Presentation by Dr. Anders Åslund, Senior Fellow, Peterson Institute for International Economics (USA) at Bank of Latvia conference ""Economic Adjustment under Sovereign Debt Crisis: Can Experience of the Baltics Be Applied to Others? Riga, November 2, 2012.

1. Why Latvia Succeeded and
Southern Europe Failed
Anders Åslund
Senior Fellow
Peterson Institute for International Economics, Washington, DC
Bank of Latvia
Riga, November 2, 2012

3. Political Preconditions
1. Immediate cause of crisis: External (liquidity freeze)
2. Big real output shock bred action
3. New government March 2009
4. Comprehensive & front-loaded crisis program
restored confidence early
5. Equity
6. Good salesmanship
7. Sufficient international support

4. Early, Radical Fiscal Adjustment
• Fiscal adjustment 9.5% of GDP in
2009 & total 16% of GDP
• More expenditure cuts than tax
increases (2/3 in total)
• Confidence restored by June 2009

5. 16% of GDP Fiscal Consolidation, 2008-11
10
percent of GDP
9
8
7
6 6.7
5
4
3 2.0
2 0.7
2.8
1 2.1
1.5
0 0.5
2008 2009 2010 2011
revenue expenditure

6. Credit default swap rates peaked in March 2009
1400
5-year, basis points
1200
1000
800
600
400
200
0
Jan-08 Mar-08May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10May-10 Jul-10 Sep-10 Nov-10 Jan-11

7. Market interest rates peaked in June 2009
30
percent per annum
25
20
15
10
5
0
Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10
RIGIBOR 3-month RIGIBOR 6-month RIGIBOR 12-month

8. Foreign currency reserves bottomed out June 2009
6
billions of euros
5
4
4th tranche of IMF
loan received
3d tranche of EC
3 loan received
1st tranche of WB
loan received
2 3d tranche of IMF
2nd tranche of IMF
loan received
loan received
1st tranche of EC
1 loan received 2nd tranche of EC
loan received
0
Jan-09 Mar May Jul Sep Nov Jan-10 Mar May Jul Sep

9. Latvia Unemployment, 2008–2012
25
percent of labor force
20
15
10
5
0
2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1

10. Structural Reforms
• Big, early expenditure cuts drove structural
reforms
• Dismissed 29% of civil servants
• Closed half state agencies
• Deregulated & improved governance
• Reduced public salaries by 26% & private
salaries by 10% in 2009

11. Equity
• Maintained social safety net
• Cut high salaries more than low ones and
social benefits
• Increased indirect taxes, property taxes &
capital gain taxes
• Prohibited double-dipping by senior officials
• Action against corruption

12. Latvia: Set for Sound
Growth since 2010
• Good governance
• Competitive costs
• Solid export expansion
• Fast rising investment

13. Measures:
Compare Latvia with PIG
• Budget deficit
• Public expenditures
• Governance
• Labor costs

14. Latvia Brought Down Budget Deficit
Percent of GDP
0
-2
-4
-6
-8
-10
-12
-14
-16
-18
2005 2006 2007 2008 2009 2010 2011 2012E
Latvia Greece Italy Portugal

15. Latvia: Public Expenditure as % of GDP Moderating
55
Percent of GDP
50
45
40
35
30
2005 2006 2007 2008 2009 2010 2011 2012E
Latvia Greece Italy Portugal

16. Latvia: Best at Ease of Doing Business Ranking, 2013
Lower score indicates greater ease of doing business
Latvia Greece Italy Portugal
0
10
20
30
40
50
60
70
80
90

17. Latvia: Sharply Falling Real Unit Labor Cost, 17%, 2008-11
110
Index, 2008=100
105
100
95
90
85
80
2008 2009 2010 2011
Latvia Greece Italy Portugal

18. Outcomes:
Compare Latvia with PIG (2)
• Export expansion
• Investment
• Growth
• Current Account

19. Rising Exports, Percent Change 2009 - 2012, yoy
YOY, Quarterly Statistics
40
30
20
Percent Change, yoy
10
0
2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2
-10
-20
-30
Latvia Greece Italy Portugal

20. Investment Recovering as % of GDP, Greece Just Falling
45
Percent of GDP
40
35
30
25
20
15
10
2005 2006 2007 2008 2009 2010 2011
Latvia Greece Italy Portugal

21. GDP Growth 2000-2012: Latvia Superior
15
Percent
10
5
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E
-5
-10
-15
-20
Latvia Greece Italy Portugal

22. Current Account Balance, 2007 & 2011: Latvia quick turn
Latvia Greece Italy Portugal
5
Percent of GDP
0
-5
-10
-15
-20
-25
2007 2011
-30

23. 7 Lessons from Latvia for the World
1. Face reality and explain it!
2. Take early credible action to restore confidence =
measures depend on severity of crisis, 2-3 years
3. Early fiscal adjustment preferable
4. Better to cut public expenditures (2/3) than to
raise taxes

24. 7 Lessons from Latvia for the World
5. Let expenditure cuts drive structural reforms
6. Make program equitable
7. Get sufficient international rescue financing up
front, but with conditions

26. Latvia: High Inflation Tamed, Only Brief Deflation
18
Average Consumer Prices, Percent Change
16
14
12
10
8
6
4
2
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E
-2
-4
Latvia Greece Italy Portugal