“It is very important to turn back to the capital markets,” Finance Minister Andris Vilks told Dow Jones Newswires. “We are committed to doing that and I think timing is quite favorable for us—let’s say from May.”

An upgrade from Fitch Ratings March 15 took Latvia back into investment-grade territory as its sovereign rating was hiked to BBB- from BB+. Analysts see this as paving the way for Riga to issue its first bond since its economy contracted a cumulative 25% in 2008 and 2009, according to figures from the International Monetary Fund.

“The Fitch upgrade and other probable upgrades are important for the bond issue,” Mr. Vilks said, adding a government review to be completed by Easter was also vital to the preparations for a return to international capital markets.

Mr. Vilks said Latvia would look to raise 500 million euros or dollars, “as the benchmark liquidity criteria at this moment” from an initial bond offer “depending on the investor response and market conditions.” Should the country’s economic prospects brighten between now and May the country “could come out with a twice or three times larger sum than that,” Mr. Vilks said.

Latvia’s gross domestic product grew 3.6% in annual terms in the three months to Dec. 31, expanding for the second quarter in a row and cementing hopes that the country’s economy has turned a corner after its credit-fueled growth was brought to a halt in 2008.

“We reached an economic turning point last year but at this moment it is even more visible because all major figures are improving,” the finance minister said.

It is difficult to assess how much interest Latvia would have to pay to borrow on international markets, Annika Lindblad, an economist at Nordea bank, said. “They haven’t been out on the market for a very long time so we don’t really have a benchmark,” Ms. Lindblad said. This also explains why Latvia might want to start with something like 500 million euros or dollars, rather than a larger amount, she added.

Mr. Vilks said Latvia isn’t in a rush to issue a bond. The country still has funds left from the $10.1 billion it borrowed from a group led by the European Union and the IMF in November 2008, according to Ms. Lindblad.

Latvia is keen to get its relations with international investors back on a normal footing as it pursues euro-zone entry in 2014. A key part of these efforts will also be keeping inflation at the low levels demanded under the Maastricht criteria for adopting the single currency, Mr. Vilks said.

Rising inflation is an “important obstacle for us” so we are going to “take already now some steps to involve society, not to provoke [society],” Mr. Vilks said. “We are hiking different taxes and fees [now] so as not to do that in coming years and we are going to make some kind of agreement with society to freeze the wage fund for the public sector for two years at least.”

Mr. Vilks would like private businesses to consider at least postponing wage rises as well, he said.

Latvia’s consumer price index rose 0.3% on the month and 4.0% on the year in February, data from Statistics Latvia showed March 8.

“The main way for the government to keep domestic price pressure in check is through wages and not letting them rise too fast,” Ms. Lindblad at Nordea said. “However, at the moment it is mainly food and energy prices, outside global factors, which are pushing up prices.”

The government must also cut its budget deficit to 3% of GDP by 2012 to meet IMF and EU targets from an underlying deficit of 6.1% in 2010, according to estimates from Fitch. This means it has little money available for wage increases anyway, Ms. Lindblad said.

They all survived, even as their earnings plunged in part because of government austerity measures. Now that Estonia, Latvia and Lithuania are growing, Martinson is putting money into such startups as Estonian online dating site Flirtic.

The Baltics’ ability to tolerate economic pain has been praised in recent months by German Chancellor Angela Merkel and Klaus Regling, chief of the European Financial Stability Facility. Latvia’s gross domestic product fell 18 percent in 2009 and Estonia’s fell 14 percent. That’s what it will take to get Greece, Portugal, Ireland and Spain through their current crisis, Martinson says.

“I would be very surprised if the southern European countries would be able to go through with necessary measures on their own,” Martinson, 44, said in a phone interview in Tallinn. “I think it will take very strong coercion to get them to do that. Perhaps Europe needs financial police.”

He has been investing in the Baltic region since the countries emerged from the collapse of the Soviet Union in the early 1990s, when a computer cost seven times his monthly wage.

After suffering through the worst drop in economic output in the world, the Baltic countries have been growing on a quarterly basis since the beginning of 2010. Estonian stocks were the world’s third-best performers last year.

Rising Ratings

Latvia’s credit rating was raised to the lowest investment grade from junk status by Fitch Ratings yesterday; the country also has investment-grade ratings from Moody’s Investor’s Service. Standard & Poor’s rates Latvia BB+, its highest speculative grade, with a positive outlook.

