ECONOMICS AND SECURITY 188 ESCEW 05 E Original: English NAT O   Pa rl i a me n t a ry  As s e mb l y SUB-COMMITTEE ON EAST-WEST ECONOMIC CO-OPERATION AND CONVERGENCE VISIT TO RIGA, LATVIA SECRETARIAT REPORT 15 & 16 SEPTEMBER 2005 International Secretariat 13 October 2005 * This  Secretariat  Report  is  presented  for  information  only  and  does  not  necessarily represent the official view of the Assembly. Assembly documents are available on its website, http://www.nato-pa.int

188 ESCEW 05 E 1 1. Vineta Mui niece, Deputy -Speaker of the Saeima opened the meeting by noting that Latvia has been involved with the NATO Parliamentary Assembly since 1995. The relationship has been an  important  one,  particularly  for  a  country  like  Latvia  where  security  concerns  are  a  central government  priority.    Latvian  officials  have  long  recognized  that  their  engagement  in  NATO demands  that  it  become  an  “exporter”  of  security  and  so  it  has  participated  in  a  number  of multilateral  peace  keeping  initiatives.  The  Latvian  people,  according  to  Vineta  Mui niece,  see international  stability,  freedom  and  democracy  as  mutually  reinforcing.    The  Latvian  nation  is deeply marked by the two totalitarian occupations and one of the central obligations of the state is to ensure that this is never repeated.   2. N. Penke State Secretary of Foreign Affairs continued on the theme of Latvia as a security contributor. He noted that his country is well positioned to share its experiences with countries that are in an early phase of political and economic transition.  Latvia has limited resources to dedicate to  diplomacy  due  to  its  small  size.  It  seeks  to  maximize  its  resources  by  focusing  part  of  its diplomatic  efforts  on  CIS  countries,  particularly  neighbouring  states.    Ukraine  and  Moldova  are consequently two priorities for Latvian diplomacy.  Because of a common set of experiences, the Latvians have also paid particular attention to the Caucuses which today face profound transition and security challenges. 3. Latvian  officials  have  worked  hard  to  establish  dialogues  with  several  CIS  countries  and have sought to deepen their understanding of the myriad challenges they face.  Latvia has sent a number  of  fact-finding  missions  to  neighbouring  countries  to  assess  their  status  and  to  better understand their needs. This is done bilaterally but with an eye on Latvia’s key roles in European and  trans-Atlantic  institutions.  After  these  missions,  the  Latvian  government  explores  financial options  for  funding  projects.  It  assesses  whether  some  projects  would  best  be  shared  out  with other Western countries that can provide expertise and funding. Latvia has accordingly recognized that it needs permanent diplomatic representation with a number of countries that were once part of the Soviet Union. This can be a challenge for a small country with limited resources, but Latvian officials feel that this should be an important diplomatic priority. 4. In Moldova, the Latvian  government is working on prison and judicial reform as well as an effort to upgrade customs procedures. Obviously the problems of Trans-Dniester remain serious and there are many in Europe with a strong interest in building up systems to cope with a range of challenges stemming from this unsettled problem. 5. Latvia’s  experience  with  Georgia  is  somewhat  different.    Although  it  enjoys warm relations with  the  government,  practical  cooperation  has  been  rather  limited  although  there  is  a  surfeit  of good will.  Filling out the practical side of the relationship is now a priority. One idea is to provide training assistance to Georgia’s border guards.  Georgia clearly needs international support in this area;  its  problems  with  Russia  in  this  regard  are particularly daunting.  Latvia will soon open an Embassy in Tbilisi. 6. The situation in Ukraine has been a growing concern in Latvia. Latvian officials know that it can be easier to make a revolution than to foster the institutions and practices needed for strong democratic government.  Corruption has posed a serious challenge to the Ukrainian transition and threatens to destroy the kind of trust needed to sustain democracy. Latvian officials are eager to expand  their  cooperation  with  Ukraine  but  are  looking  for  more  concrete  proposals  from  their Ukrainian partners.  Although the Ukrainians too seem keen to deepen relations with the EU and NATO,  there  often  seems  to  be  an  absence  of  concrete  thinking  there  about  what  exactly  this should  involve.    Latvian  authorities  are  encouraging  their  Ukrainian  counterparts  to  focus  more systematically on the reform process in order to better discern their needs.   7. Belarussia  poses  a  different  and,  in  many  ways,  a  more  difficult  set  off  challenges.    The Lukashenko  government  has  shown  no  willingness  to  engage  in  reform, and it has targeted the

