The document provides an overview of Latvia's economic developments as of May 2012, highlighting a decline in inflation, steady unemployment rates, and moderated wage growth amidst stagnant real wages. It notes improvements in competitiveness through a narrowed wage-productivity gap and stronger export shares in key markets, despite a decline in export growth due to weakening external demand. Additionally, the report details increased foreign direct investment and high banking sector capital adequacy, alongside stable monetary conditions and improving indicators in the transportation and retail sectors.

1. Recent Economic Developments
in Latvia
May,
May 2012

2. Macroeconomic Overview

3. Inflation shows a declining trend;
p
past increases driven by
y
commodity prices and tax hikes
Impact of food and energy prices on total inflation (pp) and the y-o-y inflation rate (%)
energ o
7
5
2.8
3
1
-1
Bank of Latvia forecasts:
2012: 2.4%
-3
2013: 2.0%
-5
I 2011 II III IV V VI VII VIII IX X XI XII I 2012 II III IV
Food Energy
gy Y-o-y inflation
y Y-o-y inflation excluding food and energy prices
y g gy p
Source: Central Statistical Bureau of Latvia, Bank of Latvia calculations

4. No domestic demand pressures with real wage
g
growth flat and unemployment rate still high;
p y g ;
core inflation on low level
Inflation (% of coresponding period of previous year)
6
5
4.1
4
2.8
3
2
1.4
1
0
-1
V
X
II
III
VII
XII
II
I 2012
III
IV
IX
IV
VI
VIII
XI
I 2011
12-month inflation 12-month average inflation Core inflation
Source: Central Statistical Bureau of Latvia, Bank of Latvia’s calculations

5. A moderate nominal wage growth has
resumed; however, real wages remain flat
however
Average gross wage changes by institutional breakdown (y o y %)
(y-o-y,
10
5.4
5 4.5
4.0
0
Q2
Q3
Q4
Q2
Q3
Q4
2011 Q1
2010 Q1
-5
5
2
2
-10
-15
Total Public sector Private sector
Source: Central Statistical Bureau of Latvia

6. Unemployment rate, although still high,
has continued to decline
Unemployment rate (% of economically active population; LFS)
25
Methodology change (population census) impact:
Unemployment rate: ~ + 0.7 pp as from Q1 2011
20
15
10
5
0
III
III
III
IV
IV
IV
2009 I
II
2010 I
II
II
2012 I
2011 I
2
Source: Central Statistical Bureau of Latvia; State Employment Agency

7. Wage-productivity gap has closed,
restoring competitiveness
Wage and productivity (2005 Q1 = 100, s a )
100 s.a.)
150
130
110
90
70
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
Q3
3
2000 Q1
1
2001 Q1
1
2002 Q1
1
2003 Q1
1
2004 Q1
1
2005 Q1
1
2006 Q1
1
2007 Q1
1
2008 Q1
1
2009 Q1
1
2010 Q1
1
2011 Q1
1
Labour productivity
p y Real wage
g
Source: Central Statistical Bureau of Latvia, Bank of Latvia staff calculations

8. Latvia’s export market shares are up in
most of our key markets reflecting g
y g gains in
competitiveness
Share of Latvian exports in particular country’s imports (%; 4q moving average,
country s 4q-moving
2010 Q1–2012 Jan.-Feb.)
12
0.45
9
0.30
6
0.15
3
0.00 0
share of EU27 Germany UK Sweden Denmark Finland Poland Russia Estonia
E i Lithuania
Li h i
exports 72.4% 8.3% 3.1% 6.3% 3.4% 3.1% 5.9% 10.6% 13.6% 18.1%
2011
Source: Eurostat, Central Statistical Bureau of Latvia, Bank of Latvia staff calculations

9. Current account is close to balance; main factors
behind the deficit - increase of imports for
production
Current account and its components (% of GDP)
p ( )
20
15
10 8.7
5
5.5
0
0.7 1.2
-0.3 -0.8 -1.1
-5 -2.9
-10
-5.3
-15
-20
2010 1Q Q2 Q3 Q4 2011 1Q Q2 Q3 Q4 2012 1Q E
Current Transfers Income Services Goods Current Account
Source: Bank of Latvia, E- estimated operational data

10. Latvian export trends in the geographical
distribution: the Baltic market integration and
g
emergence of new markets
Merchandise export breakdown by country (%)
100% Other – including Asian countries 8.3% (Turkey,
6.1 9.2 13.0 15.0 Afganistan, India, UAE, China etc.), African countries
90% (Egypt, Morocco, Algeria etc.)
gyp g )
23.1 20.9
80% 14.2 Other EU – Poland 7.2%, Netherlands 2.4%, France 1.7%
15.8
and Southern euro area countries (Greece, Portugal,
70% Spain, Italy) 2.0%
60% 26.5
26.9 Other
33.8
50% 44.1 Other EU
40% Scandinavia+UK+Germany
Baltic States
30% 31.7 28.1
21.6 CIS
20% 13.5
10%
13.2 14.4 14.6 14.2
0%
2000 2005 2011 2012 Q1
, Source: Central Statistical Bureau of Latvia