Credit default swaps, which investors use to protect against default or speculate on creditworthiness, in the three countries are below those for Greece, Ireland, and Portugal. Greece is only slightly less risky than Pakistan while Estonia is ranked almost as safe as France, according to CDS prices.

Lithuania’s Apranga AB, the biggest Baltic clothing retailer, returned to profit last year and now plans to open as many as eight new shops this year. The company had cut its workforce by 16 percent in 2009 and trimmed wages by 30 percent to cope with tumbling consumer spending. Shares rose 160 percent last year.

Estonia, which adopted the euro in January, saw its OMX Tallinn Index rise 72.6 percent last year. Latvia and Lithuania were among the top 10 performers. Greek stocks fell 41 percent.

Political Favor

What’s more, political leaders in the three countries have found support from the electorate. Estonian Prime Minister Andrus Ansip widened his government coalition’s majority in elections held on March 6. Latvians in October re-elected Prime Minister Valdis Dombrovskis, while Lithuanian Premier Andrius Kubilius’s governing party garnered twice as many votes as polls predicted in municipal elections on Feb. 27.

Estonia mastered the economic crisis “in an admirable way,” Merkel said in a Berlin news conference with Ansip on Oct. 21. “It’s a good, even remarkable signal that Estonia fully met the criteria for joining the euro during such difficult economic times.”

Greece, which turned to a group led by the EU and the IMF for a 110-billion euro ($152 billion) bailout in May last year, had its credit rating cut three steps to Ba1 by Moody’s Investors Service on March 7.

Street Protests

Greeks took to the streets with 496 protests and marches last year, according to police, as the government passed tax increases and budget cuts to meet the terms of its loan. Three people were killed in a fire during riots in Athens in May.

And Moody’s cut Spain’s rating to Aa2 on March 10, saying the cost of shoring up the banking industry will eclipse government estimates.

Ireland’s austerity program, bank bailout and international loan led to an election win for the opposition last month, the biggest political shift in the country’s history. The previous government lost support by turning to the IMF and euro countries for an 85-billion euro rescue package in November.

To be sure, it wasn’t all stoicism in the Baltics. A peaceful protest of about 10,000 people on Jan. 13, 2009, turned violent as a few hundred people rioted in the old city of Riga. The Latvian government collapsed about a month later.

Then Lithuanians rioted, about a month after Kubilius took power in general elections and after the government announced tax increases and spending cuts.

Euro Discipline

In both regions, currency devaluation, the traditional path to exports and growth, is not an option. The southern European countries are in the euro, as is Estonia, and Latvia and Lithuania aim to join by 2014 and thus have to limit exchange fluctuation.

A key difference, though, may lie in the recent history of the Baltics, said Hardo Pajula, an economist with SEB AB in Tallinn. Latvia, Lithuania and Estonia, occupied by the Soviet Unionfor almost 50 years, lived through its collapse. The last few years before independence in 1991 brought hyperinflation, food and fuel shortages and a wipeout of savings.

“It is rather hard to envisage a pampered citizen of a mature Western welfare state accepting the pay cuts that were pushed through in this part of the woods in the last couple of years,” Pajula said. “A great fuss has been made about the Baltic GDPs having fallen by 16 percent or 17 percent in 2009, but you have to see these things in context. Aggregate output fell perhaps by 70 percent at the beginning of the 1990s.”

Food Coupons

Shortages were so severe that coupons for staples like food and soap and alcohol had to be used. Inflation reached about 1,000 percent in the region in 1992 and savings were wiped out.

EU membership in 2004 led to a fall in interest rates, a boom in lending and rising housing prices and wages. Then the global credit crisis hit just as the regional expansion was running out of steam.

Latvia has implemented austerity measures equal to about 16 percent of GDP since the end of 2008, when it turned to a group led by the EU and the International Monetary Fund for a 7.5 billion-euro loan. Estonia passed measures equal to 9 percent of GDP; Lithuania’s budget discipline totaled 12 percent of GDP in a plan the IMF called “unprecedented by historical and international standards.”

Over Years

While the Greek package agreed to last year calls for budget cuts worth 14 percent of GDP, it will take place over four years. Spain is enacting austerity worth 8.2 percent of GDP between 2009 and 2013.