188 ESCEW 05 E 2 Polish  community  as  well  as  dissidents  for  abuse.  The  regime  remains  strong  and  highly repressive,  while  the  opposition  is  not  well  organized.  All  of  this  makes  it  difficult  to  formulate  a policy response. 8. Russia poses a different set of challenges to Latvia. Obviously the historical legacy of Soviet occupation  weighs  heavily  on  the  minds  of  Latvian  policy  makers  charged  with  formulating  a Russian policy. It is well known that outstanding national questions in the Baltic region were not settled   after   the   Second   World   War.   The   iron   curtain   simply   came   down,   Latvia   lost   its independence, and many highly complex issues were swept under the table, some of which to this day remain unsettled. This lack of closure remains a source of tension in the region and there has been some thinking on how to ease this historical burden.  Leaders in the Baltic countries lament the fact that Russia simply does not want to engage in a common reflection on the occupation, its meaning  and  its  legacy.    Mr.  Berzins  (Head  of  the  Latvian  Delegation  to  NATO  PA)  noted  that there  has  been  a  push  to create a Commission to explore this legacy and to build a consensus about Latvia’s long period of occupation.    9. On  the  other  hand,  there  is  an  important  set  of  business  links  between  the  two  countries, and this points to the interests each side should have for improved relations. Still these historical questions weigh heavily on the current relationship, with the Russian authorities generally unwilling to see the Soviet occupation of Latvia as ever having been an occupation at all; this has all kinds of implications in current Russian thinking about the Baltic States.   10. The  Latvians  want  to  deal  with  this  matter  in  an  open  and  transparent  manner.    Because there  are  many  ethnic  Russians  living  in  Latvia,  many  of  whom  are  citizens  of  that  country,  the Russians  sometimes  seem  to  reject  the  full  legitimacy  of  the  Latvian  state,  for  example,  by constantly reopening border questions that the Latvians and the broader international community view as definitively settled.  This is a problem that Estonia, in particular, is also confronting.  The Russians have also been very slow to respond to Latvian proposals for the formation of bilateral commissions  to  deal  with  outstanding  disputes,  and  this,  in  turn,  has  made  it  difficult  to  make progress  on  practical  matters  hindering  deeper  cooperation  like  double  taxation,  tourism  and customs cooperation.   11. Latvian officials see the next presidential elections in Russia as a potentially critical moment for the relationship. The Russian state has accrued enormous powers while high-energy prices are strengthening its hand.  The problem is that this windfall is dissuading Russian officials and society from embracing much needed economic and political reform. 12. The  rights  of  the  Russian  minority  in  Latvia  have  also  been  an  ongoing  source  of  tension with   Russia.   Latvian   officials,   however,   suggest   that   they   have   made   great   strides   in accommodating this minority and have established strong integration policies fully consistent with European  norms.  Their  approach,  however,  begins  from  the  premise  that  Latvia  is  a  sovereign nation. Members of the Russian minority can become naturalized citizens and many are following this course. It is not difficult to become a Latvian citizen. One needs to learn the Latvian language but the test is not difficult.  95% of those who take it pass on the first attempt.  Russian officials are apparently  reluctant  to  recognize  this,  and  do  not  publicly  encourage  the  Russian  community  to pursue this straightforward means to achieve political integration. Many Russians privately confide that  the  Latvian  policy  does  offer  the  Russian  minority  a  means  to  participate  fully  in  the  life  of Latvian politics, but they are reluctant to say so publicly.   13. Ms. Paegle from the Parliament’s Foreign Affairs Committee suggested that EU enlargement has  triggered  a  significant  realignment  of  power  within  Europe.  New  EU  powers  like  Poland  are playing  a  dynamic  role  in  the  life  of  the  Union,  and  this  has  significantly  altered  European perspectives  and  decision-making.    All  the  new  members  have  introduced  unique  views  on  key questions shaping relations with countries like Ukraine and Russia.

