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Latvia: An economic success story in the making

01.03.2012 - Latvia's efforts to stabilise its economy under the EU balance-of-payments programme have been successful, and rewarded by the return to the financial markets.

The EU balance-of-payments assistance for Latvia that expired on 19 January 2012 has been successful, but challenges remain. This was one of the key messages at a joint seminar organised by the Bank of Latvia and DG ECFIN on 1 March in Brussels. Marco Buti, Director-General for Economic and Financial Affairs at the European Commission, said: "As a result of hard work Latvia brought its budget deficit under control and the economy on a growth path again, and this has been rewarded by its successful return to the financial markets. Further reforms need to be carried out to secure this progress and deal with remaining challenges, but what we have seen so far is certainly a very good start." Speakers at the seminar emphasised that there is a need to prevent the re-emergence of new imbalances, address problem areas like the education system and further improve the situation on the labour market.

Valdis Dombrovskis, Prime Minister of Latvia, reminded that Latvia managed a fiscal adjustment of 17.5% of GDP between 2009 and 2012. He added that EU structural funds and economic reforms, with a view to cut red tape and to ease exports, helped to dampen the restraining effects of fiscal consolidation on the economy. Although Latvia's GDP contracted by more than 20% during the crisis, GDP on average still increased by about 4-5% per year over the past decade. According to the latest EU forecast, GDP grew by 5.3% in 2011 and is expected to expand by 2.1% this year, displaying the third highest growth rate in the EU. Mr Dombrovskis said: "We have seen that financial stability is a prerequisite for growth." In general he added: "Delaying adjustment does not help, as it just prolongs the recession."

Speakers at the seminar stressed that Latvia was right not to rely on currency devaluation as a solution to its problems. Ilmars Rimsevics, Governor of the Bank of Latvia, explained that the positive expectations attached to this strategy would not have materialised in the case of Latvia. Mr Buti added that foregoing the currency peg would have posed important risks not only for Latvia, but for the region as a whole.

Analyses presented at the seminar by DG ECFIN, the Bank of Latvia and other experts showed clearly that the crisis was not caused primarily by a loss of price competitiveness but rather this was the symptom of strong capital inflows, excessive internal demand and imports, and imprudent budgetary policies. The sheer size of the imbalances accumulated ultimately led to a loss of confidence and a sudden reversal of capital flows; the fast and determined fiscal consolidation seems to have created a positive impact on growth via confidence and supply side effects, thanks to its composition which dealt primarily with reducing current expenditure which had previously grown disproportionally. As Minister of Finance Andris Vilks put it, the government proved that 'less is more'.

Latvia is now preparing for the adoption of the euro, targeting the year 2014. Mr Rimsevics said that the book on Latvian crisis resolution will be completed when the country introduces the single currency.

Background:

In December 2008 multilateral financial assistance was agreed for Latvia in the light of a rapidly deteriorating economic situation and concerns related to the banking sector. In total EUR 7.5 billion were committed by the EU, the IMF, the Nordic countries (Sweden, Denmark, Finland, Norway and Estonia), the Czech Republic, Poland, the World Bank and the EBRD. In the end, EUR 4.5 billion were actually paid out, with EUR 2.9 billion coming from the EU, EUR 1.1 billion from the IMF, EUR 400 million from the World Bank and EUR 80 million from the EBRD.

The EU Balance of Payment assistance, totaling EUR 3.1 billion, was formalised with a decision of the ECOFIN council on 20 January 2009 and expired on 19 January 2012. Post Programme Surveillance will be carried out by the Commission until a large part of the funds disbursed by the EU has been be repaid.

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