…WHILE LATVIA AND LITHUANIA MAY NEED TIGHTER FISCAL POLICIES.

Latvia and Lithuania also recorded dramatic reductions in the current accounts deficits in the first quarter of 2000. But in contrast to Estonia, these deficits then rose sharply in the second quarter. Further progress on restoring external balance may depend on the fiscal policy choices now under discussion in Riga and Vilnius. Because both countries have fixed exchange rate regimes, they cannot devalue their currencies to reduce imports, boost exports and improve external balance. This constrains both monetary and exchange rate policies, and places the burden of adjustment on fiscal policy instead. To date, Latvia and Lithuania have been less fiscally responsible than Estonia.

Latvia’s current account deficit fell sharply in the first quarter, from 10 percent of GDP in 1999 to just 3.5 percent of GDP (www.bank.lv). But the deficit doubled in the second quarter to 7.4 percent of GDP. While Latvia (like Estonia) benefited from larger inflows from transport and other services, the merchandise trade deficit rose sharply, due to rapid import growth. Preventing the surge in imports from outpacing export growth may require the adoption of tighter fiscal policies, in order to dampen domestic demand.

While Lithuania’s current account deficit in the first quarter of 2000 dropped to only 3 percent of GDP, it rose to nearly 6 percent of GDP in the second quarter. In contrast to Latvia, exports rose 32 percent during the first half, while imports were up only 12 percent. The trade deficit thus fell from US$645 million in the first half of last year to US$415 million in the first six months of 2000. A tighter fiscal policy pursued during the first quarter had something to do with this: Consolidated budget expenditures fell by 13 percent in the first half of 2000. In the second quarter, however, budget expenditures and real wages grew sharply, which boosted imports and the current account deficit. Lithuania’s next prime minister–who ever this may be–will face some difficult economic policy decisions.

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