188 ESCEW 05 E 3 14. Immigration  has  become  a  central  question  for  all  of  Europe.    How  governments  order questions   pertaining   to   integration,   fealty   to   the   state   and   citizenship   is   highly   salient   in contemporary  European  politics.  The  challenge  is  hardly  unique  to  Latvia.  Although  there  are Russian  concerns  about  ethnic  Russian  non-citizens  living  in  Latvia,  Russia  itself  has  some 2 million  people  with  no  status  at  all.  They  are  neither  considered  as  Russian  nor  as  refugees. They lack social and labour rights.  Russia also has no repatriation law.  This has made it difficult for many to return to their country. 15. Internationally  Latvia  is  seeking  to  consolidate  the  gains  it  has  made  over  the  last  decade and now wants to make its own mark on the international system. There is an effort underway to prepare  leaders  for  leading  international  civil  service  positions.    Latvia  is  a  country  with  limited resources  and  so  its  diplomacy  must  be  targeted.  Along  these  lines,  it  also  works  closely  with Estonia and Lithuania throughout the Baltic Council to identify common interests and hammer out common  strategies  for  securing  these.    Baltic  unity  is  thus  seen  as  another  priority  of  Latvian foreign policy. 16. Domestically, Latvia faces a serious demographic challenge. The population is declining and the society is aging, a trend that is unfolding throughout much of Europe.  Many residents of Latvia departed  after  the  break-up  of  the  Soviet  Union,  and  there  is  still  evidence  of  a  brain  drain  that impinges on the productivity of the country.  Many young people have moved to the United States and  Ireland  while  highly  skilled  professionals  have  left  for  countries  where  they  can  earn  more money.   17. The  Committee  also  met  with  Krisjanis  Karinš,  Minister  of  Economy  and Ilmars Rimševi s, Chairman  of  the  Bank  of  Latvia  as  well  as  Mr.  Ozols  Chairman  of  the  Latvian  Investment  and Development  Agency  (LIDA)  and  Mr.  O.  Sl ti š,  the  LIDA  representative  in  Moscow.  Latvia  is undergoing a very rapid rate of growth, which has raised income levels significantly in the country. One  problem  has  been  that  most  of  this  growth  is  focused  in  Riga  and  its  environs.  Pushing development outward has been a priority but this has not proven easy. The international business community  is  clearly  interested  in  operating  in  Riga  because  of  its  dynamism,  high  levels  of education and infrastructure. But as wages and costs rise in the city, there will be new incentives to operate in the more remote areas of the country. 18. Last year the Latvian economy grew by 9% driven, in part by huge capital investments. This growth was clearly fuelled by the Euro 350 million of foreign direct investment that flowed into the country  in  2004.  This  represented  one  of  the  highest  per  capita  investment  rates  in  the  world.   Money is flowing in not only because of privatisation but also because of the exceptional business climate, Latvia’s accession to the EU and NATO, and very low tax rates. 19. There  has  also  been  a  very  substantial  increase  in  lending  to  households.    Indeed,  Latvia currently has the highest lending rate to households in Europe. With falling interest rates and with its place in the European Union now secured, economic confidence has soared. This has certainly been  a  factor  in  high  levels  of  investment  and  soaring  economic  growth.    Yet  there  are  also concerns  about  the  balance  of  payments  and  the  fact  that  the  housing  market,  in  particular,  is overheating.    Although  the  economic  outlook  remains  very  positive,  the  worst-case  scenarios would involve a sudden deflation of housing prices, significantly reduced trade and soaring energy prices. 20. Latvia  has  built  a  very  open  economy  and  the  current  account  deficit  has  been  hovering between 12% and 9% of GDP in recent years. At the same time, exports last year grew by 35%. The government hopes that the current account deficit will shrink to 7% of GDP. The deficit on the current  account  is  largely  driven  by  the  country’s  burgeoning  demand  for  capital  goods;  firms operating  in  Latvia  are  importing  many  production  inputs.  Imports  are  financed  through  the significant capital inflows—

