second world war, which replaced the 210 seat Supreme Council after the June 1993 election. The electoral system is by proportional representation, and parties require 5% of the overall vote to gain representation. The parliamentary term is four years.

The president is elected by the Saeima, by secret ballot for a maximum of two consecutive terms. The role is largely ceremonial, but he holds considerable political authority in foreign as well as domestic politics and is the head of the armed forces. The president appoints the prime minister, who in turn appoints a government which is acceptable to the Saeima. The president's right to dissolve parliament is complicated by the requirement to call a referendum before holding an early election. The president has the power to veto legislation but this veto can be overturned by a qualified majority of the Saeima.

The judiciary is based on a system of general courts, with a Supreme Court acting as the highest authority in all criminal and civil cases. Judicial institutions enjoy independence from political influence, but have been criticised as being inefficient with long delays in court hearings and enforcement of decisions. The Constitutional Court, which rules on the constitutionality of legislation, held its first session in 1996. The independent Human Rights Bureau monitors Latvian human rights and their compatibility with international norms.

The most recent elections in Latvia took place on 3 October 1998. The election was held at the same time as a referendum on amendments to the citizenship law. The election left pro-reform parties in favour of a market economy, as well as steady progress towards EU membership, in the leading positions, and signalled a continuation of government policy on these matters. The prime minister is Vilis Kristopans, of Latvia's Way. The results were:

Party% of voteNo of seats
People's Party (TP)21.1924
Latvia's Way (LC)18.0521
Conservative Union for Fatherland and Freedom (TuB/LNNK)14.6517
National Harmony Party14.1216
Social Democratic Party12.8114
New Party7.318
Others11.87-

Of the 100 members elected to the parliament, 17 were women.

c) Recent Developments

i) Mr Skele resigns as Prime Minister

On 12 April, Prime Minister, Andris Skele resigned after only nine months in office, thereby bringing an end to Latvia's ninth government since independence, the average life expectancy of since 1990 has been just over 13 months. The composition of these unstable coalitions has not changed radically over the years, which implies that factors other than ideological differences lie behind the persistent political instability. Personality clashes and close ties between political parties and rival business groups appear to be the main reasons.

Mr Skele's resignation was triggered by his attempt to dismiss the economics minister, Vladimirs Makarovs. Whereas Mr Makarovs wanted to slow down the privatisation process in order to maximise revenue, the head of the Latvian Privatisation Agency (LPA), Janis Naglis, favoured a rapid sell-off of the remaining large state assets. Mr Makarovs used legal uncertainties in Mr Naglis's contract to in effect remove him from his LPA post in April. This went against the instructions of Mr Skele, who was said to side with Mr Naglis on this issue, despite the fact that Mr Naglis was a leading member of Latvia's Way which, although part of the same coalition government, frequently disagreed with Mr Skele's People's Party. Mr Skele sacked Mr Makarovs on 7 April without consulting any of the other parties in the three-party coalition. Angered by Mr Skele's decision, Mr Makarovs's party, the centre-right For Fatherland and Freedom-Latvian National Independence Movement (FFF-LNNK), threatened to withdraw support from Mr Skele unless he reinstated the economics minister. Although the government risked losing its parliamentary majority if the FFF-LNNK withdrew its support, Mr Skele refused. Faced with a vote of no confidence with an uncertain outcome, Mr Skele handed in his resignation.

Two factors may have contributed to Mr Skele's resignation. First, he may have been aware that his personal unpopularity would have made any continuation of the coalition exceedingly difficult and could even have prevented him from implementing his economic reform programme. Indeed, his style of government had cost him his job before. In 1997 Mr Skele, who then led a broad coalition government as a non-party prime minister, was forced to resign, with several ministers citing his personal style as the main reason. When the FFF-LNNK threatened to withdraw from the government, it made it clear that it would like to see a continuation of the ruling coalition, albeit without Mr Skele. All the ruling parties have remained in the government, with the New Party having returned to the government after a nine-month absence. The new prime minister, Andris Berzins, decreed that former prime ministers should not be admitted to the new cabinet - a rule clearly designed to keep out Mr Skele.

