Unique case of Latvia:
 internal adjustment

          Kārlis Bauze, CFA
  Head of Monetary Policy Department
            ...
After double digit GDP growth Latvian
                                 economy experienced sharp adjustment

             ...
A mix of fiscal, income and structural
           policy as key adjustment mechanisms in
           Latvia
 The fixed nar...
Sizeable fiscal consolidation in Latvia has taken
                         place already in 2009

         Country        ...
Institutional fundamentals ensure to
                    smooth economic adjustment through
                    wage flexi...
Wage elasticity allow to restrain wages in both
                              public and private sector

                 ...
Cost optimization and enhancing productivity
                                  contributed to narrowing the wage-productiv...
Price flexibility in Latvia is high and increasing


                          Frequency of price changes over time 2003-2...
Price adjustment resulted into deflation

Consumer price inflation (12-month average) and core inflation (y-o-y, %)
  20.0...
Gains in competitiveness are reflected by
                                     increase in market shares in major trading
...
Improvement in competitiveness boosted export
                               growth since mid 2009

                      ...
In manufacturing structural changes towards
                                re-orientation to export markets are taking pl...
With improvements in employment prospects
                                         in export-oriented sectors, unemploymen...
Improvement in business and consumers
                          sentiment supports ongoing economic recovery

            ...
Export-based economic growth is on track


                                                          GDP growth (%)
      ...
Central bank has replenished its foreign currency
                               reserves which were drained in the market...
Money market rates have reached their historical
                           lows reflecting among other the significant
  ...
Conclusions




• Internal adjustment is undergoing
• Structural changes in the economy have taken place
• Economy is reco...
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Unique case of Latvia: internal adjustment

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Presentation by Kārlis Bauze, CFA Head of Monetary Policy Department, Bank of Latvia on
September, 2010

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Unique case of Latvia: internal adjustment

