From: Chris Scheurweghs <scheurwe@stc.nato.int>
Subject:      North Atlantic Assembly Report AK 240 (93)10
Organization: NATO HQ, NATO CENTRALIZED MEDIA SERVICE
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Date:         Tue, 23 Nov 1993 10:52:38 +0100

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NORTH ATLANTIC ASSEMBLY   ***   ECONOMIC COMMITTEE   ***   N.A.A.
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/pub/history/military/nato/naa/ec
File: ak240ec.e

AK 240
EC (93) 10
Original:  English









                            ROMANIA AND LATVIA:
                        ECONOMIES AT THE CROSSROADS







                           Draft Special Report







                      Mr. Kees ZIJLSTRA (Netherlands)
                            Special Rapporteur*










International Secretariat
October 1993

* Until this document has been approved by the Economic
Committee, it represents only the views of the Rapporteur.



                          TABLE OF CONTENTS




                                                             Page


EXECUTIVE SUMMARY                                              ii


I.   ROMANIA                                                    1

     A.   Introduction                                          1
     B.   A New Constitution and Government                     2
     C.   Economic Challenges and Prospects                     3
     D.   The State of Economic Reforms and the Future
          Market Economy                                        5
     E.   Privatization and the Role of Foreign
          Investment and Assistance                             7
     F.   Conclusion                                            9

     Table :   Selected Economic Indicators for Romania        10


II.  LATVIA                                                    11

     A.   Introduction                                         11
     B.   Key Economic Indicators and Reforms                  11
     C.   Foreign Investment and Privatization                 14
     D.   New Economic Structural Policy                       16
     E.   Foreign Trade and Assistance                         17
     F.   Conclusion                                           18

     Tables :  Baltic Economic Indicators                      19
               Selected Economic Indicators for Latvia         21


NOTES                                                          22

                             EXECUTIVE SUMMARY

Romania, long considered slow in economic and democratic
progress, has made great strides in promoting pro-Western
policies in both these crucial areas.  However, Romania faces a
critical time in its economic reform process.  To undo the
mammoth state structure within Romania's economy, greater
decentralization and privatization will have to take place there
over the next couple of years than in any of its neighbouring
countries.  The challenge facing the current government will be
to balance the pain of restructuring on a population that has
already undergone enormous hardship.  With rising budget deficits
and differing visions as to the rate and scope of the reform
process within Romania, the required consensus on reforms will be
difficult to achieve.

To regain the confidence of international lenders, foreign
investors and domestic entrepreneurs, Romania will have to
accelerate the privatization process.  At the same time,
inflation must be brought down and adequate wage adjustments for
the population to guarantee at least minimum standard of living
levels will have to be instituted.  These are steep goals to be
placed on an economy which has experienced record decreases in
production and output combined with rapidly rising unemployment
and inflation.  However, this is not the time for Western
lenders, technical experts and foreign investors to abandon
Romania.  In fact, it is essential that continued infusions of
capital and technical expertise are afforded to the government
and to the private sector.

In June 1993, Latvia elected a new parliament, and in July a new
government was formed.  Both will be closely watched on their
stewardship of economic reform. The Republic of Latvia is
undergoing immense challenges at this time.  Economic
restructuring and production efficiencies must be continued,
along with a fair citizenship policy.  The initial statements by
the new government show promise in all of these areas.

A future regional trading block between the three Baltic States
and the acquisition of stable energy supplies will be extremely
important for Latvia.  Recent trade statistics show that exports
to the West have been growing.  With the modernization of key
industries and a more transparent business climate through
well-defined government regulations, Latvia could begin to
attract much needed investment.  Its tight monetary policy has
achieved its objectives of a stable exchange rate and relatively
low inflation.  With greater capital resources, the expansion of
output and production should be realized.  This will be achieved
by larger commitments from foreign investors and should be
followed by the continued easing of lending policies internally.

Latvia will continue to experience declines in production and
output in the short term.  Rising unemployment, with the
institution of an accelerated privatization process will also be
forthcoming.  However, if the restructuring as envisioned is
achieved and critical foreign investment is able to provide the
necessary capital, Latvia will be in a position to further
integrate with the Western economies and also improve its
relationships with its neighbours.

I.   ROMANIA

A.   Introduction

1.   In order to fully grasp the complex economic developments
occurring in Romania, one must understand the current
reform efforts amidst a backdrop of both internal and external
pressures.  Romania, long considered slow in economic and
democratic progress, has made great strides in promoting
pro-Western policies in both these crucial areas.  However,
recent work stoppages and continuing discontent with the economic
reform process by many will have a vast impact on the rate of
constructing a market-led economy.  At the same time, the current
government has implemented a gradual economic reform process to
decrease the level of hardship on the workers and their families.

While this approach has limited a more severe impact than
otherwise on the population, it has also produced long-term
structural problems and reduced confidence from Western lending
organizations to provide critical lending.


2.   It is important to note the unique variables that bring
additional challenges to Romania's reforms.  Externally,
Romanian industry has suffered from the secession of trading ties
with Serbia, one of its most prominent trading partners.  While
expressing his support for the economic embargo as the only
alternative to military intervention, Romanian Foreign Minister
Teodor Melescanu stated, "We don't like these sanctions because
we think they are a bit like sanctions against ourselves."(1)
Further illustrating the deep interdependence of Romania and
Serbia is the Timisoara power plant which was jointly
constructed on the Danube to provide electric power for both
Serbia and Romania.  NATO, UN and WEU officials have praised
Romania's efforts to enforce the embargo by attempting to stifle
commercial traffic on the Danube River, the primary
transportation artery for Serbian imports and exports.  However,
this commitment to the embargo has not been without costs.
While estimates vary as to the precise cost to Romania, all agree
that it is in the region of billions of dollars.  This, together
with other factors, constricted production by over 50 per cent
over the past couple of years, with a further drop during the
first quarter of 1993.  Romania has petitioned the UN for
compensation for losses associated with the embargo.  Lastly, the
embargoes imposed on Iran and Iraq have reduced available energy
imports and cost Romania an estimated $4 billion in frozen oil
credits from the two countries.