Another reason why Mr Skele stepped down may have been connected with his public reputation. In April his name was mentioned in a parliamentary inquiry into a large paedophile ring, along with the names of several other high-ranking officials (see also below). No evidence has been produced of wrongdoing by Mr Skele or the other officials, and the allegations might simply be part of the mud-slinging that is part and parcel of political life in Latvia. However, Mr Skele's popularity was not helped when it transpired that he had sold his Ave Lat food- processing conglomerate at the end of March. The buyer, an obscure offshore company, paid Mr Skele US$29m for the group, which has recently been burdened with losses and bad debts.

ii) The new Prime Minister is Andris Berzins

Given that there are few experienced political personalities in the People's Party apart from Mr Skele, the post of Prime Minister reverted back to Latvia's Way. The party has been part of every ruling coalition since independence and can therefore resort to the largest number of experienced politicians. The president, Vaira Vike-Freiberga, let it be known that she would prefer a non-party candidate to remove the risk of another government collapse because of party political in-fighting. Among her preferred choices was Einars Repse, the energetic and highly respected governor of the Bank of Latvia (the central bank). However, Latvia's Way insisted on pushing through its own candidate, and Mrs Vike-Freiberga eventually appointed Andris Berzins to form a new government.

Mr Berzins, aged 48, is an experienced politician who served in three cabinets, as labour and welfare minister, including Mr Skele's first administration in 1995, before he was elected mayor of Riga in 1997. In contrast to Mr Skele, who is results-oriented and willing to employ a harsh leadership style in pursuit of his objectives, Mr Berzins is said to favour consensus and dialogue. He showed his consensus-building skills during his time as labour minister when he brought together trade unions and employer organisations to negotiate a number of controversial social and labour laws. He intends to continue in this vein, as indicated by his announcement that the cabinet would move from majority-voting, as exercised under Mr Skele, to consensus-based decision-making. Potentially, Mr Berzins appears well suited to bridge the splits that the two government crises since the election in October 1998 have left in the party political spectrum. Having been involved in municipal politics over the past three years, Mr Berzins might find it easier to stand above the party political fray and counterbalance conflicting demands. Mr Berzins has also managed to steer clear of political scandals - an achievement, given the scandal-ridden political climate and the fact that reports of irregularities in the Riga city administration have surfaced with considerable regularity.

Similarly, Mr Berzins enjoys high personal popularity among the electorate and although his views on economic policy are unclear, he plans to increase the powers of the finance minister, which may indicate a determination to reduce the budget deficit and further economic reform. However, like his predecessors, Mr Berzins is likely to find his main challenge in combating the vested interests that have made large-scale privatisation so politically explosive. He has said that he would like to see a separation of politics and economic interests, but has not indicated how he intends to achieve this.

iii) Paedophile case closed

The Latvian Prosecutor-General's Office has announced that it has closed the case on charges of paedophilia initiated against former Prime Minister Andris Skele, former Justice Minister Valdis Birkavs and State Revenue Service Director-General Andrejs Sonciks. The case was closed to the absence of illegal deed.

A parliamentary commission was set up in 1999 after the paedophilia scandal broke out in Latvia following a news programme by "Nedela" (The Week) on LNT (Latvian Independent Television), which alleged the involvement of senior public figures in an under-age prostitution and pornography ring. Although the commission received a great deal of attention, no criminal proceedings against the high profile names will now be taken.

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III. ECONOMIC SITUATION

a) Introduction

Latvia has a population of 2.4 million inhabitants with a 1999 GDP per capita of 2280 ECU (1). Its GDP per head in purchasing power standards is about one quarter of the EU-15 average. The country has very few natural resources and imports all of its natural gas and oil, as well as half of its electricity needs.

Supported by a broad social consensus on the need to raise living standards and approach the European economy, Latvia has pursued an extensive programme of economic stabilisation and market reforms since gaining its independence in August 1991. Real GDP growth, which was flat in 1999, is expected to accelerate to 3% in 2000, led by exports due to growth in the EU economy (2).