To be sure, the deal struck by euro-area leaders last weekend to create a permanent safety net for indebted countries starting in 2013 and lower interest costs for Greece boosted the chances they will survive the debt crisis.

Only Greece and Ireland have had to seek aid; Portugal says no bailout is needed and Spain is moving ahead to rescue its banks without emergency aid. The country’s Ibex 35 Index is up 6.2 percent and Greece’s ASE Index up 18 percent this year, while the Stoxx Europe 600 Index is down 0.8 percent.

Greece’s public debt, though, was 140 percent of GDP and its budget deficit 9.6 percent last year, the European Commission said.

Estonia’s measures helped keep its public debt at the EU’s lowest level, 8 percent of GDP. The budget deficit declined to 1 percent of GDP. Exports of goods rose 35 percent last year to a record after declining 23 percent in 2009.

To Martinson, the same future could await Europe’s heavily indebted countries if they take the needed measures.

“With or without a European financial police, southern Europe will have to go through with own austerity program anyway,” he said. “It is just a matter of time.”

The government may need between 100 million lati ($196.6 million) and 150 million lati in changes to next year’s budget, Vilks told the Riga-based magazine’s website, citing an improved economy. That amount compares with an earlier estimate for austerity measures of as much as 300 million lati, he said.

The budget savings may be made through higher real-estate taxes, and reductions in subsidies for farmers. The final figure would be affected by faster economic output, Vilks said, according to Ir.lv.

The Baltic country plans to trim its budget deficit to below 3 percent of gross domestic output next year so it can adopt the euro in 2014. Latvia turned to a group led by the European Commission and the International Monetary Fund for a 7.5 billion-euro ($10.4 billion) loan after its second-biggest bank needed a state bailout in 2008.

The EU Council’s common position on arms exports is legally binding on all EU states. Of course, competence and responsibility for arms-export controls and licensing rests with member states, not EU institutions. Indeed, under the Wassenaar Arrangement, a decision on exports is the sole responsibility of each participating state.

Implementation of the common EU position on arms exports has led to more exchanges of information, greater transparency and closer consultation. It has also harmonized export-control arrangements and procedures. But there are obvious limits to what can be achieved. Consultations are currently a bilateral matter, with no rules governing how they should be conducted — and no requirement that any final agreement on arms-export decisions be reached.

The effectiveness of this consultation mechanism is difficult to evaluate. According to the common position’s provisions, before a member state grants an export license, it should consult with any member state that has previously denied a similar license. But the common position does not specify the extent to which another member state should be consulted. More importantly, it does not require the arms-exporting member state to consult with any other member state that might have concerns.

As a result, arms exports to third countries remain a contentious issue within the European Union. At the heart of the matter is a conflict between the individual member states’ national interests — the competitiveness of European defense-

related companies and the strategic importance of defense markets when linked to national foreign policy — and the Lisbon Treaty, which refers specifically to enhanced solidarity and consultation.

If the Lisbon Treaty is to be respected, solidarity must be viewed as a political tool for moving toward a European defense policy that works for the common good. Pursuing solely national policies on technology transfer runs contrary to that goal. Clearer rules for the consultation mechanism need to be elaborated, and arms-exporting EU member states should consult all other member governments that might have concerns, not only those that have previously issued or denied an export license.

The European Union could work toward a common arms-export policy by seeking a shared understanding of the predictability and stability of third-party countries. Developing a common policy on arms exports to such countries should go hand in hand with the creation of a common and internationally competitive European defense-equipment market.

This means that cooperation with non-EU countries should not be to the detriment of solidarity and common rules within the European Union. Consulting at an early stage would help manage misperceptions — often fueled by reports in the media long before deals are concluded — and thus strengthen convergence and unity among EU member states.

Giving the EU a greater role in situations where member states’ views differ should also be considered. For example, member states could consult on sensitive or contentious issues within the Political and Security Committee. This would strengthen the EU Council’s common position, which already defines general rules for the control of exports of military technology and equipment.

As for NATO, the question of consultations among allies is addressed in Article 4 of the North Atlantic Treaty, which states that “the parties will consult together whenever, in the opinion of any of them, the territorial integrity, political independence, or security of any of the parties is threatened.”