3.   Internally, several factors have contributed to an overall
decline in economic activity over the past couple of years.
Beyond Bucharest's control, a crippling drought has caused
widespread food shortages, forcing the government to import
substantial amounts of wheat and helping to cause a trade
shortfall with Western Europe.  Even more importantly is the
legacy of Nicolae Ceausescu and the building of one of the most
centrally-planned economies in the former Warsaw Pact.  Poland,
Hungary and the former Czechoslovakia had more advanced
western-oriented economies and greater individual autonomy than
Romania under the oppressive rule of Nicolae Ceausescu.  To
dismantle the massive state structure within its economy, greater
decentralization and privatization will have to take place in
Romania over the next couple of years than in any of its
neighbouring countries.  The enormous challenge facing the
current government will be to balance the pain of restructuring
on a population that has already undergone enormous hardship and,
at the same time, reduce state and inter-industry credits.
Sadly, achieving these two goals simultaneously will be highly
unlikely.


B.   A New Constitution and Government

4.   Romania began an extensive democratic reformation by writing
a new Constitution in 1991.  The Constitution is widely
regarded in the West as a comprehensive and fair document,
structured closely to that of the Fifth Republic of France.
However, implementation of the Constitution has, in some
instances, been interpreted by the ethnic Hungarian and Gypsy
populations as discriminatory in nature towards the ethnic
minorities in Romania.


5.   However, inspections by international human rights panels
have determined that the reported violence or other
discriminatory behaviour towards ethnic minorities in Romania
stems from individual actions and is not state-sponsored.  The
Romanian government this year made a significant step in
addressing minority concerns.  On 30 March, the government
announced the formation of a Consultative Council for Ethnic
Minorities, to be composed of the Ministries of Foreign Affairs,
Justice, Interior, Finance, Culture, Education, Religion and
local public officials to be headed by a special commissioner of
the government.  The council would be responsible for
establishing closer contacts between minority representatives at
the local level and to propose measures at both the legislative
and governmental level aimed at reducing ethnic tensions.  While
its structure and purpose have been under negotiation since its
introduction, concrete results have been achieved.  A recent
agreement to reinstate the use of the Hungarian language in both
the local high schools and at the University of Cluj within the
ethnic Hungarian region of Transylvania are real breakthroughs.
Additional action that could be implemented, long sought after
by the Hungarian government and Romanians of ethnic Hungarian
descent, would be to establish consulate offices in the
respective countries.  A treaty has also been signed between the
two countries and future co-operation appears to be well on
the way.


6.   The success of the new Constitution and continuing openness
by the government toward minority and religious concerns are
critical for Romania to gain wider acceptance in the West in
preparation for an eventual integration into European and
international institutions.  Representatives from the Council of
Europe were recently reported to support  the granting of
membership to Romania in autumn 1993.  Additionally, agreements
with the European Bank for Reconstruction and Development, the
European Community, the General Agreements on Tariffs and Trade,
the European Free Trade Area and continuing discussions with NATO
have all been made possible by the steady progress on Romanian
democratic, economic and human rights issues.  For a more
in-depth analysis of the elements of the Romanian Constitution,
please see The Process of Democratization in Romania, Report by
Mrs. Huberte Hanquet (Belgium) and Mr. Javier Ruperez (Spain),
Co-Rapporteurs for the Civilian Affairs Committee, North Atlantic
Assembly 1992.


7.   The present government of Romania was sworn in on 20
November 1992.  Due to the absence of a clear parliamentary
majority, President Ion Iliescu nominated Mr. Nicolae Vacaroiu as
an independent Prime Minister to develop the future economic
policies of Romania.  However, the government is composed mostly
of Iliescu's DNSF party (now called the Social Democracy
Party of Romania) and "technocrats" with little or no party
affiliation who generally adhere to the same philosophies on
economic reform held by President Iliescu.  To attain
parliamentary majorities, the government has developed a
coalition with ultra-right parties.  This has affected the depth
and speed of the economic reform process as conservative
opponents to rapid restructuring have provided the key votes for
the government programme to restructure the economy.


8.   While even some in the government support a more rapid
privatization and restructuring plan, the need to compromise with
its conservative coalition members presents a difficult political
atmosphere to push through reforms and maintain essential ruling
ties.  Steepening outside pressure to bring swifter change will
bring added pressure on a government with a small mandate.  The
government has been slowly making strides to conform to
international monetary and structural targets over the past
couple of months.  However, most economists believe that a
broader programme will have to be implemented in the near future
to continue international backing of reforms.  This has been most
recently illustrated in the International Monetary Fund's
decision in July not to release $3 billion dollars in credits as
further explained below.



C.   Economic Challenges and Prospects

9.   During 1992, the Romanian economy displayed both signs of
economic malaise and hope for the future.  1992 economic
indicators presented a grim assessment of the future economic
stability in Romania, while foreign investment and trade showed
some signs of improvement.  For 1992, IMF estimates indicate a
reduction of 23 per cent in production, unemployment increasing
from 386,000 to 1,013,000 and dramatic decreases in the standard
of living, with an estimated 42 per cent of the population living
below the poverty line by the end of 1992.  Substantial increases
in the cost of basic needs due to the full liberalization of
prices in May 1993, introduction of a value added tax in July and
a weaker lei have continued to lower standard of living levels.
Government statistics in the first quarter of 1993 show an
increase in average monthly family expenditure on food from 49 to
59 per cent since the beginning of the year.  While these figures
are deeply associated with several economic factors relating to
government policy, additional factors have also influenced the
continuing economic downturn.