Table 1: Outlook for 2000-01: Forecast Summary Latvia

Forecast Summary
 199819992000(a)2001(a)
Real GDP Growth (%)3.90.13.05.0
Industrial Production (%)2.0-8.84.06.0
Consumer Prices (%) (b)4.72.43.54.0
Current Account balance (% of GDP)-10.7-10.2-11.6-10.1
Exchange rate (Latvian LAT : US Dollar) (b)0.590.590.600.58

(a) Forecasts (b) Annual Average

Source: Economic Intelligence Unit, EUI Viewswire, June 14, 2000.


b) Economic Performance

The stabilisation programme launched in 1992 and the introduction of market reforms first brought a sharp fall in real GDP, as well as a fall in inflation. The annual rate of increase of consumer prices has continuously decreased from nearly 1000% in 1992 to 2.4% in 1999, one of the lowest rates of the economies in transition. Latvia has emerged from the economic recession, triggered by the Russian financial crisis of August 1998. This crisis was transmitted to Latvia via its still significant trade and financial links with the Commonwealth of Independent States (CIS). Export volume to this region fell sharply and remained well below pre-crisis levels. As a result, economic growth was flat in 1999. With the continuation of strict macro-economic policies and structural reforms, helped by exports to the EU, Latvia's GDP is expected to grow by 3% in the year 2000 and by 5% in the year 2001. At the same time, inflation is expected to remain subdued with inflation levels around 3.5%. The current account deficit in 1999 remained broadly unchanged from the previous year, at around 10% of GDP. The recent pick-up of exports to the EU and CIS markets, as well as the planned prudent financial policies, may stabilise the current account deficit during 2000, notwithstanding the expected rise in imports resulting from domestic economic recovery. However, the stabilisation may by mitigated by the impact of the Euro's decline against the Dollar. This is best illustrated by the comparative experience of the Baltic States (3). Each of the Baltic States operates a fixed exchange rate regime. The price competitiveness of exports from Latvia, where the currency Lat has a fixed link to the Special Drawing Right (SDR), and Lithuania, which has a currency pegged to the US Dollar, has been negatively influenced by the decline of the Euro. The Lat appreciated by 18% against the Euro between January 1999 and May 2000. In contrast, Estonia has a currency with a fixed link to the Euro. This has enabled Estonia to preserve its price competitiveness in Euro-area markets.

c) Economic Policy

Andris Berzins took over as Prime Minister in April 2000 after the resignation of Andris Skele (see above), the fall being mainly attributed to disagreements about privatisation. Disputes over privatisation strategy have brought down the last two governments and are likely to remain a sensitive issue. Mr Berzins has brokered a compromise on privatisation and his government promises policy continuity and a more flexible approach to minority issues (4), promoting social cohesion and inter-ethnic co-operation in a country where some 30% of the population, predominantly Russian-speaking, does not have citizenship and speak little or no Latvian.

Privatisation, which initially lagged behind other reforms, gained strong momentum in 1997. The divestiture of small-and-medium scale firms is largely completed, but domestic political pressures continue to hamper the privatisation of major infrastructure enterprises. The new government has promised to privatise within a year the energy utility Latvenergo, the Latvian Shipping Company, the Gas Company Latvijas Gas and the fixed-line telecommunications monopoly Lattelecom. The cabinet has agreed to entrust oversight of major privatisations to international investment banks chosen on a competitive basis. Progress has also been made in reinforcing the regulatory structure for utilities, improving the business climate, improving the legal and judicial systems, and strengthening the efficiency and transparency of the public sector (5). Despite the political controversial nature of the privatisation process, the government and its privatisation agency have been successful to increase dramatically the share of the private sector in GDP from about one third in 1994 to over two thirds in the year 2000. However, the government still has some assets that are hard to sell, while others, most notably the electricity monopoly, Latvenergo, will be politically difficult to privatise. The opposition Social Democratic Party generated some uncertainty by organising a petition campaign demanding a referendum on the sale of Latvenergo.