But Article 4 does not relate only to imminent threats. Decisions taken by a NATO country can have implications for other allies. The transfer of military equipment and technology to third countries could affect regional security and prompt a revision of threat assessments.

The North Atlantic Council would seem an obvious forum within which to enhance solidarity among members, reassure member states that have perceptions of greater vulnerability, and avoid misperceptions. At a lower level, the Political and Partnership Committee and/or the Conference of National Armaments Directors could be used for initial consultations. These issues are of concern to all allies, so discussions should not be confined to bilateral agendas.

Arms sales and technology transfers inevitably raise complex moral and ethical questions. That is all the more reason to seek open, confidence-

reinforcing discussions among allies. Solidarity cannot be achieved when our most important institutions are excluded. Indeed, some of the most dangerous decisions made in both the EU and NATO are those that are not openly discussed beforehand.

A flash estimate from Central Statistical Bureau showed that the gross domestic product grew 3.7% year-on-year on a seasonally unadjusted basis in the fourth quarter, faster than the 2.9% rise in the previous quarter.

Sequentially, GDP grew 1.1% after adjusting to seasonal variations. This follows a 1.4% expansion in the third quarter, revised up from 0.9% growth estimated earlier.

In 2010, the economy contracted by just 0.2%, Finance Minister Andris Vilks said in a statement today. The decline was less severe than the 4% fall forecast by the government, the minister added.

According to Vilks, rapid growth in external demand and industrial output fueled growth at the final quarter of the year.

In 2009, the economy suffered a severe 18% contraction, hurt by global economic recession. The economy exited recession after three consecutive periods of quarter-on-quarter growth last year.

The International Monetary Fund and the European Commission forecasts the economy to grow 3.3% this year and around 4% next year.

According to IMF, Latvia’s economy is showing signs of bottoming out after substantial volatility and deep recession in 2009 with net exports cushioning the dramatic decline in domestic demand. Meanwhile, a rapid upturn in domestic demand is expected to strengthen recovery in 2012.

The economy plans to join the euro area by 2014 and has pledged to cut its public sector deficit to below 3% by 2012. Accordingly, the country’s 2011 budget aims to bring the deficit down to 6% this year from 8.5% in 2010.

However, IMF staff sees the need for a further 6% of GDP in adjustment to meet the Maastricht deficit criteria by 2012.

“With the economic recovery, foreign investors’ interest in the Latvian economy has renewed,” Martins Kazaks and Dainis Stikuts, economists at Swedbank’s Latvian unit, wrote in a note today. “We forecast that FDI inflows will amount to 4-5 percent of GDP in coming years; i.e., they will largely return to the pre-boom levels,” they said.

Latvia’s economy expanded an annual 3.7 percent in the fourth quarter, the quickest pace in three years, the statistics office in Riga said yesterday, as exports, industrial production and domestic demand recovered. The Baltic country’s gross domestic product shrank a cumulative 25 percent since 2008 when it was forced to seek a 7.5 billion euro ($10.2 billion) loan from a group led by the International Monetary Fund and the EU.

During the country’s economic boom, FDI flowed primarily to financial intermediation, real estate and commercial services, the note said.

“Now, foreign direct investment primarily goes to manufacturing because of its improved competitiveness and increasing export possibilities,” Kazaks and Stikuts said in the note.

Estonia had the biggest share of FDI in Latvia, accounting for 14.4 percent of the total by the third quarter of last year, according to the note. Sweden was second with 13.4 percent.

Some of the Estonian investment is actually Swedish, in particular when counting bank ownership, the note said. “Thus, it is Sweden rather than Estonia that is the true FDI leader,” they said in the note.

Besides attracting a large and dedicated following within Latvia, Skyforger has made itself known internationally. This is not too surprising. Not only does the group display accomplished musicianship and songwriting, but Skyforger also distinguishes itself by the fact that its music is influenced by Latvian folk themes and pagan traditions. Skyforger also makes use of traditional Latvian instruments. The group even dresses the part, with a wardrobe that makes band members look like ancient Latvian warriors.

Due to its growth in popularity, international recording companies have taken notice. Last year, Skyforger signed with Metal Blade Records, perhaps the best known of the labels catering to heavy metal music.

