Presentation by Ilmārs Rimšēvičs, Governor of the Bank of Latvia 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. Lessons from Latvia’s internal adjustment
strategy
Ilmārs Rimšēvičs
Governor of the Bank of Latvia
June 5, 2012

2. Presentation outline
 Overheating of Latvia’s economy
 Expansionary consolidation
 Lessons learned
 Latvia on its way to euro

3. Latvia’s economy was on a fast track
during 2004-2007

4. Latvia has lived through a boom-bust cycle:
severe recession followed years of unsustainable
double digit growth
Real GDP growth (%)
15.0
11.2
10.1 9.6
10.0 8.9
7.2 7.6
5.5
5.0
0.0
-0.3
-5.0 -3.3
-10.0
-15.0
-20.0 -17.7
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: CSB

5. Over the past boom Latvia was running
an enormous underlying fiscal gap
General Government budget balance (ESA’95), % of GDP
0
-2 -0.8
-4 -2.2 -2.7
-3.3
-6
-5.5 -5.6
-8 -6.4
-10
-7.5
-8.5
-12
-14
-16 -14.1
-18
-20 -18.6
2005 2006 2007 2008 2009 2010 2011 2012F
Consolidation effort Actual (targeted) balance
Fiscal gap Structural budget balance
Source: Eurostat, F – Bank of Latvia staff estimation

6. To be or not to be, was the question
in 2008
Many suggested devaluation as a
way out of the crisis.
Why devaluation was not an
appropriate solution?

7. One size does not fit all!
 Small vs large economy
 Open vs closed economy
 Resource rich vs resource importing
economy
 Euroized vs domestic currency
dominated economy
 etc

8. Latvia lost market access already at the outset of the
recent crisis and the fiscal gap had to be closed quickly
by a massive consolidation
Breakdown of budget consolidation measures, % of GDP
Source: Ministry of Finance; Bank of Latvia staff calculations

9. How Latvia managed to accomplish what
initially was said to be impossible?
Speed

10. A speedy consolidation can be compared to a timely
pruning of an apple-tree – harvests are earlier and richer

11. How Latvia managed to accomplish what
initially was said to be impossible?
Ownership

12. How Latvia managed to accomplish what
initially was said to be impossible?
Commitment

13. How Latvia managed to accomplish what
initially was said to be impossible?
Solidarity

14. Latvia has regained competitiveness:
wage-productivity gap has been closed
Real hourly wage and labour productivity per hour (seasonally adjusted), 2005 Q1 = 100
150
140
130
120
110
100
90
Q3
Q3
Q3
Q3
Q3
Q3
Q3
Q3
2004 Q1
2005 Q1
2006 Q1
2007 Q1
2008 Q1
2009 Q1
2010 Q1
2012 Q1
2011 Q1
Labour productivity Real wage
Source: CSB; Bank of Latvia staff calculations

15. Despite loud ex-ante warnings of protracted
recession risks under internal adjustment scenario,
a strong “V” shaped recovery followed
Real GDP growth, %
15
10
5
5.5
0
-5
-10
-15
-20
2006 2007 2008 2009 2010 2011
Source: CSB

16. 0.0
2.0
4.0
6.0
8.0
-8.0
-6.0
-4.0
-2.0
Source: Eurostat
Estonia
Lithuania
Latvia
Poland
Sweden
Slovakia
Austria
Germany
Finland
Romania
Malta
Belgium
Bulgaria
Czech Republic
France
Hungary
Netherlands
Luxembourg
GDP growth in 2011, % y-o-y
Denmark
United Kingdom
Ireland
Spain
Cyprus
Italy
Slovenia
Portugal
Greece
getting through the internal adjustment at an early stage
Latvia, other Baltic countries have clearly benefited from

17. Despite problems in many European countries,
GDP growth even accelerated in Latvia (the fastest
growing economy in Europe at the beginning of 2012)
GDP growth in Latvia, % y-o-y
8.0
7.0
+6.8%
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2011 I II III IV 2012 I
Source: CSB

18. Exports already well above the pre-crisis peak level;
Latvia ranges among the export leaders in Europe
Merchandise export revenue growth (2011 over 2009, %)
90 85
80
72 71 71
70
60 55 53
50 44 44 43 43 42
40 38 35
34 34 33 33 32
31 30 29 29
30 26 23
21
20
10
10 2
0
Belgium
Sweden
Ireland
Poland
Spain
Greece
Cyprus
Portugal
Slovenia
Estonia
Malta
Bulgaria
Latvia
Italy
United Kingdom
Finland
France
Lithuania
Hungary
Austria
Slovakia
Czech Republic
Denmark
Netherlands
Romania
Germany
Luxembourg
Source: Eurostat

19. Latvia has managed to stabilize debt at a moderate level
and to avoid a debt explosion, expected initially
General government gross debt, % of GDP
50
44.7 43.4
45 42.6
40
36.7
35
30
25
19.8
20
15
10
5
0
2008 2009 2010 2011 2012F
Source: Eurostat; Bank of Latvia staff estimation

