A number of investors have already demonstrated a preparedness to invest in Latvia’s forest sector. For these, any perception of constraints to doing so were offset by the conviction that – for the given exposure to risks of doing business in Latvia – "normal profits" could still be achieved.
Key factors critical to successful investment in Latvia’s forest sector activities are summarised below.
The political climate in Latvia is stable. The perception of that stability is widespread. Latvia is a parliamentary democracy with proportional representation and a Cabinet of Ministers of twelve members. The Prime Minister, nominated by the President (his main political role), heads the CM. The third post-independence parliamentary elections passed uneventfully in October of 1998. Governments since independence have all been coalitions. Though political parties profess their ideological differences, there is significant congruence amongst coalition members and, though turf battles exist, governments have been successful in implementing transition reforms.
A very strong emphasis is placed upon macroeconomic stability and upon creating sound fundamentals and positive incentives for business development. Liberalisation and privatisation are accorded high priorities. Though Latvia has yet to accede to the EU, union directives feature largely in providing the framework and content of very much of the legislation promulgated in Latvia.
Relations with neighbouring Baltic states are positive and co-operative efforts exist on a number of political initiatives. Interest in and adoption of international treaties and conventions on trade, environment, etc. is active. External political relations are stable and positive. Internally, domestic issues are dealt with in pragmatic fashion – even where national sensitivities may auger otherwise.
It is not inconceivable that some investors may reflect upon the issues of risk related to the large non-Latvian population – specifically because of the instability seen in their former homelands. These are likely to represent a very negligible minority of sincere investors. It is far more likely that Latvia will be viewed as potentially another gateway country, such as Finland – also a Russian neighbour – that currently has the most rapid growth rates in Europe.
Each of the three major international credit rating agencies, providing such indicators at country/ sovereign levels, has assigned Latvia to the "investment grade" category. This includes the "highest credit quality" (AAA) rating and, as a minimum "good credit quality" (BBB), which implies a low expectation of credit risk and adequate capacity for timely payment of financial commitments.
Successive government’s platforms have been consistent in their commitment to economic liberalisation, and currency and price stability. Investment policy and incentives are favourably directed towards the promotion and protection of inward capital flows.
The Law on Foreign Investment was promulgated very shortly after independence (1991) and subsequently amended for consistency with evolving reforms. Following the LFI, foreign registered natural and legal entities are accorded "national" treatment - having the same rights and duties as those possessing Latvian nationality.
No sector is completely closed to foreign participation. In fact, through privatisation foreign interests have assumed a prominent position in a number of major sectors (energy, communications).
The lat is informally pegged to the SDR (XDR) currency basket and has been successfully supported using that mechanism – including during the 1995 currency/ banking crises. Latvia’s performance criteria for its financial institutions are amongst the strictest in Europe – and are contributing to the sound fundaments upon which its viable and vigorous financial services sector is based. Government accountability and transparency is fostered through the adoption of conventional NACE, HS and ISIC accounting classifications and practices.
Latvia’s integration into regional and international commercial and policy forums is also shaping the pattern of reform. Accession to the EU receives a high priority and is actively pursued. In early 1998, the Europe Agreement between Latvia and the EU established an association with the union (including a free trade agreement).
Investments that began dramatic declines after 1990 have been slowly climbing since 1994. A survey undertaken by OECD and the Chambers of Commerce of Sweden, USA and UK collected observations from their respective business communities. The main reasons for investing in Latvia included:
geopolitical location and maritime conditions
availability of high calibre human resources, and
acceptance of foreign investment by both authorities and public.
Overall evidence suggests that Latvia’s efforts to support foreign investors’ own efforts at risk management are themselves increasingly minimising the country’s own economic risk parameters.
Forest management and development planning in Latvia must be upgraded to reflect the same expectations and implementation of higher business standards as found in other sectors.
Experienced forest sector observers will recognise very quickly the decidedly inadequate planning methodologies prevailing in Latvia. During the course of this consultancy, it was an issue voiced by many public and every private sector interest contacted. Both local and foreign investors will discount the value of investing in Latvia to reflect the foregone losses attributable to poor forest management practices. Though the lost increment may not be exactly calculable – existing practices pronounce lost productivity.
There is evidence, as discussed earlier in this report, that forest management practices fail to capture fully forestland’s earning potential. Not the least consequence of this is abnormally low stumpage rates and revenues. This consultancy witnessed directly the absence of common valuation and appraisal methodologies to the evaluation of forestland business proposals and decisions. Latvia will decidedly fail to develop and capture the economic rents inherent in its forest land resources if an appropriate "business culture" is not implemented and supported within its forestry authorities.
Not the least of the above problems deals with forest mensuration techniques and information systems. Forest establishment and tending practices are based on stand sampling and modelling techniques and on historical "traditions" that have been upgraded elsewhere decades ago – and should be adapted to Latvia’s use.