11. Sectorwise, Latvia’s merchandise export has
undergone a significant diversification, creating
g g , g
a stable export base
Structure of merchandise exports (%)
100% Others
90%
Textiles
80%
70% Transport vehicles
60% Mineral products
50%
Chemical
40%
30% Machinery and electrical
equipment
20%
Base metals
B l
10%
0% Food products
2000 2005 2011 2012 Q1
Q
Wood
Source: Central Statistical Bureau of Latvia, Bank of Latvia

12. Export growth has decelerated recently as
external demand weakens, but it still remains on
,
a solid footing
Merchandise exports by commodity groups (in nominal terms y-o-y growth)
terms, y o y
150 60
Other goods
50 Transport vehicles
100 40 Machinery and electrical
Y-o-y millions of lats
equipment
Base metals
f
30
Textiles
50 20
Wood
y,
16.7
16 7
10
Plastics
0 0 Chemical
-10 Mineral products
Agricultural and food
-50
50 -20
20
products
d t
2011 I
VIII
2012 I
VII
IX
II
III
IV
V
X
VI
XI
XII
II
III
Exports yoy, % (RHS)
Source: Central Statistical Bureau of Latvia

13. Intermediate goods dominate in the import
structure and d i i
t t d drive import growth
t th
Import by BEC product group (million EUR)
1200
1100
1000
900
800 Other items
700
Motor spirit and
600 passenger motor cars
500
Consumption g
p goods
400
300 Intermediate goods
200
100 Capital goods
0
V
IX
V
IX
2010 I
III
VII
XI
2011 I
III
VII
XI
2012 I
III
Source: Eurostat

14. With the economic environment stabilising,
Latvia has attracted considerably more foreign
y g
direct investment (FDI) in 2011 vs 2010
Net FDI inflows (% of GDP)
10
8.4 8.1
6.7
6.2
62
5.5 5.6
5
3.8 3.6 3.8
2.1
1.6 1.6 1.6
0.4
0
-0.9
-5
2006
2007
2008
2009
2010
2011
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Q1 2011
Q2 2011
Q3 2011
Q4 2011
Q1 2012 E
Q
Q
Q
Q
Q
Q
Q
Q
Source: Bank of Latvia

15. Drivers of GDP growth, initially led by
exports,
exports broadened to include investment
Real GDP growth (y-o-y %) and contribution to the growth (percentage points)
(y-o-y,
25
20
15
10 6.6 5.7 6.8
5.6
3.5 3.6 3.5
5
0 -3.5
-5.5
-5
-10
-15
-20
Q1 2010 Q2 Q3 Q4 Q1 2011 Q2 Q3 Q4 Q1 2012
flash
Private consumption Public consumption GFCF Changes in inventories
Exports Imports GDP, % yoy
Source: Central Statistical Bureau of Latvia

16. Merchandise export recovery has been
remarkably strong – placing the country
y g p g y
among the European leaders
Merchandise export revenue growth 2011/2009 (% in EUR terms)
(%,
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
Cyprus
Portugal
Estonia
Bulgaria
Latvia
Malta
Poland
Lithuania
Romania
Hungary
Slovenia
Spain
Belgium
Italy
Finland
Denmark
Ireland
United Kingdom
Netherlands
Greece
Czech Republic
Slovakia
Germany
Austria
France
uxembourg
Sweden
d
Lu
N
Source: Eurostat

17. Latvia has experienced a strong rebound in
investment last year
Gross fixed capital formation (% y-o-y)
40
29
30 24 25
22
20
10
0
-10
-20
-30
-40
-50
III
III
III
III
III
I 2011
II
IV
II
IV
II
IV
II
IV
II
IV
I 2007
I 2008
I 2009
I 2010
Source: Central Statistical Bureau of Latvia

18. Despite unfavorable external conditions, in
Q
Q1 2012, manufacturing growth remained
, gg
strong, albeit volatile
Manufacturing ol me inde
Man fact ring volume index (2005 = 100; s a )
s.a.)
130
In Q1 2012,
3.5% q-o-q, s.a.
120 and 14 8% y o y
14.8% y-o-y
110
100
90
80
70
60
II
III
VIII
II
III
VIII
II
III
VIII
II
III
IV
V
IX
X
IV
V
IX
X
IV
V
IX
X
2009 I
VI
VII
XI
XII
2010 I
VI
VII
XI
XII
2011 I
VI
VII
XI
XII
2012 I
Source: Central Statistical Bureau of Latvia