10.  The winter of 1992-93 was extremely trying for the people of
Romania.  A severe drought and antiquated pipelines have caused
dreadful water shortages throughout Romania.  Energy supplies
have also been badly hampered due to the embargoes against Iraq
and Iran and the dissolution of the Soviet Union.  While Romania
was able to overcome these hardships last winter due to a large
influx of imports, energy production and efficiency as well as
improvements in agriculture must be implemented in preparation
for the coming winter.  Unfortunately, little has been achieved
to meet the needs so far and imports of energy and agriculture
continue to grow, causing further decreases in productivity and
endangering the allocation of a sufficient supply of resources
for both  commercial and private usage.


11.  Food shortages, due to the poor domestic production capacity
worsened by the weather and record increases in inflation and
food imports, have caused long queues in state-run stores.
Between October 1990, the beginning of price liberalization, and
December 1992, food prices rose 1,360 per cent.(2) Food prices
continued to surge by 162 per cent between June 1992 and June
1993.  While the economic reform policies of Romania have been
commended by Western experts in small- and medium-sized
commercial businesses and the promotion of foreign capital to
encourage high-tech companies, there should be an identical
effort towards agricultural and energy policy. The PHARE
programme, implemented by the European Community, has initiated a
three-year effort to assist in the privatization and management
of the agricultural sector in Romania at a cost of 80 million
European Currency Units.  According to statistics provided by the
government, Romania has privatized approximately 82.6 per cent of
its agricultural sector.  However, some analysts put the figure
of actual privatized land in production at a far lower
percentage.  Additional resources to promote production
efficiency in this critical industry would be a pragmatic
approach at this stage of the reform process.  Agricultural
production assistance, through low interest loans, modern
machinery, irrigation systems and advanced growing techniques,
would be of greater value to Romania.


12.  The domestic energy industry is also in vital need of reform
and development if Romania is to reduce its imports and provide
sufficient supplies for both residential and commercial usage.
Huge power stations, constructed to service large areas,
have experienced breakdowns.  The dangers associated with this
type of system were illustrated by the 30 December 1992
closure of a power plant which caused 60,000 persons to suffer
without heating for five days.  Greater protection from a
recurrence of large-scale power outages would be to construct
inter-connections between neighbouring countries to provide
alternative sources for the affected areas.  An additional
measure would be to create an energy reserve of approximately 30
to 40 per cent as a back-up supply at the central plants.
Domestic deposits of coal and natural gas should be fully
utilized to produce a greater reserve.


13.  Clearly, a bold and comprehensive energy policy should be
fashioned in order to provide future security for Romania's
energy needs.  The government has implemented relatively few
initiatives to increase domestic energy production and
reorganize power supply.  Incentives to construct hydro-electric
power plants and the completion of Romania's first nuclear
power plant have been the sole commitments in this area.
However, much of the poor performance can be attributed to the
fact that the Romanian energy sector has received little outside
assistance over the past three years.  Foreign experts should
provide technical assistance in the form of modernizing gas
pipelines, urban power plants and promoting oil production.  The
World Bank has begun this process by helping to finance the
restructuring of the oil and gas enterprises, PETROM and ROMGAS.



14.  Even more importantly, a shift to greater efficiency in
industrial production is necessary to reduce the need for energy.

Romanian industry is extremely energy intensive, requiring vast
amounts of resources.  It is estimated that Romanian industry
uses upwards of two-thirds of all domestic consumption.(3) The
gradual movement to world energy prices has produced additional
strains on energy reserves.  This past spring, the government
reported that its domestic energy stocks were severely depleted.
During the next year, as the government searches for the proper
restructuring plan, energy efficiency within its key industries
will be extremely important to the long-term health of industry,
production efficiency and increased output.  The OECD reports
that the ratio of primary energy consumption to GDP was five
times higher than in OECD Europe and twice as much as other
Central European countries.  The Romanian government needs to
also provide energy on a more cost effective basis by allocating
resources in industries which will provide future growth rather
than to firms with historical usage that continue to acquire
large stockpiles.


D.   The State of Economic Reforms and the Future Market Economy

15.  It is quite clear that Romania has made significant steps
towards implementing a market-led economy.  Privatization,
while disappointing within large industries, is progressing well
in the small- and medium-sized concerns.  This policy reflects
the government's philosophy of "restructuring" large state-run
facilities before privatization is fully implemented.  The
reasons for this policy are three-fold, as explained by the
government:  to provide sufficient "social protection" from large
increases in unemployment and inflation; to implement
privatization at the rate of growth within the production sector;
and to ensure relatively stable capital infusions are available
to large facilities as state assistance is pared back.  However,
government policy has produced significant long-term costs,
mostly hidden through the rapid rise in inter-enterprise arrears,
continuing state credit to failing industries and off-budget
financing of selected government programmes.


16.  Government resources are extremely limited for providing
assistance in restructuring while also budgeting for sufficient
assistance for social protection.  The government forecasts a
doubling of the budget deficit to 4 per cent of the GNP for
1993-1994.  However, it is important to realize that these
numbers are predicated on the GDP remaining steady and the annual
inflation rate decreasing to 80 per cent.  These seemingly
contradictory figures place in doubt the accuracy of the
government's accounting procedures considering that during 1992,
inflation rose at a rate of 200 per cent and GDP decreased by 13
per cent in 1991 and 7 per cent in 1992.  Already, the OECD has
estimated that the 1993 budget deficit will be approximately 6
per cent.



17.  Most important are the apparent reasons for the burgeoning
budget deficit and continuing inflation.  The OECD has recently
released a report on the state of the Romanian economic reform
process and its prevailing impacts on the population.  While
acknowledging the historical forces which place Romania's efforts
to reform its economy at a far greater disadvantage than its
neighbours, it also concludes that the government must intensify
the restructuring process and stabilize inflation.  To achieve
these goals, the government will have to accelerate the reform
process and ensure sufficient protection for the population from
its effects.  The Government and the Parliament face great
challenges in achieving this balance.