The second most criticised issue provided by local operators and investors during this consultancy was that of the arrangement under which the state provides access to forest stands.
It warrants repeating that loggers are innovative and can succeed under a variety of circumstances – as long as "normal" profits are obtainable. What they find least acceptable is an inability to plan.
Latvia’s forest service should make use of a wide range of tenure arrangements to attract a similarly wide range of operators. This increases the level of participation overall and will promote the development of distinct "phase contractors" specialising in given forestry activities. This approach has been successfully applied in many areas to maximise the scope for increased efficiency throughout the sector – from stump to mill yard.
What current tenure arrangements lack most, especially the longer term ones, is an ability to plan an operator’s road building and logging activities adequately. Realistically, each tenure holder should have accurate credible estimates for the species, volumes and specific location of cut-blocks (coupes, etc.) – for each of the next five years of logging (updated annually). Beyond that the general location of his operations for the next ten years should also be known – and at a less precise level, even the next twenty years.
It is far from acceptable for an operator to be directed to a given year's logging areas only as the logging year progresses from cut-block to cut-block (unfortunately, not an uncommon occurrence).
Another common occurrence is the less than consistent manner of assigning specific forest management roles to tenure holders (also previously discussed). During this consultancy, many operators expressed concern over their inability to assess their competitiveness in the absence of a credible and consistent methodology for allocating timber volumes and the associated tenure terms. Under more competitive circumstances – with less robust and more "normal" profit margins – industry’s expectations for a more business like treatment will be greater. Neither state forest authorities of tenure holders is well served by current tenure arrangements.
Details on the macroeconomic significance of stumpage have been presented in an earlier section.
Only the fact that " … stumpage will be collected …" should be stipulated and codified in legislation. Specific stumpage calculation principles should be prescribed in regulations following the law. The actual methodology for stumpage calculation should be articulated in lower hierarchy of instruments (e.g. practices or procedures manual). Actual "stumpage rates" should be calculated/ re-calculated at least quarter-annually and appear in a "schedule" attached to each and every contract entered into between the state and a logging developer.
Again, with profit margins relatively robust, it may have been forgivable to not approach the issue of stumpage and its calculation from a more openly professional and financially responsible basis. Undoubtedly, state revenues have been less than what they should have been – though this should no longer be considered acceptable.
Continued attraction of investment funds into the forest sector is a likely prospect given the relatively underdeveloped state of Latvia’s forest sector. It would serve the nation’s economic development interest well to rectify the confusion and capriciousness currently surrounding the issue of stumpage.
The above forestry related issues have been further heightened by concerns of the impact upon all tenure arrangements and timber supply of a possible pulp producer – whose anticipated requirements are estimated to be between 2.4 and 2.9 million m3 annually!
The FS has little choice but to rectify its forest management, stumpage tenure arrangements if it is to continue to attract investors – local or otherwise – and to optimise forestland resource benefits thereby.
Investments in physical capital in the forest sector are predicated somewhat on an efficient public sector – private sector "interface" wherever these must work together to reach their respective objectives. It does not serve the state well to have its interests represented by under-trained under-utilised staff.
The demands of transition have necessitated a higher level of performance from personnel in all industrial sectors in Latvia – public and private. This is equally the case for forest sector professionals and workers. The relevant concepts, however, are relatively easy to acquire. Upgrading of skills may be most limited – in the short to medium term - by funding – and there is no expectation that this will not occur. Planning and project preparation in some areas of HR development has already commenced.
More generally, from an investment risk perspective, observations surveyed from the expatriate business community suggested that a higher level of competency was also required to ensure consistent interpretation of legislation and its application – particular in terms of taxation. Interpretation and application of bilateral tax treaties were of particular concern.
Inadequate investment by the state in its forestland "capital" is of direct concern to investors. This is particularly the case for long-term agreement holders who would ordinarily be assuming similar responsibilities and cost on what is also state land – on the state’s behalf.
It is clearly a state role to ensure the efficient collection and distribution of what are clearly State revenues. The Forest Development Fund, one of a number of "special" state budget allocations, is both collected and disbursed directly by the Forest Service.
The right of the state to collect and disburse revenues is normally perceived as its sovereign duty – and not commonly delegated to the extent that it has been in the case of the FDF. Overall state revenues are very likely to increase – from stumpage (assuming higher value-added), from fines (upon improved enforcement), and license fees, retained security deposits, etc. It is prudent for the state, if not fiscally imperative, to assume a more direct role in the receipt and disbursement of such funds.
Issues related to stumpage calculations and forgone state revenues (discussed earlier) are relevant to funding levels of state forestry agencies and activities. It need only be added here that, investor confidence in the state’s ability to meet its responsibilities in respect of its forest land resources is subject to the states committing adequate funds to that role.