188 ESCEW 05 E 4 however  has  limited  the  capacity  of  the  central  bank  to  stem  inflationary  pressures.  Bank authorities have thus had to rely on changes in reserve requirements to manage inflation but this is not always easy.   Fiscal policy is also an important tool for macro economic management; there are significant pressures on the government to bring down budget deficits. The government hopes to accede to the Euro by 2008, and this ambition is helping to discipline fiscal policy.  Next year’s elections, however could pose problems as the temptation to spend will be higher. There are also concerns  about  inflation.    Energy and food prices have risen considerably in recent months and the inflation rate is now approaching 6% 21. Since the Russian financial crisis of 1997, Latvia has shifted its commercial links so that it is less  dependent  on  trade  with  Russia,  although  Russian  gas  supplies  remain  essential.    Latvia’s biggest trade partners include Germany, Lithuania, Sweden and Estonia.  80% of its trade is with EU. 22. The Latvian Investment and Development Agency (LIDA) is charged with promoting Latvian business abroad through trade and export promotion. It also works to attract investment to Latvia while  administering  those  European  structural  funds  dedicated  to  advancing  the  work  of  private entrepreneurs.    Over  the  last  year  and  half,  LIDA  has  worked  on  projects  worth  more  than Euro 100 million, which have generated 100 thousand jobs. Latvian exports have soared over the last  decade,  while  just  in  the  past  year,  foreign  direct  investment  has  increased  by  40%, encouraged, in part, by the country’s very open investing rules. This investment will inevitably lead to  further  increases  in  exports.  Latvia  has  also  created  special  tax-free  economic  zones.  The accession  agreement  with  the  EU  will  allow  these  zones  to  operate  until  2017.    Latvia  appears quite welcoming to foreign investors; it is now firmly anchored in the West yet it is very close to Russia and knows that country well. It is also near important Scandinavian markets, and because of its liveability, it is a country where international business managers can easily live and operate from. 23. Latvia’s  key  exports  include  wood  products,  machinery  and  mechanical  appliances  and textiles. Although 90% of textiles produced in the country are exported, the industry is not directly threatened  by  the  rise  of  China’s  textile  business.  In  Latvia,  that  sector  is  very  specialized  and operates  in  niche  markets  that  the  Chinese  are  unlikely  to  fill.  Latvian  investment  specialists suggest that it can be terribly difficult to compete with China for plants when the investor foresees the need to create more than 1000 jobs. At that point, the wage component of the investment is very important. It is, however, far more competitive for investments that will create fewer jobs.  In these cases other factors become important such as the education level of workers, geographical proximity to markets, and business ethics become more important. 24. Economic  analysts  in  Latvia  recognize  that  its  highly  qualified  labour  force  is  one  of  its strongest  assets.  Latvia  enjoys  a  very  high  level  of  education  and  a  strong  tradition  in  the sciences.    The  level  of  enrolment  in  the  universities  is  the  second  highest  in  the  world.  One problem is that the universities are not turning out a sufficient number of engineers. Government authorities believe that Latvia must move quickly to play a role in emerging high technology and service sectors in order to exploit the capabilities of its work force and to avoid having to compete with lower wage countries. But it must target its activities simply because it is such a small market with finite resources.  Latvian officials also expect to generate high foreign exchange earnings in transport and tourism. 25. Latvian  trade  with  Russia  remains  important.  It  imported  Euro  614  million  of  goods  from Russia  last  year  and  made  Euro  255  million  in  exports.    Exports  to  Russia  include  food, machinery,  chemicals  and  textiles  as  well  as  electronics.  Imports  from  Russia  include  energy, metal products and timber, which are processed in Latvia. Latvia is clearly emerging as a business hub for the CIS, and this is why Russians are also investing in the country. Russian investors are attracted to the country’s place in the EU, its stability, the fact that Russian is widely spoken, and

