Latvia and the Euro. Ilmārs Rimšēvičs Governor. Latvijas Banka

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1 Latvia and the Euro Ilmārs Rimšēvičs Governor. Latvijas Banka October, 2013

2 Despite loud ex ante warnings of protracted recession risks under internal adjustment scenario, a strong V shaped recovery followed Real GDP growth, % Source: CSB

3 Latvia has implemented sizable fiscal consolidation underpinned by structural reforms Breakdown of budget consolidation measures, % of GDP Source: Ministry of Finance; Bank of Latvia staff calculations

4 Currently Latvia s economy is balanced and grows at the fastest pace in EU Annual GDP growth in 2Q 2013, % Latvia Malta Estonia Slovakia Ireland Germany Luxembourg France Austria Belgium Finland Spain Portugal Italy Netherlands Slovenia Greece Cyprus

5 Euro brings a change of perspective 5

6 Why euro on 1 January 2014? Crucial decisions are made within the euro area, Latvia will participate in making decisions that affect our daily life Why not to take advantage of the benefits as soon as possible? Euro area is not collapsing but getting stronger Credible compliance with Maastricht criteria Criterion Maastricht criteria Latvia s performance Inflation (April 2013*) 2.7% 1.3% Budget balance (% of GDP; in 2012) -3.0% -1.2% Government debt (% of GDP; in 2012) 60% 40.7%* Interest rate (April 2013*) 5.5% 3.8% Source: Bank of Latvia, * - Convergence report of May 2013

7 Latvia will benefit from Euro introduction in many ways Credit rating Long term interest rate Government debt service Exports Income account Investment GDP Budget balance Current account Net foreign assets Welfare Consumption Direct taxes Disposable income

8 Euro will help save government money by lowering debt servicing costs Additional annual interest payments failing to introduce the euro and continuing to borrow and refinance the debt in the financial market (EUR million) Savings of EUR 787 million in 10 years Source: Bank of Latvia s estimates

9 Ratings of countries that joined the euro area in the latest enlargement rounds have improved by up to 3 notches Change in major credit rating agency ratings a year before and after the country joined the euro area Standard&Poor s Fitch Moody s A year before After a year Total A year before After a year Total A year before Slovenia AA AA +1 AA AA +1 Aa3 (AA ) Cyprus A A+ +1 A+ AA +1 A2 (A) Malta A A 0 A A+ +1 A3 (A ) Slovakia A A+ +1 A A+ +1 A1 (A+) Estonia A AA +3 BBB + +/ no change + 2 notches Source: Bloomberg A+ +3 A1 (A+) After a year Aa2 (AA) Aa3 (AA ) A1 (A+) A1 (A+) A1 (A+) Total notch + 3 notches 0 0

10 Other things being equal, euro will raise Latvia s credit rating Long-term foreign currency credit ratings for Latvia and Estonia AAA AA+ AA+ AA A+ A+ A BBB+ BBB+ BBB BB+ BB+ BB B+ B+ B AAA AA+ AA AA A+ A A BBB+ BBB BBB BB+ BB BB B+ B B Standard&Poor's - Latvia Fitch - Latvia Fitch - Estonia Source: Reuters Standard&Poor's - Estonia Lowest investment-grade

11 The "devaluation ghost" and the related costs will cease to exist RIGIBOR indices RIGIBOR and EURIBOR indices Avots: Bank of Latvia

12 Euro will save transaction and conversion costs (EUR 650 million in the last 6 years) EUR/LVL foreign exchange conversion for customers of bank and currency exchange offices (EUR million) Source: Bank of Latvia, costs have been calculated on the basis of turnover and exchange rate difference in cash and noncash EUR/LVL transactions in banks and currency exchange offices

13 Had the euro been introduced in 2008, the financial crisis in Latvia would have been less severe Access to ECB funding Protection of the sound banks in case of a bank run The soundness of banks will be in their own hands The ECB funding will not cure insolvency/lack of capital

14 Impact of introduction of euro on prices in previous cases was small relative to other factors (oil prices, tax increases etc.) Impact of euro introduction on inflation Inflation in Estonia (%) Estonia 0.30 Malta 0.20 Slovakia 0.25 Impact on inflation (pp) Consumer protection activities launched already in Latvia Source: Eurostat

15 Long-term benefits will outweigh shortterm costs Indicator Savings in the government budget due to lower debt servicing costs (in 10 years from euro changeover) Benefits from export growth and a decrease in the interest rate for the private sector ( , in cumulative terms) Benefits from the lack of currency conversion costs (in 10 years from euro changeover) One-off euro introduction costs in the public sector (estimates of the Ministry of Finance) One-off euro introduction costs in the private sector Payments in the ESM capital (in 5 years from euro changeover) Bank of Latvia costs (provision of cash) Value ~800 million EUR ~8 000 million EUR ~700 million EUR 12 million EUR ~ million EUR 199 million EUR 21 million EUR

16 In fact euro is already widely used in Latvia 82% 44% 59% Share of euro in loans to domestic companies and households (June 2013) Share of euro in domestic companies and households deposits (June 2013) Settlements in euro for imports or exports of goods and services (2012) Source: Bank of Latvia

17 Population in Latvia generally welcome the implicit benefits from the euro and share euro zone's main working principles To what extent do you agree with the following statements? The Government should not spend more than it earns 91,2% 4,5% 4,3% In the coming years, the national debt and debt service burden should be reduced Low interest rates on loans are important for the development of the country and for individual borrowers 87,3% 86,1% 5,4% 7,3% 3,6% 10,3% In the economic sphere, Latvia should activelly collaborate with the strongest partners 82,7% 8,7% 8,6% Latvia must show solidarity to other European countries because in the long run it will be beneficial also for us Source: Latvijas Fakti 78,7% 10,4% 10,8% 0% 25% 50% 75% 100% Fully + more agree Fully+ more disagree Don t know/na

18 Public support for euro is steadily increasing Respondents attitude towards euro changeover in Latvia 2008 V -53,5 29, V -47,1 35, V -45,7 38, V -55,5 32, X -70,6 25,3 4 Negative 2012 XII -66,1 30,9 3,0 Positive 2013 I 2013 II -62,8-65,4 32,8 31,5 4,4 3,1 Hard to tell 2013 III -63,5 28,5 8, IV -61,8 35,5 2, V -61,1 35,5 3, VI -58,5 38,0 3, VII -59,4 36,8 3, VIII -56,5 38,9 4,6 Source: TNS Latvia 18

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