Changing Latvia in the Changing Euro Area

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Presentation by Zoja Razmusa, Member of Council, Bank of Latvia. Euro Conference Latvia 2013.

Presentation by Zoja Razmusa, Member of Council, Bank of Latvia. Euro Conference Latvia 2013.

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  • 1. Changing Latvia in the Changing Euro Area Zoja Razmusa 12 September 2013
  • 2. CHANGES FROM THE LATVIAN PERSPECTIVE
  • 3. Economy is dominated by micro enterprises while large enterprises contribute around one third of the total value-added created by businesses 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%100% 20052011 Micro Small Medium Large Economically active market sector statistical units (%) Source: Central Statistical Bureau of Latvia; Eurostat 19 23 26 32 Micro Small Medium Large Value added by enterprise size class, non-financial business economy (available information for 2010, %)
  • 4. During crisis the economy re-adjusted towards a more export-oriented model 125.5% 0 20 40 60 80 100 120 140 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F 2014F 2015F Exports Imports Exports and imports to GDP ratio (%) Sources: Central Statistical Bureau of Latvia; F – Bank of Latvia forecast.
  • 5. With euro area countries becoming more important trading partners for Latvia, euro is a major currency in foreign trade settlements Currency structure of foreign trade turnover in Latvia (%) Source: Central Statistical Bureau of Latvia. 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2005 2012 Other currencies (services) Other currencies (goods) USD (services) USD (goods) EUR (services) EUR (goods) Merchandise export breakdown by country (mln LVL) 0 1 000 2 000 3 000 4 000 5 000 6 000 7 000 2000 2005 2008 2012 Other Other EU Scandinavia(ex Finland) +UK CIS Baltics* Euro area * Estonia included in the euro area since 2011
  • 6. Latvia’s export has undergone a significant diversification, diminishing the vulnerability to asymmetric shocks 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2000 2005 2008 2013 1H Others Textiles Transport vehicles Mineral products Chemical Machinery and electrical equipment Base metals Food products Wood Structure of exports (%) Sources: Central Statistical Bureau of Latvia, Bank of Latvia.. 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 2000 2005 2008 2013 H1 Government services, n.i.e. Personal, cultural and recreational services Other bussiness services Royalties and licence fees Computer and information services Financial services Insurance services Construction services Communication services Travel Other transportation services Pipeline transport Auto transport Railway transport Air transport Sea transport ServicesGoods
  • 7. Latvian economy being sufficiently flexible has undergone a significant adjustment and regained competitiveness: wage-productivity gap has been closed Real hourly wage and labour productivity per hour in manufacturing (s.a., 2005 Q1 = 100) Sources: Central Statistical Bureau of Latvia;; Bank of Latvia staff calculations. 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20131H Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovak Republic Slovenia Merchandise export shares in world import (2002=100) 100 120 140 160 180 Q12005 Q3 Q12006 Q3 Q12007 Q3 Q12008 Q3 Q12009 Q3 Q12010 Q3 Q12011 Q3 Q12012 Q3 Q12013 Labour productivity Real wage
  • 8. Macroeconomic challenges • No ailing macroeconomic imbalances are evident as external and internal balance has been restored and competitiveness has been regained. • Challenges ahead are rather of structural nature • Labour market: long-term unemployment; quality of education • Product market: export sophistication; innovations, R&D; business environment
