Latvian Economy: development scenarios and challenges Ilmārs Rimšēvičs Bank of Latvia Governor Riga, November 2011.

Latvian Economy: development Latvian Economy: development scenarios and challengesscenarios and challenges

Ilmārs RimšēvičsBank of Latvia Governor

Riga, November 2011

Latvia successfully recovered from the crisis, we predict this year’s GDP growth at 4.8%

GDP growth, GDP growth, %%

* - GDP forecast according to forecast base scenario

In the third quarter, GDP growth remained high

GDP growth GDP growth (%)(%)

Latvia has already implemented sizable fiscal consolidation

Breakdown of budget consolidation measures, Breakdown of budget consolidation measures, % of GDP% of GDP

Latvia has quickly regained its cost competitiveness: wage-productivity gap has narrowed considerably

Real hourly wage and labour productivity per hour (2005 Q1 = 100, seasonally adjusted)Real hourly wage and labour productivity per hour (2005 Q1 = 100, seasonally adjusted)

Competitiveness and export growth fostered recovery; countries with fixed exchange rate are European leaders in

terms of export growth

Goods exports in Goods exports in 2010, % 2010, % y/yy/y

With economic recovery, unemployment has dropped. Employment growing in almost all branches

Registered unemploymentRegistered unemployment, %, %

Global economic prospects are unfortunately beginning to deteriorate; growth predictions for Latvia’s main

trading partners are being reduced substantially

GDP forecast for euro area in 2012, % (JP Morgan, time axis- moment of making forecast)GDP forecast for euro area in 2012, % (JP Morgan, time axis- moment of making forecast)

The European Commission has admitted: recession – a drop in production and services volumes possible.

On10 November, Commissioner Oli Rehn warned of possible“repeated recession" in Europe, when announcing the EC forecasts for EU countries, which point to an expected drop in growth.

“The future outlook is unfortunately gloomy. This forecast is the last wake-up call. The recovery in the EU has come to a standstill and there is a risk of a new recession unless decisive measures are taken.”

The resolution of the European debt crisis will not be fast, speculations and fluctuations in the financial

markets will continue     2009 2010 2011 2012 2009 2010 2011 2012

Greece 127.1 142.8 157.7 166.1 -15.4 -10.5 -9.5 -9.3Italy 116.1 119.0 120.3 119.8 -5.4 -4.6 -4.0 -3.2Belgium 96.2 96.8 97.0 97.5 -5.9 -4.1 -3.7 -4.2Ireland 65.6 96.2 112.0 117.9 -14.3 -32.4 -10.5 -8.8Portugal 83.0 93.0 101.7 107.4 -10.1 -9.1 -5.9 -4.5Euro area 79.4 85.3 87.7 88.5 -6.3 -6.0 -4.3 -3.5Germany 73.5 83.2 82.4 81.1 -3.0 -3.3 -2.0 -1.2France 78.3 81.7 84.7 86.8 -7.5 -7.0 -5.8 -5.3EU27 74.4 80.0 82.3 83.3 -6.8 -6.4 -4.7 -3.8Austria 69.6 72.3 73.8 75.4 -4.1 -4.6 -3.7 -3.3Netherlands 60.8 62.7 63.9 64.0 -5.5 -5.4 -3.7 -2.3Spain 53.3 60.1 68.1 71.0 -11.1 -9.2 -6.3 -5.3Finland 43.8 48.4 50.6 52.2 -2.6 -2.5 -1.0 -0.7Slovakia 35.4 41.0 44.8 46.8 -8.0 -7.9 -5.1 -4.6Slovenia 35.2 38.0 42.8 46.0 -6.0 -5.6 -5.8 -5.0Estonia 7.2 6.6 6.1 6.9 -1.7 0.1 -0.6 -2.4Great Britain 69.6 80.0 84.2 87.9 -11.4 -10.4 -8.6 -7.0Hungary 78.4 80.2 75.2 72.7 -4.5 -4.2 1.6 -3.3Poland 50.9 55.0 55.4 55.1 -7.3 -7.9 -5.8 -3.6Latvia 36.7 44.7 48.2 49.4 -9.7 -7.7 -4.5 -3.8Denmark 41.8 43.6 45.3 47.1 -2.7 -2.7 -4.1 -3.2Lithuania 29.5 38.2 40.7 43.6 -9.5 -7.1 -5.5 -4.8Czech Republic 35.3 38.5 41.3 42.9 -5.9 -4.7 -4.4 -4.1Romania 23.6 30.8 33.7 34.8 -8.5 -6.4 -4.7 -3.6Sweden 42.8 39.8 36.5 33.4 -0.7 0.0 0.9 2.0Bulgaria 14.6 16.2 18.0 18.6 -4.7 -3.2 -2.7 -1.6

