Latvia's Internal Adjustment and Lessons for Europe

Latvia’s internal adjustment and lessons for Europe Ilmārs Rimšēvičs Governor of the Bank of Latvia May 24, 2012

Presentation outline  Setting the scene: some

developments before the crisis  How Latvia came through the

recent crisis?  What are the lessons learned and

implications for Europe?

Latvia’s economy was on a fast track during 2004-2007

However, if driving fast, one has to make sure that the pace is sustainable

Latvia has lived through a boom-bust cycle: severe recession followed years of unsustainable double digit growth Real GDP growth (%) 15,0

10,0

7,2

7,6

8,9

10,1

11,2 9,6 5,5

5,0

0,0

-0,3 -3,3

-5,0

-10,0

-15,0

2011

2010

2008

2007

2006

2005

2004

2003

2002

F – forecast

2009

-17,7

-20,0

Over the past boom Latvia was running enormous underlying fiscal gap General Government budget balance (ESA’95), % of GDP 0 -2

-0,4

-4

-0,5

-0,4

-4,2

-9,8

-8,2

-3,3

-6

-5,5

-6,4

-8 -10

-8,5

-3,5

-1,9 -0,8

-2,2

-2,7

-5,6

-7,5

-12 -14

-14,1

-16 -18 -20

2005

2006

2007

Consolidation effort Fiscal gap Source: Eurostat, F - BoL staff estimation

2008

-18,6 2009

2010

2011

2012F

Actual (targeted) balance Structural budget balance

To be or not to be, was the question in 2008

Many suggested devaluation as a way out of the crisis.

Why devaluation was not an appropriate solution?

Latvia lost market access already at the outset of the recent crisis and the fiscal gap had to be closed quickly by massive consolidation Breakdown of budget consolidation measures, % of GDP

Source: Ministry of Finance; Bank of Latvia staff calculations

How Latvia managed to accomplish what initially was claimed being impossible?

Speed

A speedy consolidation can be compared to a timely pruning an apple-tree – you earlier and richer harvest

How Latvia managed to accomplish what initially was claimed being impossible?

Ownership

How Latvia managed to accomplish what initially was claimed being impossible?

Commitment

How Latvia managed to accomplish what initially was claimed being impossible?

Solidarity

Latvia has regained its competitiveness: wage-productivity gap has been closed Real hourly wage and labour productivity per hour (seasonally adjusted), 2005 Q1 = 100 150 140 130

120 110 100 90

Labour productivity Source: CSB; Bank of Latvia staff calculations

Real wage

Q3

2011 Q1

Q3

2010 Q1

Q3

2009 Q1

Q3

2008 Q1

Q3

2007 Q1

Q3

2006 Q1

Q3

2005 Q1

Q3

2004 Q1

80

Despite loud ex-ante warnings of protracted recession risks under internal adjustment scenario, a strong “V” shaped recovery followed Real GDP growth, % 15

10

5,5

5 0 -5 -10 -15 -20

2006 Source: CSB; F – Bank of Latvia forecast

2007

2008

2009

2010

2011

Source: Eurostat

Estonia Lithuania Latvia Poland Sweden Slovakia Austria Germany Finland Romania Malta Belgium Bulgaria Czech Republic France Hungary Netherlands Luxembourg Denmark United Kingdom Ireland Spain Cyprus Italy Slovenia Portugal Greece

Indeed, Latvia and other Baltic countries have clearly benefited from getting through the internal adjustment at an early stage GDP growth in 2011, % y-o-y

8,0

6,0

4,0

2,0

0,0

-2,0

-4,0

-6,0

-8,0

Despite problems in many European countries, GDP growth even accelerated in Latvia (the fastest growing economy in Europe at the beginning of 2012) GDP growth in Latvia, % y-o-y 8,0

+6.8%

7,0 6,0 5,0 4,0

3,0 2,0 1,0 0,0

2011 I Source: CSB;

II

III

IV

2012 I

Exports already well above the pre-crisis peak level; Latvia ranges among the export leaders in Europe Merchandise export revenue growth (2011 over 2009, %) 90 80

85 72 71 71

70 60

55 53

50

44 44 43 43 42

40 30

38 35 34 34 33 33 32 31 30 29 29

26 23 21

20

10

10

2

Estonia Bulgaria Latvia Lithuania Romania Greece Czech Republic Malta Sweden Cyprus Slovakia Poland Hungary United Kingdom Portugal Slovenia Netherlands Germany Spain Austria Belgium Italy Finland France Denmark Ireland Luxembourg

0

Source: Eurostat

Latvia has managed to stabilize debt at moderate level and to avoid initially expected debt explosion General government gross debt, % of GDP 50

44,7

45 40

42,6

43,4

2011

2012F

36,7

35 30 25 20

19,8

15 10 5 0

2008 Source: Eurostat, F -Bank of Latvia forecast

2009

2010

Lessons

What are the lessons learned?