  1. 1. Unique case of Latvia: internal adjustment Kārlis Bauze, CFA Head of Monetary Policy Department Bank of Latvia September, 2010
  2. 2. After double digit GDP growth Latvian economy experienced sharp adjustment Real GDP growth (y-o-y, %) 15 12.2 10.6 10.0 10 8.7 6.4 7.2 4.8 5 2.9 0 -5 -2.5 -4.6 -10 -15 -20 -18.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 F 2011 F 2012 F Source: Central Statistical Bureau of Latvia; F - (forecast) Bank of Latvia 2
  3. 3. A mix of fiscal, income and structural policy as key adjustment mechanisms in Latvia  The fixed narrow band exchange rate of the lats as the anchor for monetary policy until the euro adoption.  Policy mix - as tools for restoration of competitiveness and a precondition for the export-based economic recovery in Latvia: • Sizeable fiscal consolidation; • Fiscal consolidation measures designed with the focus on structural reforms and wage/employment cuts in the public sector; • Cost optimization and enhancing productivity in private sector. 3
  4. 4. Sizeable fiscal consolidation in Latvia has taken place already in 2009 Country Year Total Revenue Current Capital consolidation measures expenditure expenditure measures measures Latvia 2009 9.9 1.8 5.7 2.4 2010 4.2 2.2 1.6 0.4 Lithuania 2009 3.5 0.2 1.3 1.9 2010 5.6 0.5 3.9 1.2 Estonia 2009 7.7 2.8 4.2 0.7 2010 2.3 2.3 0.0 0.0 Ireland 2009 2.0 1.1 0.5 0.4 2010 2.4 0.0 1.8 0.6 Hungary 2009 2.8 0.6 1.0 1.2 2010 1.4 0.0 1.4 0.0 Romania 2009 3.8 0.9 2.9 0.0 2010 3.1 1.0 2.1 0.0 Greece 2010 2.5 0.5 1.7 0.3 Source: Convergence programmes; Bank of Greece; Bank of Latvia 4
  5. 5. Institutional fundamentals ensure to smooth economic adjustment through wage flexibility in Latvia Collective bargaining coverage (%) Source: ETUI-REHS 5
  6. 6. Wage elasticity allow to restrain wages in both public and private sector Gross nominal hourly wage y-o-y growth (%) 40 30 20 10 0 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 -6.3 -10 -20 -30 Total economy Manufacturing Construction Trade Transport Public administration Source: Central Statistical Bureau of Latvia 6
  7. 7. Cost optimization and enhancing productivity contributed to narrowing the wage-productivity gap Wages and productivity (whole economy, seasonally adjusted, expressed per hours worked, 1Q 2005=100) 170 160 150 140 130 120 110 100 Q3 Q4 Q1 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 Q3 Q4 Q2 2005 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 Productivity Real wage Source: Eurostat, Bank of Latvia’s calculations 7
  8. 8. Price flexibility in Latvia is high and increasing Frequency of price changes over time 2003-2009 (%) 70% Frequency of price changes: 60% Latvia 27.8% Euro zone 15.1% 50% The United States 24.8% 40% 30% 20% 10% 0% I VII I VII I VII I VII I VII I VII I VII 2003 2004 2005 2006 2007 2008 2009 Source: Bank of Latvia’s calculations
  9. 9. Price adjustment resulted into deflation Consumer price inflation (12-month average) and core inflation (y-o-y, %) 20.0 15.0 10.0 Forecast 5.0 6.5 0.0 -1.8% -5.0 -3.3% -10.0 IV IV IX IX IV IX III V X III V X III V X I 2011 II VII VIII II XII VII VIII II XII VII VIII XII I 2009 I 2010 VI XI VI XI VI XI 12 month average inflation Core inflation Source: Central Statistical Bureau of Latvia; Bank of Latvia’s calculations 9
  10. 10. Gains in competitiveness are reflected by increase in market shares in major trading partner countries Export market shares (% of major trading partners’ imports in Q4 2008 – Q2 2010; 3-months moving average) 0.45 12 9 0.30 6 0.15 3 0.00 0 Finland UK Poland Russia Germany Denmark EU 27 Sweden Lithuania Estonia Source: Bank of Latvia’s calculations 10
  11. 11. Improvement in competitiveness boosted export growth since mid 2009 Nominal export growth (I 2005=100) 200 190 180 170 160 150 140 130 120 110 100 IX IX IX IX IX V V V V V V III III III III III III VII VII XI VII XI VII XI XI VII XI VII 2005 I 2006 I 2007 I 2008 I 2009 I 2010 I Source: Central Statistical Bureau of Latvia 11
  12. 12. In manufacturing structural changes towards re-orientation to export markets are taking place Share of export (in % of total turnover in particular sectors) Source: Central Statistical Bureau of Latvia 12
  13. 13. With improvements in employment prospects in export-oriented sectors, unemployment started to decline Unemployment rate (% of economically active population) 25 20.4 19.7 19.4 20 18.4 16.7 15 13.9 9.9 10 7.2 6.5 6.3 5 0 VI XI VI XI VI VII VIII XII VII VIII XII VII VIII IV V IX X IV V IX X IV V II II II III III III 2008 I 2009 I 2010 I Registered unemployment rate Unemployment rate (Labour Force Survey) Source: Central Statistical Bureau of Latvia; State Employment Agency 13
  14. 14. Improvement in business and consumers sentiment supports ongoing economic recovery Economic sentiment and confidence indicators (balance, %) Source: European Commission 14
  15. 15. Export-based economic growth is on track GDP growth (%) 4 9.0 9.3 11.4 10.0 15 2 10 0 5 -2 -4 0 0.8 -6 -1.5 -2.1 -5 -4.7 -6.0 -8 -10 -10 -10.1 -15 -12 -17.8 -16.8 -20 -14 -18.1 -19.1 -16 -25 Q2 Q2 Q3 Q4 Q3 Q4 Q2 Q2 2007 Q1 2009 Q1 2008 Q1 2010 Q1 Q4 Q3 q-o-q, SA y-o-y, NSA (right-hand side) Source: Central Statistical Bureau of Latvia 15
  16. 16. Central bank has replenished its foreign currency reserves which were drained in the market turmoil following Lehman’s collapse in 2008 Lats exchange rate against euro and Bank of Latvia interventions 0.710 200 150 100 Bought / sold million lats 0.705 50 EUR/LVL 0 -50 0.700 -100 -150 -200 0.695 -250 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Foreign exchange interventions (RHS) BoL ask BoL bid Market ask Market bid Source: Bank of Latvia 16
  17. 17. Money market rates have reached their historical lows reflecting among other the significant improvement in financial market sentiment Money Market Index RIGIBOR (%) 35 30 25 20 15 10 5 0 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 O/N 1M 3M 6M 1Y Source: Bank of Latvia 17
  18. 18. Conclusions • Internal adjustment is undergoing • Structural changes in the economy have taken place • Economy is recovering

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