Latvia may return to the international bond market in the second half of next year, when the government expects another credit-rating upgrade, Finance Minister Andris Vilks said.

Receiving a higher debt grade in the first half of 2011 would “mean that probably we will move for a Eurobond issue for the second half of the year,” Vilks said in an interview in Riga yesterday. “We will go only when we feel it’s the right time, when the rates are okay.”

Latvia’s economy, which shrank by about a quarter since 2008 in the world’s deepest recession, returned to growth in the third quarter as export demand boosted industrial production. The improved finances of the bailout-loan recipient prompted Standard & Poor’s to raise the country’s debt rating one level to BB+, one step below investment grade this month.

The country, recommended for investment with a Baa3 rating at Moody’s Investors Service, needs to climb one more step at either S&P or Fitch Ratings to make its debt eligible for more investment funds. Fitch also rates Latvia at BB+, its highest junk grade.

“If the government is able to meet its fiscal targets and the economy shows further signs of a sustained recovery, the rating will come under upward pressure over the medium term,” said Douglas Renwick, a London-based analyst at Fitch, in an e- mailed reply to questions from Bloomberg. “However, the size of the fiscal adjustment is still considerable and this poses risks to meeting the 2014 euro target.”

‘Strong Capital Flows’

Latvia last tapped the Eurobond market in March 2008, when it sold 400 million euros of bonds due 2018. The yield on the Eurobond fell 7 basis points today to 5.302 percent, compared with a yield of almost 12 percent in March last year.

“Given the improvement in investor sentiment towards the Baltic state and the solid performance of the Latvian government, Latvia has a high chance of taking its share from the strong capital flows to emerging economies,” said Yarkin Cebeci, an Istanbul based economist at JPMorgan Chase, in an email. “A possible Latvian issuance will be well received.”

The Baltic nation turned to a group led by the European Union and the International Monetary Fund for a 7.5 billion-euro ($10 billion) loan in 2008 after its second-biggest bank failed. Gross domestic product grew 2.9 percent in the third quarter, the first annual expansion in 10 quarters.

‘Better Than Expected’

“The economy is performing better than expected,” Vilks said, citing an estimate that GDP will remain flat this year, compared with an earlier projection for a 4 percent decline. The revision may allow upgrades to estimates through 2013, he said.

Five-year credit-default swaps on Latvian debt, which investors use to protect against default or speculate on a borrower’s credit worthiness, fell about 2 basis points yesterday to 272.3, according to data provider CMA. Latvian CDS prices reached almost 1,200 basis points in March 2009.

The increase in economic performance allowed the government to agree with the IMF and the EU on about 280 million lati ($525 million) in austerity measures in the 2011 budget instead of previous forecasts for as much as 440 million lati. The government needs to find about 50 million lati more in measures that are sustainable to meet the criteria of the loan, the IMF and the European Commission said in a joint statement yesterday.

Budget-Deficit Outlook

The government may pass a supplementary budget as early as in the first quarter or “most likely” after the second quarter, Vilks said. The budget deficit will be about 8 percent of GDP this year, lower than the bailout’s 8.5 percent limit, he said. The 2011 gap may narrow to 5.4 percent, based on “conservative’ figures, compared with a 6 percent limit, according to Vilks.

Prime Minister Valdis Dombrovskis’ Cabinet, re-elected in October, raised taxes, reduced expenditure and slashed state pay to meet the terms of the international loan in two budgets in 2009. The country has passed austerity measures equal to about 14 percent of GDP since the bailout program started in late 2008, according to central bank estimates.

The government, backed by the country’s lenders, opted for a strategy of bolstering competiveness by forcing prices and wages to fall. Latvia decided against increasing its competitiveness by letting the lats depreciate, keeping it pegged to the euro to protect foreign-currency borrowers.

‘Largest Concern’

Government debt will peak at about 50.4 percent of GDP, according to the IMF, compared with earlier estimates for as much as 90 percent. Inflation is the biggest risk to planned euro adoption in 2014, Vilks said.

“This is the largest concern for us, inflation, rather than the fiscal balance,” he said. Consumer prices may rise by an average of about 2 percent next year, due in part to increases in the value-added tax, he said.

Latvia has a “very limited corridor for maneuvers” before inflation picks up, he said. Missing the euro-target date may delay the switchover to 2020 because of accelerating consumer- price increases, according to Vilks.

Fighting rising prices “would demand a very, very serious approach,” he said. Euro adoption may demand “a kind of consensus” among people, businesses and the government to curb inflation and wages, he said.

Bloomberg