This crisis has shown that

MORE is LESS and LESS is MORE

"One doesn't die from debt, one dies from not being able to borrow" General government gross debt, % of GDP 200

2005 150

Rogoff & Reinhart debt thresholds for advanced and emerging economies

100

50

Greece* Ireland Italy Portugal US Belgium France UK EU27 Germany Spain Hungary Austria Malta Cyprus Netherlands Poland Slovenia Finland Slovakia Latvia Denmark Czech Rep. Lithuania Romania Sweden Luxembourg Bulgaria Estonia

0

Source: AMECO

"One doesn't die from debt, one dies from not being able to borrow" General government gross debt, % of GDP 200

2010 150

Rogoff & Reinhart debt thresholds for advanced and emerging economies

100

50

Greece* Ireland Italy Portugal US Belgium France UK EU27 Germany Spain Hungary Austria Malta Cyprus Netherlands Poland Slovenia Finland Slovakia Latvia Denmark Czech Rep. Lithuania Romania Sweden Luxembourg Bulgaria Estonia

0

Source: AMECO

"One doesn't die from debt, one dies from not being able to borrow" General government gross debt, % of GDP 200

2013 150

Rogoff & Reinhart debt thresholds for advanced and emerging economies

100

50

Greece* Ireland Italy Portugal US Belgium France UK EU27 Germany Spain Hungary Austria Malta Cyprus Netherlands Poland Slovenia Finland Slovakia Latvia Denmark Czech Rep. Lithuania Romania Sweden Luxembourg Bulgaria Estonia

0

Source: AMECO

Most Euro area countries suffering from high debt are still running large budget deficits Euro area fiscal indicators, % of GDP General government gross debt Greece* Ireland Italy Portugal Belgium France EU27 Germany Spain Austria Malta Cyprus Netherlands Slovenia Finland Slovakia Luxembourg Estonia Source: AMECO

2000 104.4 37.5 108.5 48.5 107.8 57.4 61.9 60.2 59.3 66.2 55.0 59.6 53.8 26.3 43.8 50.3 6.2 5.1

2005 101.2 27.2 105.4 62.8 92.0 66.7 62.9 68.6 43.0 64.2 69.7 69.4 51.8 26.7 41.7 34.2 6.1 4.6

2010 144.9 94.9 118.4 93.3 96.2 82.3 80.3 83.2 61.0 71.8 69.0 61.5 62.9 38.8 48.3 41.0 19.1 6.7

2013 198.5 121.1 118.7 112.1 100.3 91.7 84.9 79.9 78.0 73.7 71.5 70.9 66.0 54.6 53.5 51.1 20.3 6.1

General government budget deficit 2000 -3.8 4.7 -0.9 -2.9 -0.1 -1.5 0.5 1.1 -1.0 -1.8 -5.8 -2.3 2.0 -3.7 6.8 -12.3 6.0 -0.2

2005 -5.6 1.7 -4.5 -5.9 -2.8 -3.0 -2.5 -3.3 1.3 -1.8 -2.9 -2.4 -0.3 -1.5 2.5 -2.8 0.0 1.6

2010 -10.8 -31.3 -4.5 -9.8 -4.2 -7.1 -6.6 -4.3 -9.3 -4.4 -3.6 -5.3 -5.0 -5.8 -2.8 -7.7 -1.1 0.3

2013 -6.8 -7.8 -1.1 -3.2 -4.6 -5.1 -3.2 -0.7 -5.3 -2.9 -3.6 -4.7 -2.7 -5.7 -0.8 -5.2 -0.9 -0.8

Latvia’s example shows that Speed, Ownership,

Commitment and Solidarity works Real GDP growth, % y-o-y 10

Talks about consolidation and inability to deliver

5

2012 I

IV

III

II

2011 I

IV

III

II

2010 I

IV

III

II

2009 I

IV

III

II

2008 I

0

-5

-10

-15

-20 Source: CSB

First large consolidation implemented by Dombrovskis government