In addition to the large-scale privatisation objective, the new government wishes to tighten fiscal policy. Latvia's fiscal policy aims to achieve approximate fiscal balance over the medium-term, on a cyclically-adjusted basis. The government aims to contain the general government fiscal deficit to at most 2% of GDP in the year 2000. The government programme entails painful cuts, which are difficult to implement at a time when (unofficial) unemployment remains high. At the end of 1999 the number of registered unemployed was about 9% of the labour force. If measured, according to the International Labour Organisation (ILO) methodology, which counts job seekers rather than those applying for unemployment benefits, the figure is several percentage points higher. Large regional variations in unemployment persist, with the capital Riga, registering an unemployment rate less than 5%, while rural areas have much higher unemployment figures.

d. External Economic Relations

Latvia-EU

In October 1999, Latvia received a favourable evaluation in the Commission's Annual Review of Accession Preparations. On the economic front, the Commission noted clear improvements and concluded that Latvia could now be classified as a "functioning market economy", a distinction that it failed to receive in the 1998 assessment. However, there were also concerns about delays in large-scale privatisation and remaining weaknesses in the banking sector, which were brought to light by the Russian crisis. It will be necessary to raise the share of gross fixed investment in GDP by improving the investment climate, to diversify the export base away from low value-added products, and to stimulate growth in the small and medium-sized business sectors. The 1999 collapse of the Russian export market is expected to accelerate these developments.

Latvia has made important progress in aligning its legislation and its policies further with the internal market acquis in the areas of foreign trade, state aids and competition. It has taken over many EU laws regulating taxation, energy, environmental protection and transport. However, some progress has to be made in areas of intellectual and industrial property, data protection, company law, telecommunications, customs and agriculture. Although the institutional framework to implement the acquis has improved, implementation and infringement capacity have to be strengthened.

The European Council in Feira on June 19-20 mentioned that: ".... of the eight chapters opened, only cultural and audio-visual policy, external relations and competition were not provisionally concluded with Latvia...."

In 1998, the EU accounted for 56.6% of Latvia's exports and 55.3% of its imports. The most important trading partners are: Germany (16% of export, 17% of import), Sweden (10% of export and 7% of import) and the United Kingdom (13% of export and 3% of import.). The CIS supplied 19% of imports and took 16% of exports, with Russia alone accounting for 12% of each. In 1999, the relative importance of trade with the EU increased; the EU received 62.5% of the Latvian exports. In order to diminish its persistently high current account deficits, Latvia needs to increase exports of products with higher value added.

Latvia has a liberal trade regime. As of 1 June 2000, it abolished the temporary import tariff on pork products. This safeguard measure had been considered by the EU as an infringement of the Europe Agreement, and an important matter of principle, to achieve a matched removal of the candidate countries' import duties and EU exports refunds.

Latvia-Russia

On April 5, 2000 the Russian Duma rejected a bill to impose economic sanctions against Latvia - including an end to Russian oil exports through Latvia and a ban on Latvian firms operating in Russia. Although the threat of sanctions appears to have diminished, Russia maintains a watchful eye on what it sees as discriminatory legislation on citizenship affecting Latvia's 650.000 strong Russian minority.

Russian economic sanctions would also hurt influential Russian business interests in Latvia, particularly in the oil exporting and bank sectors. Latvia's trade exposure with Russia is over 10% of its trade volume. However, this does not really reflect the full extent of Latvia's economic reliance on Russia. The transit trade between the West and Russia brings Latvia economic benefits. Around 15% of total Russian oil exports transit through Latvia, bringing in 100 million dollars in transit fees. The costs to Russia of not having its own Baltic Sea export route are considerable. Russia, convinced that its neighbours have inflated transmit fees, has started the construction of the Baltic Pipeline System, which will reduce its dependence on oil terminals in the Baltic States, particularly the Ventspils terminal in Latvia.

Traditionally Latvia has, of the three Baltic States, enjoyed the closest relationship with Russia because of its best developed transit infrastructure among the Baltic States, the largest Russian-speaking community and its strategic geographic position. Although, Latvia has converted its economic relations away from the former Soviet Union to a significant extent in the 1990s, it retains a greater reliance on Russia economically that neighbouring Estonia.

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(1) EUROSTAT. "The GDP of the Candidate Countries", Statistics in Focus, Economy and Finance, 17/2000.

(2) The Economist Intelligence Unit, Latvia, Country Outlook, June 28, 2000.

(3) Oxford Analytica, "Euro impact", May 17, 2000

(4) Oxford Analytica, "Privatisation problems", June 7, 2000.

(5) http://www.imf.org/external/mp/loe, "Supplementary memorandum of economic policies" Memorandum the Government at the Bank of Latvia to the International Monetary Fund, June 15, 2000.


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© Enlargement: 2000-07-31