188 ESCEW 05 E 5 its  proximity  to  Russia  itself.  Latvia  is  a  Western  country  that  clearly  understands  the  East.  It  is also  a  safe  haven  for  Russian  investors  who  fear  the  political  vagaries  of  operating  in  the  ever more politicised Russian market. 26. Indeed,  Russia’s  president  and  the  government  have  begun  to  reassert  state  control  over the  market  and  are  using  economic  assets  to  extend  their  political  power  and  leverage  over  its neighbours  and  particularly  those  countries  that  were  once  part  of  the  Soviet  Union.  This  is particularly   apparent   in   the   oil   sector.   This   has   been   described   as   stealth   imperialism   in Keith Smith’s recent study of Russian oil geo-politics. 27. Of  course,  Latvian  relations  with  Russia  are  closely  related  to  EU  relations  with  Russia. Russia, of course, is the largest neighbour of the EU and the relationship has been defined by a series of agreements made over the last decade. The launch of the Tacis programme was the first of  these  and  it  was  followed  by  the  signing  of  a  Partnership  and  Cooperation  Agreement  which outlined  an  institutional  framework  for  cooperation  including  two  summits  a  year,  parliamentary cooperation and frequent opportunities for dialogue. In 1999 the EU outlined a common strategy that stressed deeper cooperation with Russia in areas like energy investment, transportation and environment.  This document is still being refined and it has had little practical effect although the energy  dialogue  has  produced  some  tangible  results.  Clearly  the  EU  and  Russia  have  several shared  interests  in  the  energy  sector.    Russia  is  the  most  important  energy  supplier  to  the  EU followed by Norway and Saudi Arabia. The EU meets 35% of its energy needs through Russian imports and has became Russia’s most important market. 28. Yet  the  situation  is  not  as  rosy  as  Brussels  likes  to  claim.  Recently  German  Chancellor Gerhard Schroeder met the Russian President Vladimir Putin to sign a deal that gave a green light to the construction of a 1200 km gas pipeline under the Baltic Sea.  Russia will pay 51% of the capital cost of this pipeline that should be completed by 2010.  There are also plans to build trunk lines to Finland and Sweden.  The Baltic states, however, are very unhappy that these deals were made  bilaterally  without  EU  wide  consultation.  Latvian  officials  feel  that  this  will  mean  that  the Baltic states will have to make separate deals with their Russian neighbours.  This will put them at a disadvantage, particularly given Russia’s penchant to wield the energy card against those states that it sees as somehow challenging their broader international ambitions.  The Latvians know that energy price hikes are inevitable. They are concerned however that the Russian energy policy will become  increasingly  politicised  and  used  to  apply  pressure  on  issues  that  the  Latvians  feel  are matters of sovereign concern. 29. This is why there is great unease with the German pipeline deal and particularly the fact that broader European interests were not considered when the deal was signed.  Chancellor Schroeder simply  wrote  off  Baltic  objections.  The  Latvians  are  thus  pushing  the  EU  to  develop  a  coherent energy  policy  and  a  unified  policy  toward  Russia  that  will  better  reflect  these  concerns  and  to better anticipate a Russian pattern of using energy for political purposes-something that has been particularly evident in Ukraine and in the Caspian.  The Latvians are also concerned that Europe may put itself at risk by relying too heavily on Russia to provide its energy needs.  Germany, for example, seems willing to secure as much as 50% of its needs from Russia, and this will give the Russians a great deal of political leverage over that country and its neighbours.  