The Adjustment in Latvia

Transcription

1 The Adjustment in Latvia Gabriele Giudice Head of Unit, DG ECFIN Mission Chief for EU BoP Assistance to LV European Commission ELIAMEP conference Poros, 8 July 2011

2 Latvia: crisis in 2008, in the midst of a storm by : Access to international capital markets closed (Parex Banka) Multilateral support ( 7.5 bn over 3 years from EU, IMF, others) But in early 2009: Economy free-falling Government resignation Confidence very low Concerns about insufficient action taken Path to euro adoption (2012) no longer credible Doubts about the peg: Latvia under financial attack (6/2009) % y-o-y Latvia: GDP growth, projections and outcome Initial (IMF Jan. 2009) Outcome IMF July 2009 = COM June 2009 LV CP July 2011 ELIAMEP conference Poros 2

3 Budget running out of hand after some hesitation, strong reaction Most of the adjustment decided between June and December 2009 Fiscal consolidation over 16 % of GDP since end 2008 (though several measures not of best quality, nor permanent) two-thirds expenditure cuts, in line with international best practice 25% wage cuts Major lay offs Public administration reform Local administrative entities down by 80%, lower transfers Cuts in hospitals and schools by 30%, subsidies VAT, PIT, special levies, Real estate, car taxation, fight to the grey economy % of GDP LV: Consolidation measures =16.6% of GDP 0,5 2,8 6,7 expenditure 2,1 1,9 revenue ,8 0,8 8 July 2011 ELIAMEP conference Poros 3

4 Multilateral external support: Not free from tensions Summer 2009: IMF doubted whether to continue support Had too negative fiscal projections Underestimated implications of its inaction (devaluation and contagion) Commission believed in possible adjustment and necessity of acting quickly and decisively Ultimately, the European Council supported the Commission: the EU acted for the first time ever ahead of IMF % of GDP Latvia: general government deficit, projections and outcome Initial (IMF Jan. 2009) Outcome IMF July 2009 COM June July 2011 ELIAMEP -3 conference Poros 4 % of GDP Latvia: general government debt projections and outcome Initial (IMF Jan. 2009) IMF July 2009 COM June 2009 Outcome LV CP LV CP

5 From crisis to stabilisation and recovery Global economy and financial system stronger Domestic factors Strong budgets, good implementation Financial sector stabilisation Internal adjustment for competitiveness Active labour market policies and social focus 8 July 2011 ELIAMEP conference Poros 5

6 Strong budgets, good implementation First, prudent approach to economic scenario = positive surprises Consolidation implemented without serious slippages (but not all as expected), which was a risk given the size and also in view of electoral temptations (and again with possible new election this year ). Aim to bring deficit below 3% of GDP in 2012 is realistic, though still requires a consolidation of about 1 to 1½ % of GDP, and - as usual - risks remain 8 July 2011 ELIAMEP conference Poros 6

7 Financial sector stabilisation Second, confidence in the financial system which triggered the crisis in 2008 now restored Latvian authorities remained strongly committed to the long-standing monetary and exchange rate arrangement. Took significant financial system stabilisation measures, notably by restructuring Parex Banka and MLB, while prudential supervision and regulation has been strengthened further. Private sector remained involved in the country 8 July 2011 ELIAMEP conference Poros 7

8 0.710 Calm(ing) after the storm Latvia - EUR/LVL exchange rate 10 Latvia - Policy and interbank market interest rates Nov Feb May Aug Nov Feb May Aug Nov Feb Source: Reuters EcoWin 0 Nov Feb May Aug Nov Feb May Aug Nov BoL refinancing rate BoL marginal deposit facility rate O/N RIGIBOR ECB main refinancing operations (fixed rate) BoL marginal lending facility rate Feb 11 Source: Reuters EcoWin 8 July 2011 ELIAMEP conference Poros 8

9 External competitiveness Third, external competitiveness is improving, following an adjustment of wages and employment of a massive scale. But also a change in the structure, quality, more investment (EU Funds) There is no need of a significant price deflation Exports are picking up strongly and export market shares are increasing. However, risks from surging imports and accelerating inflation and wages should not be overlooked 8 July 2011 ELIAMEP conference Poros 9

10 Internal devaluation Institutional fundamentals helped wage flexibility in Latvia (low unionisation, private labour law contract in public administration, easy dismissal rules) Cost optimization and enhancing productivity contributed to narrowing the wage-productivity gap Gains in competitiveness are reflected by increases in market shares in trading partner countries and a broadly balanced C.A Q Q4 y-o-y% 2006 Q1 Wages and productivity whole economy, s.a.(q1 2005=100) Q Q1 Q3 Real comp./empl (CPI deflat.) Productivity / hours worked Sources: Statistics Latvia, Eurostat, COM calculation 2008 Q1 Q Q1 Q3 Graph II.13.3: Latvia - Current account, inflation, unit labour cost forecast Current account (% of GDP) HICP ULC 2010 Q1 Q3 8 July 2011 ELIAMEP conference Poros 10

11 Labour markets improving while seeking social fairness Fourth, unemployment is still vey high (16%), but receding quickly from record levels (>20%) Steps have been taken to help the labour force remain active, retrain and strengthen its skills, cover the social needs, using effectively the EU funds Perhaps this is one of the reasons Latvia has managed to avoid widespread social unrest 8 July 2011 ELIAMEP conference Poros 11

12 Latvia s experience with crisis: what lessons for Europe? Can be overcome if there is, first and foremost, national commitment and incisive action to ensure solvency Adjustment does not need a devaluation nor a sustained deflation (good for debt dynamics)! Growth can return faster, esp. if adjustment based on reforms Liquidity problems must not lead to insolvency : important that EU provides ample support and shelter Ultimately much less money needed : LV only 4.3bn out of 7.5, the EU banking sector also used a fraction. Paradox of Latvian PM: re-elected after massive consolidation and reform (the same in Estonia). However, realism is necessary, more needs to be done, including to avoid the pitfalls of the next boom 8 July 2011 ELIAMEP conference Poros 12

13 Thank you for your attention! Gabriele Giudice Head of Unit, DG ECFIN Mission Chief for EU BoP Assistance to LV European Commission ELIAMEP conference Poros, 8 July 2011