Presentation by Gabriele Giudice (European Commission, DG ECFIN) 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. Against the Odds: Lessons from
the Recovery in the Baltics
BoL/IMF conference,
Riga, 5 June 2012
Gabriele Giudice
European Commission – DG ECFIN

2. Strong but clearly unsustainable growth
LV : Current account (% of GDP) LV : Domestic demand (% of GDP)
0% 125
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
120
-5% 2000 2001 2002 2003 2004 2005 2006 2007
115
-10% 110
-15% 105
100
-20%
95
-25% 90
1999 2000 2001 2002 2003 2004 2005 2006 2007
-30% Latvia EU12 Average
Current account (% of GDP) EU27 GR,IE,PT,ES
2

3. Eventually, the Baltic tigers lost lustre
LV : the bust LV : loss of credibility
200 14.00
190 12.00
180
Real GDP, chain-linked 10.00
170
2000Q1=100 L-T gov. bond yields
160 8.00
150 6.00
140
4.00
130
2.00
120
110 0.00
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
100
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
2005 2006 2007 2008 2009
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Long term government bond yields
3

4. Uncompetitive exports
or unsustainable imports?
300
75%
LV : foreign trade in constant prices
LV : shares of Labour in GVA
(2000=100) 70%
250
65%
Imports of G&S Construction
60%
200 Industry
55%
50%
150
Export of G&S Total economy
45%
Services
100 40%
35%
50 30%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
4

5. How to adjust?
Prices and wages had to regain the lost ground
But also quantities and quality had to change (and
devaluation would not have helped to achieve that)
Reducing the size and improving the quality was
particularly necessary for the government budget
5

6. A strong and frontloaded fiscal consolidation
Start of strong consolidation
LV: QUEST II
simulations for GDP %
GDP
chain-linked 2000Q1=100
deviation, calibrated to
effective consolidation,
negative impact = -6%
Cumulated
consolidation
(rhs)
Consolidation measures as reported by the government 2009 2010 2011
(Convergence Programme April 2011), % of GDP 9.5 4.0 2.6
6

7. The private sector quickly responded
This likely compensated the effects of the fiscal contraction
% 04
dlohesuoH latipac ssorG HH's tot. bk deposits Strong
% growth (3-q mov. avg)
% 03
noitpmusnoc noitamrof consolidation
% 02
% 01
starts in LV
%0
3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q
%0 1-
1102 0102 9002 8002 7002 6002 5002 Net FDIs,
%0 2- flows, mil. lats, rhs
(3-q mov. avg)
%0 3- Consumer confidence
indicator
%0 4-
L-T Gov.
%0 5- bond yields
%0 6-
7

8. The return of confidence Contributions to year-on-year nominal GDP
growth
gave a boost to the 25
economy, after its loss 20
15
10
had sunk it. 5
0
-5 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
-10 2008 2009 2010 2011
(QUEST II simulations based on Latvia's data, % -15
changes in interest rates and impact on GDP, -20
from baseline ) -25
Exports Imports Net exports
"Non-
Keynesian"
confidence
effect coming
from the
reversal of
interest rates
8

9. And supply-side effects kicking in over time...
GROSS VALUE ADDED BY KIND OF ECONOMIC ACTIVITY (% of GDP)
16%
Manufacturing
14%
12%
10%
8%
Construction and PA
6%
4%
2%
0%
2005 2006 2007 2008 2009 2010 2011
(C) Manufacturing (F) Construction (O) Public administration and defence
9

10. Beyond fiscal consolidation:
the EU-sponsored reform agenda
• Better use of EU funds;
• Improving policies for the unemployed (100-lats program, training and vouchers,
reforming the State Employment Agency);
• State-Owned Enterprises reform;
• Reforms in public administration (using ESF for public officials trainings; protection of
staff working with EU funds; merit-based motivational payments);
• Improving public procurements (EPS, centralizing procurements, ex ante checks,
extra staff for the Procurement Office);
• Small Business Act (easier/cheaper to start companies);
• Improved competition policy (more resource allocated to the authority);
• Measures to attract foreign investment (Establishing a special PM-led group),
• Enhancing financial engineering instruments (MLB, LGA, Holding Fund);
• Attention to quality of spending (e.g., road construction).

11. Possible keys to success
• Flexibility of economy
• Rapid and decisive action
• Ownership of the programme
• Political and social sustainability
11

12. Some lessons
• National commitment is a must, fairness as well
• Time a key dimension
• Smart adjustment goes beyond an 'internal
devaluation'
• Growth can return faster and adjustment can be
easier than planned, but be prudent.
• Liquidity problems must not plunge an adjusting
country into insolvency
12

13. Against the Odds: Lessons from
the Recovery in the Baltics
BoL/IMF conference
Riga, 5 June 2012
Gabriele Giudice
European Commission – DG ECFIN