  • 9. Changes in monetary policy framework (I) ESCB Bank of Latvia until 2014 Main channel of monetary transmission Interest rate channel Exchange rate channel Main source of liquidity for the banking system Central bank liquidity providing - open market operations Central bank liquidity providing - foreign exchange operations Liquidity obtained from the mother companies, external financing Excess liquidity in the banking system ~250 bln. EUR (2.6% of GDP) ~ 700 mln. LVL (~4.3% of GDP) Role of exchange rate Flexible exchange rate, FX interventions only in exceptional circumstances Tightly fixed exchange rate, automatic FX interventions
  • 10. Increasing role of interest rate channel will be determined by currency structure of private sector borrowing from banks non-financial corporations 0 1 2 3 4 5 6 7 8 Bln. LVL Volume in lats Volume in euro Volume in other currencies 0 1 2 3 4 5 6 7 8 Bln. LVL Outstanding bank loans to households Source: Bank of Latvia.
  • 11. Changes in monetary policy framework (II) Eurosystem Bank of Latvia Main refinancing operations 0.5% 2% Marginal lending facility 1% 2.5%–7% Deposit facility 0% 0.05%–0.075% Minimum reserve requirement ratio 0–1% 0–2%–4% Non-traditional monetary policy operations Long-Term Refinancing Operations Outright Monetary Transactions Securities Markets Programme None
  • 12. Money market rates in Latvia have historically been higher and more volatile than in the euro area 3 month money market rates in Latvia vs the euro area 0 1 2 3 4 5 6 7 jan.2010 jan.2011 jan.2012 jan.2013 RIGIBOR 3M EURIBOR 3M 12 month money market rates in Latvia vs the euro area 0 1 2 3 4 5 6 7 8 9 10 jan.2010 jan.2011 jan.2012 jan.2013 RIGIBOR 1Y EURIBOR 1Y % %
  • 13. RECENT POLICY CHANGES IN THE EURO AREA
  • 14. Euro area's policy response to crisis POLICY AREA BEFORE THE CRISIS NOW Economic and fiscal policy Stability and Growth Pact (SGP) Enhanced EU economic governance under the European semester; A reinforced fiscal surveillance (SGP; Fiscal Compact) A new initiative – macroeconomic surveillance (Macroeconomic Imbalances Procedure (MIP)) Monitoring of structural reforms (Europe 2020 Strategy)
  • 15. Structural budget balance, general government (% of GDP), 2003-2007 average -7 -6 -5 -4 -3 -2 -1 0 1 2 3 Greece Portugal Italy Malta France Cyprus Slovakia Euro area average Slovenia Latvia Germany Austria Belgium Netherlands Estonia Luxembourg Spain Ireland Finland Source: European Comission. New threshold
  • 16. Countries that tightened fiscal policy during the boom can relax during the dowturn. Countries that did not, cannot FI DKSE BG LU ES NE IE EE BE CY AU DE SKSI CZ LV LTFR PL IT UK RO MT PT GR HU -1 0 1 2 3 4 5 6 7 -8 -6 -4 -2 0 2 4 Changesinstructuralbalance2011-2013 (%ofGDP) Average structural balance 2004-2008 (% of GDP) Source: European Comission.
  • 17. Sovereign risk assessments by markets in the euro area 2008 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 0.0 25.0 50.0 75.0 100.0 125.0 Governmentbondyields(%) Government debt (% of GDP) 2012/2013 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 0 25 50 75 100 125 Government10YbondyieldsJuly2013(%) Government debt in 2012 (% of GDP) Source: Eurostat.
  • 18. Permanent vs temporary changes in policy framework • Extraordinary loose monetary policy and non-standard monetary policy measures are temporary o should and will be withdrawn when economic conditions in the euro area normalize • Moreover, these measures cannot replace the necessary structural reforms and fiscal discipline, going forward • Changes to the euro area's fiscal and financial frameworks, on the other hand, are permanent
  • 19. 78,7% 82,7% 86,1% 87,3% 91,2% 10,4% 8,7% 3,6% 5,4% 4,5% 10,8% 8,6% 10,3% 7,3% 4,3% 0% 25% 50% 75% 100% Latvia must show solidarity with other European countries because in the long run it will be beneficial also for us In the economic sphere, Latvia should activelly collaborate with the core partners Low interest rates on loans are important for the development of the country and for individual borrowers In the coming years, the national debt and debt service burden should be reduced The Government should not spend more than it earns To what extent do you agree with the following statements? Fully + more agree Fully+ more disagree Don't know/NA Population in Latvia generally shares euro area's main working principles Source: Latvijas Fakti.