Public debt, % of GDP* Budget balance, % of GDP*

*highlighted=non-compliance with Maastricht criteria; data source: European Commission (forecasts accordingly unchanged as per political scenario)

Recent experience shows: those countries that manage to straighten their finances are more successful in

staying above the water

GDP annual growth rate; 2nd quarter, GDP annual growth rate; 2nd quarter, % %

Still much to do to straighten out state finances: budget deficit implies higher interest payments and

increased debt

* Bank of Latvia forecast, ** along with FISIM

General Government debt and interest payments (EKS’95 methodology)General Government debt and interest payments (EKS’95 methodology)

In a short time, Latvia has become a country with a debt burden

Total debt of state and local governments (% of GDP, ESA’95 methodology)Total debt of state and local governments (% of GDP, ESA’95 methodology)

Total expenditure of state consolidated general budget is higher than in 2007

p - predicted

Latvia’s credit ratings are low! That means: fewer jobs, higher interest payments

Standard&Poor’s rating agency’s long-term currency liability ratingStandard&Poor’s rating agency’s long-term currency liability ratingA+

A+

A–

BBB+

BBB+

BBB–

BB+

BB+

BB–

What do low credit ratings mean for the public sector?

Schedule of central government debt repayment by nominal, mil.latsSchedule of central government debt repayment by nominal, mil.lats

If euro is not introduced and credit ratings are not improved, it may cost the budget an additional billion

lats in interest payments in the next 10 yearsAdditional annual interest payments if euro not introduced and borrowing and refinancing Additional annual interest payments if euro not introduced and borrowing and refinancing

the debt in the financial market, mil. latsthe debt in the financial market, mil. lats

In 10 years, we will overpay by almost 1 billion LVL

-15

-10

-5

0

5

10

15

I 20

09 II III

IV V VI

VII

VII

I

IX X XI

XII

I 20

10 II III

IV V VI

VII

VII

I

IX X XI

XII

I 20

11 II III

IV V VI

VII

VII

I

IX

%

Loans to domestic businesses and households, annual growth rate (%)Loans to domestic businesses and households, annual growth rate (%)

What do low credit ratings mean for the private sector?Further drop in lending and limited opportunities to

finance new investments

State budget will be the decisive factor that will determine future development of the economy

Determining clear steps towards the balanced budget

Adopting the Fiscal Responsibility Law

In 2012, budget deficit must be under 2.5% and continue to shrink in subsequent years

Maximum permitted budget deficit (accg to ESA’95) levels, to stop the excessive deficit procedure instigated against Latvia (will substantially improve confidence in state finances; a precondition for meeting the Maastricht criterion):

– in 2012 – 2.5% of GDP

– in 2013 – 1% of GDP

– in 2014 – balanced budget

Budget must be consolidated independently of euro introduction plans. Yet euro changeover would be an

additional advantage

Measure

EURO

Budget strategy

Budget balance (% of GDP)Budget balance (% of GDP)

We are predicting that inflation in 2013 will approach the Maastricht criterion. Yet if negative risks materialize,

inflation may exceed the criteria

Forecast of inflation and Maastricht criterion, %Forecast of inflation and Maastricht criterion, %

Countries with the lowest inflation in EU2011 2012 2013 III

Evaluation of Maastricht criterion

3.0 2.4 2.4

1st place IE 1.1 IE 0.7 GR 0.8

2nd place SE 1.5 GR 0.8 IE 0.8

3rd place CZ 1.8 ES 1.1 ES 1.2

* EC autumn forecast BoL calculations

It must be noted that “the window of opportunity” for euro introduction may very possibly be shut after 2014

Inflation and Maastricht inflation criterion, %Inflation and Maastricht inflation criterion, %