Globalisation and competitiveness
Globalisation
A pervasive development in open economies in recent years is the ease with which it is now possible to engage in virtually "borderless" transactions within a number of markets – including commodities such as forest products.
Trends towards large associations of trading countries or common markets appear to be growing. Even in specific industries, alliances are being formed which – though not strictly monopolistic in nature – have similar impacts. This is very visible, for instance, amongst air carriers, financial service institutions, communications, media and automobile manufacturers.
Resisting the "natural" tendencies of transnational expansion invites the risk of foregoing legitimate investment that may otherwise also be consistent with broader national social and economic development objects.
The loss of direct control over globalisation processes can, however, also lead to the risk of marginalisation and instability – by bidding down wages, extracting tax concessions, and disregarding social and environmental consequences while harnessing local resources for production activities. It is instructive to assess these risks by comparing the process of globalisation to the earlier intentions and activities of colonialism – with which it is sometimes loosely compared (neo-colonialism).
Globalisation is nurtured through advances in technology, increased mobility of production inputs (entrepreneurship, finances, labour) and its ability to penetrate markets otherwise inaccessible. This has been most dramatic in developing countries and those in transition. The results may be considered mixed, with both positive and negative results – but governments are prudent to examine its ramifications closely.
Competitiveness
The general impression on observing the progress of some components of the Latvian forest sector is very positive. Significant upgrades have taken place in many of its mills. Manufacturing standards and product quality is improving and marked periods of growth have been evident. Many aspects of the development of the sector have the appearance of being directed by movement towards increased competitiveness.
Within the forest sector (as with others), mills and processing centres were acquired by their current principals (owners) from the state in early post-independence redistribution programmes. For a number of reasons, it was a sound strategy to provide for the continuity of these plants – regardless of the initial productivity and efficiency of operations. Effort to now increase the efficiency of these mills will only add to the successes thus far achieved by the sector and to maximise their competitiveness in the long term. The truly efficient operations will prosper in freely competitive markets. Less efficient ones will be less successful and some will fail.
Certain forest sector participants have expressed preparedness to support the development of a competitive sector. The full measure of this expression of preparedness, however, can only be gauged once the sector has been exposed to more realistic competitive circumstances. Ultimately, the threat of loosing favourable access to timber resources, or market share or even mill ownership under more competitive arrangements may affect owners’ interest in further liberalisation – and support for such measures will evaporate!
Without a liberal attitude in regards to competition, it will take much longer for Latvia to eventually meet – and, perhaps, surpass – the standards and criteria necessary to effectively continue to compete in existing international forest products markets.
Within international markets, integration is taking place – backwards (with providers of raw materials, equipment and supplies), and forwards (with downstream processors, transport and sales services) – creating huge complexes of enterprises able to capture significant regional advantages and posing significant challenges for more independent operators in their region. In Latvia’s geographic region, the Finnish forest sector presence (with an AAC of approximately 65 million m3/annum) through Stora/Enso, Metsä, and UPM-Kymmene is a prominent example of dominance in this way.
Within the forest products sector, European participants are decidedly active in establishing links to increase their competitiveness. However, and perhaps surprisingly, there is a remarkable degree of independence amongst firms. Alliances are not static and are subject to dissolution and realignment – especially where they result in improved efficiency, reduced costs and greater market penetration. Even the Finnish examples given above somewhat regularly undergo realignment.
The immediate geographic area wherein Latvia is situated is one of the world’s most developed and competitive non-tropical forest products areas – in solid wood, reconstituted (engineered) wood products and pulp and paper products. Only North America’s forest sector is similarly developed – in terms of comparable size and level of technology. Whether this sword has two edges or not will rest with how truly competitive the Latvian forest sector actually becomes.
For Latvia, the significance of having to operate in such a regional market place is apparent.
Not maximising sector efficiency will lead to eventual displacement by other regional operators. Compliance with trade conventions (WTO, EU, etc.) and its own "national" treatment of foreign investors almost certainly ensures that this will take place. Clearly, Latvia can not reserve its timber resources to the exclusive use of Latvians. The only remaining option to maintaining or increasing "competitiveness" then becomes the loss of operating independence through strategic sectoral alliances – Latvian or otherwise.
Even domestic markets, when they do develop, can end up being served by more competitive non-Latvian producers – as the same conventions just referred to above also open Latvian borders to such traffic. In addition, with accession to the EU almost a foregone conclusion, the scope for protecting the domestic forest products sector from external interests is significantly reduced – if not totally spent.
The good news is that Latvia shows an overwhelming preparedness to tackle and contain this challenge by continued liberalisation and competitive restructuring and rationalisation.