The Latvians do not  see  Russia  simply  as  an  energy  provider;  it  is,  from  their  perspective,  a  huge  neighbour confronted  with  a  continuing  identity  crisis  and  a  great  deal  of  uncertainty  about  its  values  and direction.  If Russia ignores the needs of new EU members, while meeting the energy demands of the old 15, then Europe will be divided and considerably weakened.  Russia understands this very well and it is playing this card to the obvious chagrin of Latvian political leaders. 30. The  Committee  also  had  an  opportunity  to  meet  NATO  Ambassadors.  The  Ambassadors reinforced  several  of  the  points  that  Latvian  speakers  had  made  the  day  before.    Several interesting points were made in these discussions:

188 ESCEW 05 E 6 31. Latvia has grown substantially but only recently has it reached the wealth level that it enjoyed in 1991.  This is indicative of how difficult the transition has been and the amount of sacrifice that has been made to build a functioning market where previously none existed. There are still some challenges that have to be met. Now that it has achieved membership of both NATO and the EU, it is now challenged to define a new set of national policy objectives.  Of course, it wants to continue to grow economically and bring its standard of living at least up to the European average.  It is also true that countries like Latvia are going to change the EU in important ways.   Moreover the Baltic states in particular can become EU ambassadors in the CIS countries.  They have a particularly valuable role to play in countries like Moldova and Ukraine whose experience they understand all too well. 32. Latvia is also seen as a very assertive country with a very clear understanding of its national interests.  It is playing an important role in the region, and in many respects its diplomatic clout is greater than its size.  Its visceral understanding of Russia is very important to the EU and its voice is thus welcome in both EU and NATO circles. 33.    The delegation also had an opportunity to meet the President of the Riga airport authority, Mr. Dzintars Pommers  and  Ms.  Tina  Kuze,  a  board  member  of  Hansa  Bank,  one  of  the  largest banks  in  Latvia.  The  airport  is  state  owned  and  is  not  slated  to  be  privatised.  Over  the  last  14 years it has undergone massive change.  In Soviet times, it only handled flights from the Eastern block. After the Soviet system collapsed air travel to Riga did as well.  Passenger traffic fell from 2 million passengers a year to 250,000.  But since then the airport has made very steady gains in passenger  numbers  while  undergoing  a  total  transformation  of  its  management  principals,  and flight links. The airport has invested some Euro 53 million to reconstruct the terminals— that have been largely raised through airport usage fees.  The facility is now very highly regarded; it has  attracted  a  number  of  airlines  including  Ryan  Air  and  has  won  awards  for  the  quality  of  its services.   The goal ultimately is to handle five million passengers a year. Obviously achieving this hinges on several factors, not the least of which includes future gasoline prices. 34. The banking sector has also experienced a massive transformation over the last 14 years.   In a sense it has gone through two transitions. There was the initial effort to create a market-based banking  system  after  the  collapse  of  communism.  This nascent system had to be reconstructed subsequently after the banking crisis of 1995, which was in part due to an inadequate regulatory system.  Once  a  strong  supervisory  system  was  in  place,  however,  Latvia’s  banking  system developed  swiftly  and  provided  a  stable  financial  anchor  for  the  economy  and  a  key  vehicle  for mediating relations between savers and investors.  Hansa bank itself was founded in 1992 when there were 63 banks operating in the country and it was the second smallest of these. Since then it has emerged as the largest bank in the country having undergone two mergers. It is today part of a  larger  Swedish  bank.    Hansa  is  a  universal  bank  offering  a  range  of  financial  services  from deposit retail banking to life insurance and commercial lending.  70% of middle managers at the bank are women as are three of the 8 board members.