18.  Recent labour unrest, culminating in strikes by both mining
and railway unions during the summer, have highlighted the
precarious position the government finds itself in proposing
additional sacrifice to speed up the process to a market-led
economy.  The gathering strength and influence of Romania's
unions could prove to be a new and important obstacle to any
attempt of the government to begin severely reducing credits and
increasing the privatization of state-run companies.  While
some strategic sectors (energy and defence) will be exempted from
much of the privatization process, several other important
industrial sectors must be allowed to succeed or fail without
government intervention.  The failure to implement reform of
large enterprises has been the major stumbling block between the
Romanian government and the International Monetary Fund which
has refused to disperse $3 billion in critical foreign credits.


19.  Two important economic reform measures introduced this year
were the lifting of price controls in May and the introduction of
a value added tax in July.  Price controls were lifted in January
on various products and an increase in wages of 20 per cent was
awarded to the population to ease the financial burden.  The
original package expired in May 1993.  Labour Minister Popescu
has stated that the government intends to provide wage indexation
close to 80 per cent for all products and services where
subsidies are eliminated as part of a comprehensive programme to
provide sufficient social protection.  While indexation has
occurred, it has varied by sectors.  However, with the continued
sharp increases in inflation, the projected "social protection"
targets visualized by the government will most likely fall short
of their intended benefits.


20.  Additionally, the government's monetary programme has
promoted a lack of confidence and backing in the lei and assisted
in its gradual devaluation.  The devaluation of the lei, the
releasing of price controls on most goods, and the continuing
reliance on imports due to poor domestic production levels in
strategic areas has fuelled continued inflation.  The inability
to reduce inflation and the government's gradual privatization of
state-owned industry has been brought on by the continuing
issuance of credit to insolvent, non-performing enterprises to
ensure employment.  In 1991, the government provided full debt-
relief to all enterprises in the hope that reducing arrears would
provide sufficient capital for expansion and improvements in
efficiency.  Unfortunately, enterprises for the most part have
not made the necessary cost-cutting measures and have begun
again to acquire substantial inter-enterprise arrears.  Large
state-run businesses continue to acquire inter-enterprise debt,
believing that state intervention and support will continue to
protect their industries.  It is estimated that inter-enterprise
debt has reached $2.3 billion, 20 per cent of GDP.(4) This has
promoted a lack of confidence in the government's monetary and
privatization policies which has precipitated the further
devaluation of the lei and 200 per cent annual increases in
inflation.  The OECD states in its report that "when economic
policy has been faced with the dilemma of either supporting
unproductive activities at a cost of sacrificing monetary, fiscal
or structural reform goals, or imposing financial discipline,
(including economic prices) and facing higher unemployment and
firm closures, the former option has been taken more often than
not".  However, as the labour strikes dramatically illustrate,
the government will have to be extremely careful to balance
sacrifice and also provide some level of economic security for
the population.


21.  Obviously, it is imperative that the government begin to
quicken the pace of privatization of non-performing industry.
A strong bankruptcy code and strong enforcement procedures should
also be considered.  Business practices go relatively unchecked,
with complaints ranging from unfair business practices to a
burgeoning underground economy.  It is estimated that Romania
loses approximately $1 billion in tax revenue due to
non-reporting of income.(5) While these characteristics are
common in all of the newly independent states, Romania has the
opportunity to change this course before it reaches the levels
seen in many of the CIS countries.


E.   Privatization and the Role of Foreign Investment and
Assistance

22.  The role of foreign investment and direct assistance is
considered vital within the context of Romania's privatization
programme.  The National Agency for Privatization was created in
the summer of 1990.  Since its inception, over 12,000 small
and medium enterprises have been privatized by public offerings
and an additional 6,500 larger companies are currently in the
privatization process.  Romania has constructed an extremely
attractive package of foreign investment incentives, some of the
most enticing in either Central or Eastern Europe.


23.  With regard to tax and customs, capital equipment imported
by foreign investors is free from customs duty.  Imported
supplies intended for production purposes are exempt for two
years.  Additionally, foreign businesses may receive a five-year
tax free holiday for industrial, agricultural and construction
enterprises and one of three years for transportation and for the
exploration and development of natural resources.  When the tax
holiday expires, companies may reduce their tax on profits
by 50 per cent if reinvested in Romania, when used for corporate
investment or enhancing the environment.  A 25 per cent
reduction in tax liability can be achieved if half of the energy
requirements are imported or half of the total production is
exported.  Unfortunately, one element of the privatization plan
that could have produced greater foreign investment, permitting
foreign firms to own land in Romania, was defeated in the
Romanian Parliament.  A leasing arrangement has been put in its
place.


24.  The key to the eventual privatization of all state-owned
businesses is the mass privatization programme currently
underway.  The programme encompasses 6,500 businesses, accounting
for $23 billion in value or 50 per cent of the aggregate
corporate worth in Romania.  Seventy per cent of the total shares
in these businesses have been placed in a state ownership
fund (SOF) which must sell 10 per cent of its assets each year
under law until privatization is complete.  Therefore, it is
hoped that the attractive foreign investment policies will be
sufficient enticement to sell off the 70 per cent share within
the SOF, thereby completing the privatization process in the next
seven years.  The remaining 30 per cent of the shares have been
placed in a private ownership fund (POF).  These shares have been
released to the general public in the form of certificates.