Kurbads, as many of Skyforger’s previous works, delves deep into Latvian folklore and presents a series of songs about the warrior Kurbads, son of the mare.

To be sure, the music of Skyforger is an acquired taste. Besides it being heavy metal, which might not be to the liking of some listeners, the music is particularly aggressive. The vocals are more growled than sung, making the lyrics almost unintelligible at times. Fortunately, the booklet that comes with the compact disc includes full lyrics in Latvian with English translations.

Formed in 1995, the group is just past its 15th anniversary as an ensemble. However, the CD packaging is vague about the identities of the band members. They are only listed by the first names and nicknames: there is Peter on lead vocals and guitars, Edgars “Zirgs” on bass and vocals, Kaspars playing folk instruments and singing, Edgars “Mazais” on percussion, and Martins, also on guitars.

The Skyforger songs that I like the most are the ones that use traditional instruments, such as “Ķēves dēls,” which features what sounds like a Latvian stabule (reed pipe) and is about the birth of Kurbads. There is also Skyforger’s interpretation of a Latvian folksong, “Tēva dēla pagalmā,” sung in a very gruff, though slightly more intelligible, style.

I actually wish there were more songs that more prominently feature Latvian instruments, or even Latvian folk song melodies. Of all of the Skyforger songs that I have heard, the one that I have liked the most is the band’s heavy metal version of the Latvian folk song, “Migla, migla, rasa, rasa,” found on Skyforger’s 2003 album, Pērkonkalve. Apart from the previously mentioned songs, and besides the lyrical content, there seems to be less of a Latvian influence in the melodies and music this time around.

The songs continue the story of Kurbads, with “Deviņgalvis,” a song about Kurbads’ battle with the ogre with nine heads (after finishing off an ogre with slightly fewer heads: six); “Velnukāvējs,” the story of the forging of a mighty sword for Kurbads; and Kurbads’ own violent death in “Pēdējā kauja,” where, after slaying the Serpent Witch with one hand and a giant ogre with the other, he finally succumbs to the snake poison already in him, falls on his sword and dies.

As a bonus track the album also features a cover version of the song “Kurbads,” originally recorded by Latvian hard rock band Opus Pro in 1986, though played with much heavier guitars and more aggression.

To be honest, I found Kurbads to be difficult to get into. There is no denying Skyforger’s talents, as band members certainly have written some monster riffs on this record. The lyrical content is certainly unique, but something still seems missing here. The playing is tight and aggressive, but (perhaps it is my advancing age) it would still have been nice to hear a bit more singing and a bit less growling. It becomes difficult to distinguish the songs if they are all fast tempo, aggressive riffing. In any case, one must admire the band’s success, as well as its dedication to its art. Hopefully this is the album that brings Skyforger a larger worldwide following, which it certainly deserves.

Egils Kaljo is an American-born Latvian from the New York area who lives in Rīga, Latvia. When not working in the information technology field, he plays the guitar, sings in the University of Latvia Choir Juventus and does translation work for the Latvian Music Information Centre. Kaljo began listening to Latvian music as soon as he was able to put a record on a record player, and still has old Bellacord 78 rpm records lying around somewhere.

The global financial crisis has affected, with varying degrees of severity, different economies. While countries such as China, Canada and Australia have been relatively unscathed, the previously booming Baltic region has been especially hard hit. Latvian GDP, for example, contracted by almost 25% in 2008-09, the unemployment rate rose from under 5% to over 17% and the government budget deficit for 2009 ballooned towards 18% of GDP. Heightened doubts about the sustainability of the currency peg to the euro in the face of the global crisis sparked a collapse in investor confidence, a flight of capital, a contraction in credit and a sharp rise in the cost of government and bank borrowing. In effect, Latvia was engulfed by a cycle of vicious negativity.

The overwhelming consensus by the spring of last year was that devaluation and debt default was inevitable. Unable to access the debt markets, the Latvian authorities were forced to seek the external support of the IMF, the EU and their Nordic neighbours, and a package of loans was approved by the ECOFIN council in January 2009. Facing a continuing cycle of negativity, the inevitable devaluation and debt default was expected to follow and the yield on the Latvian (euro-denominated) government bond, maturing in March 2018, soared to almost 12% by March 2009.

