By Carolyn Cohn
LONDON (Reuters) - Euro zone entry in January will likely lift Latvia's flagging inflation rate by 0.2-0.3 percentage points next year, its central bank governor said on Friday.
The Baltic country has been recording strong economic growth and has relatively low debt levels after a deep recession during the global credit crisis, when it slashed spending to keep its currency pegged to the euro.
But prices fell 0.4 percent year-on-year in September, having eased 0.2 percent the previous month, and the central bank cut interest rates in response. It expects inflation to average 0.7 percent for all of 2013.
Other countries that have adopted the shared currency such as Estonia, which joined in 2011, have seen prices climb as a result. But Ilmars Rimsevics said in interviews with Reuters and Reuters Insider television that the impact would be muted in Latvia.
"Our estimation is somewhere between 0.2 and 0.3 percentage points," Rimsevics said, adding that he expected inflation to reach 2 percent next year.
(For link to Insider interview, see http://reut.rs/168eVMA)
The euro zone's average inflation rate is expected to be 1.5 percent this year and 1.3 percent in 2014, based on European Central Bank staff projections.
Rimsevics said he expected the 22 billion euro economy to grow 4.1 percent this year, one of the fastest growth rates in Europe, and added that the country provided an example for euro zone nations of economic recovery.
The IMF said last week, however, that Latvia was one of a number of countries in eastern Europe that were likely to see sharp falls in potential growth due to a slower expansion in western Europe.
Rimsevics will become a member of the European Central Bank's governing council next year if, as expected, he is reappointed governor after his current term ends this year.
Rimsevics, who said he has been influenced by free-market economists such as Milton Friedman and Friedrich Hayek, declined to comment on whether the ECB should provide more long-term loans to banks.
But he said Latvia, which started to climb out of recession in 2009/10 using internal devaluation, could provide a positive example for struggling euro zone members such as Greece, adding that Latvia had seen a 90 percent rise in exports from pre-crisis levels.
"Internal devaluation means basically making yourself more competitive and taking all the suspicions away from the markets, especially for all open economies which are quite dependent on international financial markets."
With a deficit to GDP ratio of less than 1.5 percent and public debt to GDP of 40 percent, Latvia easily meets the entry criteria for the single currency bloc.
Three of its banks - ABLV Bank, AS SEB banka and Swedbank - will be subject to stringent euro zone stress tests, according to a provisional list released this week.
"I do not have any doubt that they are going to pass," Rimsevics said.
Latvia's banking system came under criticism earlier this year for high levels of non-resident deposits, following the bailout of Cyprus, which held lots of Russian investors' bank deposits.
But Rimsevics said that historically Russians had chosen to make deposits in Latvia and that there had been no rapid rise.
"Today it is not higher than 20 years ago."
Non-resident deposits make up about 40 percent of GDP and between 40-50 percent of all deposits. Such deposits in Cyprus accounted for more than 1-1/2 times GDP prior to the bailout.
Rimsevics added that access to direct lending from the ECB would provide added support to the country's banking system.
"The missing element in 2006-07...was no access to the ECB window."
(This story was refiled to add dropped word "may" in headline)
(Additional reporting by Julia Fioretti; Editing by Hugh Lawson)