25.  Signs of the emerging private sector can be illustrated by
its increasing role in foreign trade transactions.  In 1990,
the private sector accounted for 1 per cent of all foreign
transactions.  Today, the estimated percentage of private sector
foreign transactions is 30 per cent.  This rapid increase has
been facilitated by a maximum tariff on goods of 30 per cent.
However, continued trade protectionist measures by the EC and the
continued unwillingness of the United States to grant the MFN
status has severely hampered Romania's ability to expand its
trade.  Romania signed an association accord with the EC in March
and has negotiated an additional agreement this summer to speed
up the introduction of lower tariff barriers from the Community
to Romanian goods.  In addition, negotiations with the United
States concerning the MFN status continue with the granting of
the MFN status expected by the end of 1993.


26.  The response by foreign investors to date has been
significant in some areas.  Over 16,000 joint ventures have been
created, with an estimated $500 million in capital.  The majority
of these partnerships are in small and medium concerns.
However, it is important to note that over the past year and
half, forty companies with more than $1 million in foreign
capital have been created in Romania.  The largest investors have
been the United States, Netherlands, Germany, United Kingdom,
Italy and France.  Unfortunately, very little investment has been
introduced in large industrial concerns which require immediate
restructuring, closure or sale to reduce government liabilities
toward maintaining employment.


27.  Aid from international lending institutions and additional
technical assistance provided by the PHARE programme of
the EC and the United States Agency for International Development
is all important if Romania is able to attain additional
financial stability to continue to attract investors.  At this
juncture, approximately $900 million has been committed by the
G-24.  Of this total, the European Community is providing $500
million.  The EBRD has contributed $210 million and the European
Investment Bank another $30 million to assist directly in the
privatization programme.  Lastly, the IMF has provided two
stand-by agreements totalling $1.05 billion and an additional
$355 million in commercial loans.  Unfortunately, IMF loans have
not achieved the positive real interest rates that they had hoped
to produce through these arrangements.  The recent decision by
the IMF in July to postpone the dispersement of $3 billion
dollars in credits will severely hamper government efforts to
restructure the economy and attract foreign investment.  The IMF
has required the government to increase the pace of
privatization and lower inflation before granting approval of the
loans.  Without the IMF credits, this process will be vastly more
difficult to achieve.


28.  As for future trade initiatives, Commerce Minister
Constantin Teculescu has stated  that while his country had
conducted 70 per cent of its trade with the West last year, he
hoped that new trade areas could be developed - specifically,
with Russia, China, Japan and the Persian Gulf States.  In
addition, he expressed full support for a stronger and more
active Black Sea Co-operation Council that would stimulate
economic growth regionally.  This type of balanced trade approach
of combining traditional areas of trade with newly-developing
economic areas is precisely the prescription required to cure
Romania's trade imbalance.


F.   Conclusion

29.  In the face of three very difficult years since the fall of
Nicolae Ceausescu, Romania has taken the important steps
towards full democracy and the implementation of a market-led
economy.  While inflation, privatization uncertainties and
political instability will continue to plague Romania in the
near-term, there are strong signs of a growing market economy.
However, the next year will be a critical time for the future of
the Romanian economy.  The government will have a very difficult
balancing act in order to achieve the needed structural reforms
and also ensure the population will be able to endure the
necessary sacrifices.  To gain the confidence of international
lenders, foreign investors and domestic entrepreneurs, Romania
will have to accelerate the privatization process.  At the same
time, inflation must be brought down and adequate wage
adjustments for the population provided to guarantee at least a
minimum standard of living.  These are steep goals to be placed
on an economy which has experienced record decreases in
production and output combined with rapidly rising unemployment
and inflation.



                                   Table

                 SELECTED ECONOMIC INDICATORS FOR ROMANIA
                 (*) See File: ak240a.tif


30.  The increasing debts, slow privatization of large state-run
companies and continuing high rates of inflation will perhaps
make it difficult for multilateral lending organizations to
justify further credits.  However, this is not the time for
Western lenders, technical experts and foreign investors to
abandon Romania.  In fact, it will be critical that continued
infusions of capital and technical expertise are afforded to the
government and to the private sector.  Romania has great
advantages with its natural resources and well-educated
workforce.  With assistance, these advantages could be turned
into a strong economic force and a stable and dependable ally.


II.  LATVIA

A.   Introduction

31.  In June 1993, Latvia elected a new parliament and in July a
new government was formed.  Both will be closely watched on its
stewardship of economic reform.  The election was dominated by
the issue of economic restructuring and better living conditions
for the population.  Many of the structural reforms and the tight
monetary policy of the past couple of years are beginning to show
dividends.  However, several areas of importance remain to be
dealt with.  Potential complications in successfully passing
important statutes in parliament, and their subsequent
implementation, may arise due to a coalition government which
commands less than 50 per cent of the seats in parliament.  A
strong and broad consensus over the direction and pace of further
privatization combined with increased foreign credits and
investment will be pivotal over the next year.  As the parliament
is to be re-elected in October 1995, little time is afforded to
show the significant results demanded by the population.


B.   Key Economic Indicators and Reforms

32.  The latest official rate of registered unemployed is
approximately 6 per cent of the active population.  However, if
unemployment is measured more broadly to encompass
under-employment and unfiled claims, the percentage of unemployed
is estimated to have reached upwards of 44 per cent.(6) It is
important to note that at the beginning of 1992 there was still
no official unemployment.  According to Government statistics,
the consumer price index had increased by approximately 700 per
cent in 1992. Unfortunately, standard of living levels were
affected due to an average monthly wage increase of 350 per cent,
exactly half of the accumulated inflation.  Recent government
figures show the rate of inflation decreasing substantially with
only a 2.3 per cent rise in prices for June 1993, as compared to
40 per cent during June of 1992.  The sharp reduction in
inflation is attributed primarily to a relatively stable price
for fuel, which has risen by 25 per cent over the past year.  The
GDP of Latvia fell by one-third in 1992, as have foreign trading
volumes.  Lastly, the budget deficit continues to rise,
surpassing in July the government's estimates for all of 1993.
Most experts attribute the rise in the budget deficit to the
inability of the tax system to effectively collect revenues.