With the continuing support of the international community however, the Latvian authorities have implemented a range of policies which have restored the government finances to a sustainable path. The consensus narrative of devaluation and default has come unstuck. There has been no break in the currency peg to the euro. There has been no debt default. Fuelled by restored competitiveness, Latvian exports are booming and the economy is growing again. Confidence and capital have returned and the yield on the March 2018 government bond is now touching 5%. The ‘inevitable’ of 18 months ago has turned out to be avoidable. Some of the key policies implemented were:

• A 20% cut in the average public sector salary in the 2009 budget followed by a further 5% reduction in the 2010 budget

• A reduction in the number of government agencies from 76 to 39

• A reduction in the number of hospitals from 59 to 42

• An increase in the main VAT rate from 18% to 21%

These and other measures have combined to put the Latvian government budget deficit on a credibly sustainable path of below 10% of GDP in 2009, below 8.5% of GDP in 2010, below 6% of GDP in 2011 and below 3% of GDP in 2012.

Despite the extraordinary difficulties of recent years, Latvia has chosen to make the decisions to underpin its long-standing policy of becoming a credible member of the eurozone in 2014. The message for Ireland is clear. Debt default need not be the inevitable outcome of being engulfed in a cycle of negativity and economic freefall. Economic recovery can be embarked upon without taking an existential risk with our banking system and currency. Our policy makers are not powerless in battling a widely expected inevitable slide into an experimental unknown.

By pursuing policies which return our government finances to a credibly sustainable path, the Irish authorities can follow the example of Riga and change the narrative of inevitable debt default into one of restored credibility and renewed prosperity. There is nothing inevitable about our current predicament. We should look to Latvia.

John Looby is an investment manager at Setanta Asset Management

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.

S&P raised the rating to BB+, one level below investment grade, analyst Frank Gill said in a statement from London today. The grade has a stable outlook, meaning the credit evaluator is more likely to keep it unchanged than to cut or raise it. The rating is on a par with Azerbaijan, Romania and Greece.

Latvian gross domestic product grew an annual 2.7 percent in the three months through September, the first expansion in 10 quarters. The country has passed austerity measures equal to about 14 percent of GDP since the crisis began in 2008 and plans more in the 2011 budget to comply with its 7.5 billion-euro ($10 billion) international bailout from a group led by the European Commission and the International Monetary Fund.

“Continued commitment to fiscal discipline and further strengthening in economic activity could lift the country to investment grade in 2011 or in early 2012,” said Yarkin Cebeci, an economist at JPMorgan Chase & Co., in an e-mailed comment.

The yield on Latvia’s Eurobond due 2018 fell 13 basis points today to 5.36 percent, which compares with a yield of almost 12 percent in March last year.

‘Marked Improvement’

Asking rates for three-month loans at the Riga interbank offered rate, or Rigibor, was little changed at 0.83 percent today, about 20 basis points below the euro-area rate, known as Euribor. The difference, or spread, between the rates reached 2,868 basis points in June 2009 when speculation mounted that the lats, which has a fixed rate to euro, would be devalued.

The ratings changes “reflect a marked improvement in Latvia’s current account,” S&P said. “Confronted with sharply tighter credit conditions, past imbalances have rapidly unwound. The process has helped to restore competitiveness.”

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 6 basis points today to 277.4, according to data provider CMA. Latvian CDS prices had reached almost 1,200 basis points in March 2009.

Economic Recovery

The economy is recovering after shrinking about 25 percent through nine quarters of declines, the International Monetary Fund estimates. S&P estimates that Latvia’s deficit will fall to below 3 percent of gross domestic product in 2012, a key requirement to adopt the euro in 2014.

Latvian net general government debt levels are projected to peak at 35 percent of gross domestic product in 2013, S&P said in the statement.

“The rating news shows that the measures are clearly paying off,” said Lars Christensen, chief emerging-market analyst at Danske Bank A/S, by phone. “It’s helpful for the efforts to return to the markets. It’s a sign of approval from the rating agencies and from the markets further down the road of what Prime Minister Valdis Dombrovskis has been doing.”

Moody’s Investors Service rates the country Baa3, its lowest investment grade, with a stable outlook. Fitch Ratings has a BB+ rating for Latvia, one level below investment grade, with a stable outlook. Fitch places Estonia at A, its fifth- highest investment grade, while Moody’s has the country at A1.