19. Transport sector has been booming in Q1
2012
Cargo turnover in transport (% y-o-y)
y o y)
40
30
22.6
20 16.0
10
n.a.
0
-10
-20
-30
-40
2008 2009 2010 2011'Q1 Q2 Q3 Q4 2012'Q1
Ports Railway By road
Source: Central Statistical Bureau of Latvia

20. Retail trade has been growing in Q1 2012
g g Q
Selected indicators (2005=100)
150 In Q1 2012,
3.4% q-o-q, s.a.
q q,
and 11.7% y-o-y
100
50
0
VII
VII
VII
2011 I
VII
2008 I
2009 I
2010 I
2012 I
Private consumption Retail trade turnover
Source: Central Statistical Bureau of Latvia

21. Financial sector

22. Deleveraging is ongoing
although at a slower pace
Domestic lending annual change (%) and contribution to the change (pp)
15
*significant lending decrease due to
10 withdrawal of credit institution’s
institution s
licence to Parex banka
5
0
-5
-10
-15
I III V VII IX XI I III V VII IX XI I III V VII IX XI I III*
2009 2010 2011 2012
Government Financial institutions Non-financial corporations
Households Total Total (with Parex effect correction)
Source: Bank of Latvia

23. In 2012, the average level of deposits is almost
unchanged vs 2011 – the depositors’ confidence
g p
is quite stable
Domestic deposits (mln lats)
5600
5400
5200
5000
4800
IVV
V
IXX
X
IVV
V
IXX
X
IVV
V
IXX
X
IVV
V
IXX
X
IVV
II
II
VI
II
II
XI
II
II
II
VI
II
II
XI
II
II
II
VI
II
II
XI
II
II
II
VI
II
II
XI
II
II
II
08
09
I 2010
11
I 2012
V
X
V
X
V
X
V
X
I
II
VI
VII
XI
I
II
VI
VII
XI
I
II
VI
VII
XI
I
II
VI
VII
XI
I
II
I 201
I 200
I 200
Total deposits (mln. lats) Total deposits (with Parex effect correction; mln. lats)
Source: Bank of Latvia

24. The backing of the monetary base with
foreign reserves is around 200%
Net foreign assets and Monetary base (mln lats)
4500
4000
3500
3000
2500
2000
1500
1000
500
0
IV
V
V
IX
X
X
IV
V
V
IX
X
X
IV
V
09
10
II
II
VI
II
II
XI
II
11
II
II
VI
II
II
XI
II
12
II
II
V
X
V
X
I
II
VI
VII
XI
I
II
VI
VII
XI
I
II
I 201
XII 200
I 201
I 201
Net foreign assets Monetary base
Source: Bank of Latvia

25. Banking sector capital adequacy ratios –
at historical highs
Capital adequacy ratios (%)
20
18
16
14
12
10
8
6
4
2
0
Q1 2006 Q3 Q1 2007 Q3 Q1 2008 Q3 Q1 2009 Q3 Q1 2010 Q3 Q1 2011 Q3 Q1 2012
CAR Tier 1 ratio
Source: Financial and Capital Market Commission

26. Liquidity remains on a very high level
q y y g
Liquidity ratio (defined by FCMC %)
FCMC,
70
60
50
40
30
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
Q1 2011
Q1 2012
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q
Q
Q
Q
Q
Q
Q
Source: Financial and Capital Market Commission

27. NPLs have peaked in Q3 2010; signs of
improvement are evident
Amount of loans over 90 days past due, provisions and their share in outstanding
%
loans mln lats
20
Share of provisions in outstanding
2,800
,
18 loans
16 Share of loans over 90 days past 2,400
due in outstanding loans
14 Provisions (right-hand scale) 2,000
,
12
Loans over 90 days past due (right- 1,600
10 hand scale)
8 1,200
6
800
4
400
2
0 0
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
2005
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
Q1 2011
Q1 2012
2
Q1 2
2
2
2
2
2
2
Source: Bank of Latvia, Financial and Capital Market Commission

28. 10%
15%
20%
25%
30%
0%
5%
jan 08
0
mar 08
0
mai 08
0
Source: Bank of Latvia
jūl 08
0
sep 08
0
nov 08
0
jan 09
0
RIGIBOR 3M
mar 09
0
mai 09
0
jūl 09
0
sep 09
0
nov 09
0
jan 10
mar 10
mai 10
RIGIBOR 6M
jūl 10
sep 10
Money market rates (%)
nov 10
jan 11
mar 11
mai 11
jūl 11
RIGIBOR 12M
sep 11
nov 11
Money market rates remained stable
at low levels for a long period of time
jan 12
mar 12
mai 12