33.  However, some of the economic policies implemented since the
beginning of the year were revealing initial results.
The latest economic performance figures released by the
government in June 1993 show that inflation seems to be under
relative control, the exchange rate for the lats steady and a
significant foreign trade surplus.  Unfortunately, production
continues to fall at a rapid rate while stocks of finished
products continue to grow.  Importantly, the government's reform
efforts have been supported since September 1992 by a stand-by
agreement with the IMF.  However, despite generally adhering to
IMF guidelines, most notably in the realm of monetary policy, the
lack of purchasing power and the absolute reliance on foreign
energy has caused the GDP to fall in 1992, with an expected
additional drop in 1993.


34.  A case in point was the introduction in May 1992 of an
interim currency intended as a precursor of Latvia's own
currency, the lats.  By November 1992, the Latvian rouble
appreciated by 40 per cent against the Russian rouble and against
hard currencies as well.  However, this seemingly positive
development also had a detrimental effect by reducing exports to
the CIS by Latvian industries that had contracted to receive
payment for their products and services in Russian roubles.  This
in turn, has severely reduced corporate revenues at a time when
additional resources are critical to industrial and commercial
expansion.


35.  The lats was introduced on 5 March 1993 and further issued
on a gradual scale, with its value set by the market.  The
lats has shown remarkable strength and has provided a stable
exchange rate.  As inflation has been a major factor in public
dissatisfaction with government policies in the past, prices are
now stable and in some sectors falling.  Foreign investors are
also increasingly being lured by the stable currency which should
bring much needed foreign hard currency reserves into the
economy.  In fact, while initially criticized for leaving the
Rouble Zone, Latvia and the other Baltic countries have been able
to avoid much of the currency turmoil which reached a climax this
summer with the Russian Central Bank's decision to withdraw
pre-1993 roubles from circulation.


36.  However, the state of Latvian production and output
continues to cause problems for economic planners.  Several
factors are associated with the persistent decreases in
production.  The continuing divergence in the exchange rate
between the lats and the Russian rouble; the disintegration of
the Soviet economy and the resulting reduction in its production
and rising inflation has stifled the flow of strategic resources
and materials to the economy; the disappearance of military
orders from the CIS; and a steep fall in consumer demand.  The
Latvian industrial sector will need complete restructuring in
order to compete with more technologically advanced export
markets.  In addition, stable energy supplies and lower prices
must be made available for long-term confidence to implement
production contracts.  Lastly, increased capital, both internally
and externally, must also be made available in order to provide
the necessary resources to facilitate the restructuring process
and increase economic growth.

37.  The energy crisis brought on by Russia's new policy of
demanding world market prices for energy supplies has had
a severe effect on Latvians, both for commercial and private
users.  Latvia has practically no domestic energy resources and
has traditionally received such supplies from Russia and the
other Baltic States.  This sudden increase in energy prices has
resulted in a severe reduction in the purchase of energy
supplies.  Although private energy consumption is subsidized by
the government, many Latvian citizens had to undergo immense
hardships during the winter of 1992-1993.  Higher energy costs
have also directly contributed to the large rise in unemployment
stemming from a reduction in output of 31 per cent in 1992
and 44.6 per cent during the first six months of 1993.  The even
greater decrease in production over the first half of 1993 can
be partially attributed to the shutting off of energy supplies by
Latvian authorities, and briefly by Russian exporters, due to
delinquent payments by Latvian industries.  As of August 1993,
over 100 Latvian enterprises were without gas supplies.
Continued strained relations with Russia and increasing prices
for energy have brought uneasiness by potential investors in
production facilities.


38.  The lack of advanced technology and capital to make
production improvements and efficiencies have also stunted
economic growth.  Domestic investment has been suppressed due to
commercial and governmental lending policies that appear to be
overly cautious and restrictive in both the amount of available
credit and the loan terms.  The president of the Commercial Bank
of Latvia has expressed considerable frustration at the absence
of a set of regulations and laws to govern the business sector.
The resulting risk in lending to potential entrepreneurs has led
the bank to provide loans for a maximum one-year term.  These
conditions prevent banks from actively participating in the
privatization process and helping stimulate economic growth.
Tight monetary policies introduced by the central bank have only
exacerbated this lack of capital.


39.  However, the contradictory policy objectives of reducing the
rate of inflation through a conservative monetary policy
and also working to promote domestic and foreign investment and
meet infrastructure needs illustrate the dilemma facing Latvia.
After apparently conquering inflation, the Central Bank of Latvia
has reduced interest rates three times over the past six months.
However, even with these recent reductions, the current interest
rate stands at 38 per cent.  These continued high rates preclude
a large majority of investors due to the impossibility of
acquiring a return on investment exceeding the lending costs.
Obviously, the key in the short-term to acquire much needed
capital will be the success of Latvia's foreign investment
strategies and implementing sweeping business regulations.
Foreign capital will also be critical at this juncture to ensure
sufficient capital expansion while allowing tight monetary
policies to proceed.  This will require industry to modernize and
reduce the need for energy.





C.   Foreign Investment and Privatization

40.  Foreign investment, until there are more attractive monetary
and lending policies, will remain the most important element to
promote future economic growth and industrial restructuring.  At
present, foreign investment is on a decline following an initial
surge after independence.  This trend can be attributed more to
lending and political policies of the former Latvian government
than to its foreign investment laws.  While a significant
impediment exists with the inability for foreign investors to own
land in Latvia, tax incentives have been implemented to stimulate
outside interest.  Specifically, current law provides tax breaks
to foreign investments that exceed $1 million during a three-year
period.  Unfortunately, this policy is not applied across the
commercial spectrum but only targeted to industries approved by
the government such as the tourism and
transportation sectors.

