Presentation by Mark Griffiths, Mission Chief for Latvia, IMF at International Conference: "Against the Odds: Lessons from the Recovery in the Baltics" organized by the International Monetary Fund and the Bank of Latvia. Riga, June 5, 2012

1. LATVIA: LOOKING AHEAD –
THE REMAINING CHALLENGES
Agnese Bukovska, Mark Griffiths, and Bertrand Gruss
International Monetary Fund
Riga - June 5, 2012

2. A. Many Successes (Session I)
2
 Fiscal adjustment
 Recovery
 Low interest rates
 Current account deficit shrinks
 Low inflation

3. Three Challenges
3
A. Joining the Euro
B. Ensuring sustainable growth
C. Making growth inclusive

4. Three Challenges
4
A. Joining the Euro
B. Ensuring sustainable growth
C. Making growth inclusive

5. B. Sustainable Growth – Why Important?
(1) Income Levels Low
5
GDP per capita
(2010, PPS, percent of EU27)
140
120
100
80
60
40
20
0
PL
CZ
PT
GR
IT
AT
BG
LT
SK
EU
Euro
FR
DE
NL
RO
MT
FI
EE
HU
SI
CY
ES
SE
IE
UK
BE
DK
Latvia
Sources: Eurostat

6. B. Sustainable Growth – Why Important?
(2) Current Account and Competitiveness
6
Latvia - Growth and Current Account Balance
(1997-2011)
15
Current account balance (% of GDP)
10 2009
y = -0.7598x - 4.8226
5
2010
0 2011
-5
2000
2002 1997
1999 2001
-10 1998 2003
2008 2004 2005
-15
-20
2007 2006
-25
-20 -15 -10 -5 0 5 10 15
Real GDP growth (%)

7. B. Sustainable Growth – What is Needed?
(1) More Investment in Tradable Sector
7
Foreign Direct Investment (Stock/GDP, 2007)
50
45 FDI in the Tradable Sectors FDI in the Nontradable Sectors
40
35
30
25
20
15
10
5
0
RS SI Latvia RO LT PL BA MK AL SK CZ HR HU EE BG
Sources: Kinoshita (2011), IMF WP/11/123

8. B. Sustainable Growth – What is Needed?
(2) Structural Reforms to Boost Competitiveness
8
Areas of structural reforms:
 Rule of Law / Business Environment
 Stronger Product Market Competition
 Improving Tax Administration

9. B. Structural Reforms
Weak Rule of Law Deters Investment
9
Institutional Framework
(GCI scores 1 to 7=best)
Property rights
7
Latvia EU27
6 OECD Nordic
5
Favoritism in 4
Efficiency of legal
decisions of 3 framework in
government
2 settling disputes
officials
1
Transparency of
Ethics and
government policy
Corruption
making
Sources: Global Competitiveness Report, WEF

10. B. Structural Reforms
Weak Product Market Competition…
10
Goods market efficiency
(GCI 6th pillar, 1 to 7=best)
5.5
5.0
4.5
4.0
3.5
3.0
CEE LT Latvia EU27 OECD EE US Nordic Japan Asian
Sources: Global Competitiveness Report, WEF Tigers

11. B. Structural Reforms
…Worsens Price Competitiveness
11
Income and Price Level
(2010)
160
DK
140 y = 0.4889x + 48.546
R² = 0.945
Price level (EU-27=100)
FI
120 IE SE
FR
BE
IT Euro NL
DE
100 Estonia GR
ES
EU UK
AT
Latvia PT
CY
80 CZ MT SI
BG SK
HU
60 PL
RO
Lithuania
40
20 40 60 80 100 120 140 160 180
GDP per capita (EU-27=100)
Sources: Eurostat

12. Three Challenges
12
A. Joining the Euro
B. Achieving sustainable growth
C. Making growth inclusive

13. C. Why Inclusive Growth?
High Rates of Poverty and High Inequality
13
Latvia - Poverty and Inequality Levels Are High
(2010)
50
Share of population at risk of
poverty or soc. exclusion
BG
RO
40 Latvia
30 HU Euro IE Lithuania
PL GR
IT PT ES
EU
CY UK
MT
20 SK BE DE
SI Estonia
FI FR DK
AT LU
SE NL
CZ
10
3 4 5 6 7 8
Income inequality (the S20/S80 decile ratio)
Sources: Eurostat

14. C. Why Inclusive Growth?
High Unemployment Rates
14
Unemployment
(in percent of active population, seasonally adjusted)
25
Latvia Estonia Lithuania
20
15
10
EU27
5
0
Q1 2002 Q1 2004 Q1 2006 Q1 2008 Q1 2010
Sources: Haver Analytics

15. C. Why Inclusive Growth?
Employment Still Well Below Pre-Crisis Level
15
Latvia - Change in Employment 2007Q4-2011Q4
(Thousand of people)
Financial intermediation
Agriculture
Public administration and defence
Other
Manufacturing
Construction
Total
-200 -150 -100 -50 0 50
Sources: CBS

16. C. Why Inclusive Growth?
Middle-Aged Unemployment High in Baltics
16
Unemployment-Population Ratio
(Percent by age group, Q4 2011)
14
15-24 25-49 50-59
12
10
8
6
4
2
0
Latvia EE LT EU27
Sources: Haver Analytics

17. C. Policies for Inclusive Growth:
(1) Reduce Labour Tax Wedge (Low Income)
17
Tax wedge, single person without children
(67% of average wage, 2010)
50
45
40
35
30
25
20
15
10
5
0
Switzerla…
EU
BG
Japan
SK
Euro
RO
DE
FR
PT
PL
GR
LT
CZ
AT
IT
LU
NL
FI
EE
SE
HU
US
IE
SI
Latvia
BE
MT
UK
DK
ES
Sources: Eurostat

18. C. Policies for Inclusive Growth:
(2) Enhance Active Labour Market Policies
18
Spending on Active Labor Market Policies (AMLP)
(PPS per person wanting to work, 2009)
6,000
5,000
4,000
3,000
2,000
1,000
0
FI
FR
BE
CY
Euro
RO
EE
GR
PL
IE
SI
UK
SE
LU
HU
Latvia
DE
NL
PT
DK
SK
MT
CZ
AT
BG
LT
ES
EU
IT
Sources: Eurostat

19. C. Policies for Inclusive Growth:
(3) Increase Spending on Social Protection
19
Spending on Social Protection Benefits
(Percent of GDP, 2009)
35 35
30 EU-27 30
25 25
20 20
15 15
10 10
FI
FR
CY
BE
Euro
EE
RO
GR
PL
IE
SI
LU
HU
UK
NL
SE
DE
SK
Latvia
PT
DK
MT
CZ
AT
BG
LT
ES
EU
IT
Sources: Eurostat

20. C. Policies for Inclusive Growth:
(4) Improve Education
20
Average scale scores, PISA
(Average science, mathematics, reading; 2009)
560
550
540
530
520
510
500
490
480
470
460
FR
FI
ESP
BE
EE
PL
GR
IE
SI
UK
HU
LU
NL
DE
SE
SK
Latvia
PT
DK
AT
CZ
LT
OECD ave
IT
EU ave
Sources: OECD

21. Conclusion
21
Latvia’s “Mission Impossible” is over: well done!
Challenges remain:
 Responsible macro / joining the Euro
 Structural reforms for competitiveness and
sustainable growth
 Reducing unemployment and inequality to
make growth more inclusive