Latvia’s Emerging Capital Markets

Summary The growth of the Latvian capital markets over the next few years will be driven by supply-side developments. The main source of supply will likely be shares of privatised companies. A second source will be the government’s own financing needs which will lead to an increasing supply of government securities. Growing difficulties in financing budgetary deficits and the phasing-out of direct lending from the central bank will require the government to tap a wider range of market sources. On the demand side, the successful stabilisation programme has provided a sound basis for savings and investment. However, Latvian investors have been exposed to events which severely undermined their confidence in financial institutions. The introduction of the proposed reform of the pension system - involving the development of a funded pension pillar - would have a significant impact on securities markets in the longer term. It is likely that the Riga Stock Exchange (RSE) will be the only licensed trading system in Latvia. Openness of the RSE to all brokerage houses eligible and willing to participate is critical and should be secured by appropriate regulation. The Central Depository for Securities (LCD) should be strictly supervised by the Securities Commission. Latvian commercial banks will play an important role in the development of the capital market. Their lending/deposit activities should be separated from their capital market activities. Poor enforcement of the law is likely to be a problem. The most appropriate solution may be to create an independent commission covering institutions offering and dealing in all non bank long-term financial instruments offered to the public at large. A strong role should be envisaged for self -regulation of market participants. The involvement of investment funds, insurance companies and pension funds in the more active corporate governance of companies in which they invest should be allowed once markets are liquid enough to provide a valuation of portfolios, and once the necessary skills are developed in portfolio management and in administrative supervision of financial institutions. To succeed as a capital market centre Latvia has to become an open economy, which would include permitting the tree flow of foreign portfolio investment- This could help Latvia find its niche in the provision of capital market services to neighbouring countries. To achieve these goals, Latvia would have to establish its competitive advantage vis-d-vis other well-established European market centres as well as the new centres in Central Europe.