41.  Another major impediment to the participation of foreign
direct investment in the privatization process is the
conspicuous absence of a centralized institution responsible for
the entire privatization process.  The approval procedures for
the privatization of state and municipal property include a
number of steps, all of which involve two or more local and
government agencies.  This unnecessarily cumbersome procedure has
led to a general lack of co-ordination, created confusion
for potential outside investors, and has slowed considerably the
pace of the privatization process.  The new government, in its
first address, stated that it intends to construct a central
privatization agency, streamline investment procedures and
provide a coherent unified government policy to attract foreign
investors.  Prime Minister Birkavs also stated that the
government intends to privatize 75 per cent of all state-owned
property by 1996.  However, he expressly pointed out that the
privatization of small- and medium-sized concerns would take
precedence over that of large industrial enterprises.  In order
to avert large-scale unemployment through the immediate closure
of large enterprises that are insolvent, the government will
attempt to assist in promoting sub-units within the concerns that
could be successful independently.  Western technical experts
should play an active role in identifying potentially attractive
and successful spin-off companies within these large enterprises.


42.  Latvia's Supreme Council passed a decree in March 1992 which
advocated privatization targets for the following two
years.  However, to date, the privatization of industries has
been far slower than originally planned.  In 1992, the slow pace
was attributed to the absence of a Latvian currency and
sufficient private savings.  However, over the past 6 months,
many observers have come to believe that unclear government
regulations, the absence of a privatization agency and the
postponement of many key reforms until parliamentary elections
also contributed to this delay.  With the new government's pledge
to streamline the privatization process and to construct a
centralized agency, hopefully the privatization process will
accelerate.


43.  By the end of 1992, local governments had privatized 157
shops, 29 catering establishments and 116 service centres,
which account for 4 per cent of such establishments in Latvia.
The majority of privatized establishments were sold to
companies, while about one-third were purchased by private
entrepreneurs.  The total proceeds from the sale amounted to
269.9 Latvian roubles ($1.8 million).(7) Seventy-three per cent
of all consumer goods manufactured during the first six months of
1993 were produced by state-owned companies.


44.  Land reform and privatization policies have been of
particular interest to Western advisors as the key to the future
economic welfare of Latvia.  Many observers believe that current
policies in these critical areas are not entirely based on
economic principles, but seemed to be interlaced with other
objectives aimed at tilting economic advantage toward ethnic
Latvians.  Considering the devastating history of Latvia, this
policy is certainly understandable.  However, if this policy
becomes permanent, it may have undesirable effects on the
efficient use of resources and foreign investment.

45.  Latvian citizenship laws are based on current guidelines
adopted by the Supreme Council on 15 October 1991.  These
guidelines stipulate that only those who were citizens before
1940 and their descendants are entitled to automatic citizenship;
others can only receive citizenship if they have been a resident
for a minimum of 16 years and are able to complete successfully
a fluency test of the Latvian language.  The consideration of
future citizenship requirements on this issue had been postponed
until the new Parliament was elected.  However, it should be
pointed out that a large percentage of the ethnic minority
population in Latvia (possibly as high as a third of the total
population) were unable to participate in the elections due to
the absence of an official citizenship policy.

46.  The concerns expressed by both potential outside investors
and internally by Latvians without citizenship have centred
on the government's proposed land ownership provisions which
allow for the outright ownership of any facility but deny the
right to own the property.  This seems to hamper any incentives
for foreign investors to make long-term commitments, critical
to sustained growth, and has incited a great amount of concern by
non-ethnic Latvian groups who fear they will be  unable to
fully  participate in  the  reform process.  It should be noted
that ethnic Russians compose almost 85 per cent of the workforce
in the heavy manufacturing sector; their experience and
resources, if invested, would undoubtedly accelerate the process
of restructuring Latvia's industries.

47.  In response to the concerns of foreign investors to this
policy, Prime Minister Birkavs stated "we must create
opportunities to invest in real estate for those foreign
companies that make big investments in prioritized areas".  With
regard to the concerns of ethnic Russians, the Prime Minister
stated that a "citizenship law will be the main guarantee of
constitutional rights, whereby Latvia is a unified state with the
right of cultural autonomy for its traditional minorities; after
its adoption, the naturalization process can begin, as well as
voluntary repatriation of those not wishing to become citizens;
membership of a minority will not restrict political and social
rights; non-citizens will be guaranteed all internationally
recognized rights".(8) Western multilateral institutions such as
the Council of Europe, the United Nations and the European
Parliament have all expressed concerns over the citizenship
guidelines currently in force.  The West should continue to urge
the immediate implementation of a citizenship law that conforms
to all international human rights agreements.


48.  Lastly, the Russian government has made it very clear that
they do not intend to proceed with military withdrawal from
Latvia or Estonia before the agreed deadline because of their
concerns over the plight of the large ethnic Russian populations
within these two countries.  The North Atlantic Assembly and its
member governments have been very clear that they would like
Russia to proceed unabated in its withdrawal from all three
Baltic countries.


D.   New Economic Structural Policy

49.  The new government has outlined an extensive restructuring
of the Latvian economy to improve productivity, output and
competitiveness.  With low inflation and a stable currency,
Latvia is in a good position to begin further reducing interest
rates and provide additional investments in key strategic
industries.  The government has announced a plan to target
resources in several areas that are considered imperative for
future economic development.


50.  The government foresees three phases of restructuring.  The
first phase is to improve its infrastructure, communications and
financial sector by improving commercial transport,
telecommunications and the banking system.  Within industry, the
target is the "rehabilitation and privatization" of large
commercial enterprises to be done in conjunction with a
restructuring of the banking system to ensure proper payment of
outstanding loans.  This could also take the form of stock
swaps for debt relief.