20. What are the lessons
learned?

21. This crisis has shown that
MORE is LESS and LESS is MORE
www.nowpublic.com

22. "One doesn't die from debt, one dies from not being
able to borrow"
General government gross debt, % of GDP
200
Rogoff & Reinhart
2005 debt thresholds
150
for advanced and
emerging economies
100
50
0
Czech Rep.
US
UK
EU27
Greece*
Belgium
Hungary
Bulgaria
Portugal
Estonia
Malta
Italy
France
Austria
Spain
Finland
Latvia
Ireland
Netherlands
Sweden
Slovenia
Slovakia
Lithuania
Cyprus
Poland
Germany
Romania
Luxembourg
Denmark
Source: AMECO

23. "One doesn't die from debt, one dies from not being
able to borrow"
General government gross debt, % of GDP
200
Rogoff & Reinhart
2010 debt thresholds
150
for advanced and
emerging economies
100
50
0
Czech Rep.
US
UK
EU27
Greece*
Belgium
Hungary
Bulgaria
Portugal
Estonia
Malta
Italy
France
Austria
Spain
Finland
Latvia
Ireland
Netherlands
Sweden
Slovenia
Slovakia
Lithuania
Cyprus
Poland
Germany
Romania
Luxembourg
Denmark
Source: AMECO

24. "One doesn't die from debt, one dies from not being
able to borrow"
General government gross debt, % of GDP
200
Rogoff & Reinhart
2013 debt thresholds
150
for advanced and
emerging economies
100
50
0
Czech Rep.
US
UK
EU27
Greece*
Belgium
Hungary
Bulgaria
Portugal
Estonia
Malta
Italy
France
Austria
Spain
Finland
Latvia
Ireland
Netherlands
Sweden
Slovenia
Slovakia
Lithuania
Cyprus
Poland
Germany
Romania
Luxembourg
Denmark
Source: AMECO

25. Most Euro area countries suffering from high
debt are still running large budget deficits
Euro area fiscal indicators, % of GDP
General government gross debt General government budget deficit
2000 2005 2010 2013 2000 2005 2010 2013
Greece* 104.4 101.2 144.9 198.5 -3.8 -5.6 -10.8 -6.8
Ireland 37.5 27.2 94.9 121.1 4.7 1.7 -31.3 -7.8
Italy 108.5 105.4 118.4 118.7 -0.9 -4.5 -4.5 -1.1
Portugal 48.5 62.8 93.3 112.1 -2.9 -5.9 -9.8 -3.2
Belgium 107.8 92.0 96.2 100.3 -0.1 -2.8 -4.2 -4.6
France 57.4 66.7 82.3 91.7 -1.5 -3.0 -7.1 -5.1
EU27 61.9 62.9 80.3 84.9 0.5 -2.5 -6.6 -3.2
Germany 60.2 68.6 83.2 79.9 1.1 -3.3 -4.3 -0.7
Spain 59.3 43.0 61.0 78.0 -1.0 1.3 -9.3 -5.3
Austria 66.2 64.2 71.8 73.7 -1.8 -1.8 -4.4 -2.9
Malta 55.0 69.7 69.0 71.5 -5.8 -2.9 -3.6 -3.6
Cyprus 59.6 69.4 61.5 70.9 -2.3 -2.4 -5.3 -4.7
Netherlands 53.8 51.8 62.9 66.0 2.0 -0.3 -5.0 -2.7
Slovenia 26.3 26.7 38.8 54.6 -3.7 -1.5 -5.8 -5.7
Finland 43.8 41.7 48.3 53.5 6.8 2.5 -2.8 -0.8
Slovakia 50.3 34.2 41.0 51.1 -12.3 -2.8 -7.7 -5.2
Luxembourg 6.2 6.1 19.1 20.3 6.0 0.0 -1.1 -0.9
Estonia 5.1 4.6 6.7 6.1 -0.2 1.6 0.3 -0.8
Source: AMECO

26. Latvia’s example shows that Speed, Ownership,
Commitment and Solidarity works
Real GDP growth, % y-o-y
10
Talks about
consolidation
5
and inability to
deliver
0
II
III
IV
II
III
IV
II
III
IV
2011 I
II
III
IV
2008 I
2009 I
2010 I
2012 I
-5
-10
First large consolidation
-15
implemented by Dombrovskis
government
-20
Source: CSB

27. Latvia is well positioned to comply with the Maastricht
criteria and qualify for EURO introduction in 2014
Maastricht criteria estimate forecast and 12 month average inflation, %
4.5 forecast EURO 2014:
4.0 measurement of
compliance
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
V
X
V
X
V
X
II
II
VII
VIII
XII
VII
VIII
XII
VII
VIII
XII
IX
IV 2011
IX
IV
IV
IX
III
III
VI
XI
VI
XI
VI
XI
I 2012
I 2013
12 month average inflation in Latvia Mastricht criteria**
Source: Eurostat, EC and Bank of Latvia staff estimations; ** - negative inflations excluded

28. By introducing EURO in 2014 Latvia would bring
positive experience for other European countries
General Government budget balance (ESA95), % of GDP
0.0
-1.0 -0.4
-0.8
-2.0 -1.4
-1.9
-3.0
-4.0 -3.5
-5.0
-6.0
-4.2
EURO
-7.0
-8.0
-9.0 -8.2
-10.0 Budget strategy Measure-
-9.8 ment
-11.0
-12.0
2007 2008 2009 2010 2011 2012F 2013T 2014T
Source: Eurostat, F – Bank of Latvia staff estimation, T – targeted budget balance