51.  The second phase would emphasize traditional sectors of the
economy which are not energy intensive.  The textile and
electronics industries would be provided additional government
investment.  These industries, while currently competitive within
Latvia's traditional trading areas, either lack the present
production technologies to compete with western producers or
have lost their markets due to economic restructuring in the
East.  For example, the electronics industry has primarily been
structured to produce within the defence industry, while machine
building enterprises use relatively primitive technology in its
production.  The third phase would develop centres to train
prospective entrepreneurs who wish to own small- and medium-
sized businesses.  This plan would work in conjunction with a
programme implemented by the European Community.
Agriculture has also been identified as a critical sector and
would be restructured so as to promote the use of co-operatives
and the further privatization of processing plants.
Additionally, the government also intends to impose import duties
on agriculture products to provide protection from competitors.
The World Bank has agreed to supply a $25 million loan for the
purpose of increasing available capital for the privatization of
processing plants and for individual farmers.


E.   Foreign Trade and Assistance

52.  While foreign trading volumes dropped by a third, Latvia has
been able to achieve a large trade surplus.  Forty per cent of
all imports were for energy, primarily from Russia.  What is
needed is an expansion in trade growth both in the East and
with Western neighbours.  Although the logical first step would
have been to re-establish the traditional economic ties as a
matter of priority, the former Latvian government concentrated
its efforts on developing trade partners in the West.  While
integrating with the economies of the West is obviously essential
to future prosperity, short-term trade policy would be more
efficient if it concentrated on its neighbours.  This fact is
illustrated in the composition of current Latvian industry.
Until the needed restructuring and improved efficiency of
industries is concluded, Latvia's industrial base and
infrastructure will remain oriented mainly toward the East.
Russia accounted for 28 per cent of all exports during the first
five months of 1993.


53.  Unfortunately, this leaves Latvia in somewhat of a quandary
due to the fact that its neighbours are currently undergoing deep
economic downturns with little demand for consumer goods.
Therefore, the Latvian government will need to implement a
two-track approach by restructuring industry to compete in the
West while also working closely with its Baltic neighbours to
stimulate economic growth and trade regionally.  Only by
re-establishing traditional trade ties while adapting the
infrastructure can the Baltic ports regain their traditional role
as the gateways to the West.  Thus, substantial Western
assistance is required to help alleviate the pain from reforms.


54.  The International Monetary Fund has already granted Latvia a
$60 million loan and has been working closely with the
central bank on monetary policy.  An additional $65 million is
expected to follow soon due to Latvia's firm grip on inflation.
The G-24 has since contributed an additional $300 million in
balance of payments' support to the three Baltic States.  In
addition to the various assistance projects co-ordinated through
G-24, the EC has extended other forms of aid to Latvia.  On 3
March 1993, the Latvian Parliament ratified a ECU 80 million ($94
million) loan from the EC, which will be used to purchase fuel,
raw materials, equipment and technology.  The funds will be
distributed through the Latvian Investment Bank and other
commercial banks.*  Other international organizations have plans
to provide the sort of technical assistance which is critical
during this phase of policy formulation.



*    Loans to individual companies are limited to $3 million,
repayable in three years. The total EC loan has to be repaid
in seven years.


55.  It should be noted that Latvia is an active participant in
the Council of Baltic Sea States, which was formed following
a conference in Copenhagen on 5-6 March 1992.*  Its aim is to
promote economic and democratic development, foster
co-operation and boost ties between the EC and the non-EC members
of the region.  Within this framework, the three former
Soviet Baltic republics have also been engaged in negotiations
aimed at establishing a free trade zone between the three
countries.  While negotiations broke down in March 1993, there
are great expectations that a trilateral treaty will be signed
this autumn between the Baltic States.  Future trade and
political collaboration between the Baltic States will reap
rewards for all three states.


F.   Conclusion

56.  The Republic of Latvia is undergoing immense challenges at
this time.  It is critical for both the security of the Baltic
region and the rest of the former Soviet Union that the economic
reform process is successful in this strategically important
country.  With its ports, educated workforce and close proximity
to the economically strong Nordic neighbours, Latvia has many
natural advantages.  Economic restructuring and production
efficiencies must be continued, along with a fair citizenship
policy.  The initial statements by the new government show
promise in all of these areas.


57.  With the recent parliamentary elections and the formation of
a new government it is hoped that Latvia will accelerate
the privatization of industries and improve the climate for
foreign investors.  A future regional trading block between the
three Baltic States and the acquisition of stable energy supplies
will be extremely important for Latvia.  Recent trade statistics
show that exports to the West have been growing.  With the
modernization of key industries and a more transparent business
climate through well defined government regulations, Latvia could
begin to attract much needed investment.  Its tight monetary
policy has achieved its objectives of a stable exchange rate and
low inflation.  With greater capital resources, the expansion of
output and production should be realized.  This will be achieved
by larger commitments from foreign investors and should be
followed by the continuing easing of lending policies internally.




58.  Latvia has been faced with some daunting challenges over the
past three years.  Its achievements have been
considerable.  However, the slow privatization process, unclear
citizenship guidelines and lack of a stable energy supply will
only continue to cause long-term economic problems.  Now appears
to be the time for Latvia, with the assistance and backing
of Western lending organizations, to correct these deficiencies.



_______________________________

*    The members of the Council of Baltic Sea States are:
Denmark, Estonia, Finland, Germany, Latvia, Lithuania, Norway,
Sweden, Poland and Russia.



BALTIC ECONOMIC INDICATORS

(*) See File: ak240b.tif
              ak240c.tif
              ak240d.tif


                                   NOTES

(1) Financial Times, 18 March 1993

(2) Radio Free Europe, 5 February 1993 / Rompres, 14 and
    24 December 1992

(3) "Romania - an Economic Assessment", OECD, Paris 1993.

(4) Financial Times, 26 August 1993

(5) Ibid.

(6) The Baltic Independent, 16-22 July 1993

(7) The Baltic Independent, No.151, 5-11 March 1993

(8) Latvian Radio, Tiga, 09:00 20 July 1993


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