EU balance-of-payments assistance for Latvia: Foundations of Success
Description: The aim of the seminar is to evaluate the Latvian economy's past and prospective economic performance: accumulation of imbalances in the boom period by the end of 2007, economic reforms and correction of imbalances driven by the EU/IMF financial assistance programme in 2009-11, as well as future developments in the areas of growth potential, structural reforms and competitiveness. The analysis of the successful implementation of the financial programme, including the use of internal devaluation policies for correcting imbalances and restoring competiveness, is expected to contribute to academic debates and policy guidance for other countries facing similar economic challenges.
The Latvian economy was the fastest growing in the EU from 2000 to 2007 reflecting convergence prospects and foreign financial inflows contributing to strong domestic demand. However, many imbalances were accumulated in the boom period. Consequently, the economy experienced the steepest contraction in the EU in 2008-09 on combination of productivity drops and adverse external shocks. During that period, real GDP contracted by 25% from peak to trough. The recession led to a rapid increase in unemployment and a fall in wages. The economic crisis also took a heavy toll on public finances, as the general government deficit widened from 0.3% of GDP in 2007 to 4.2% in 2008 and 9.7% in 2009. To address the crisis, in December 2008 the country reached an agreement with the EU and the IMF on a medium-term financial assistance programme. The national authorities and the international lenders agreed on a comprehensive adjustment programme that included substantial fiscal consolidation, a wide range of structural reforms, and a strengthening of social safety nets to protect most vulnerable. The economy moved back to growth and job creation in 2010 at a pace exceeding initial expectations and the government successfully re-entered the international bond markets in 2011, well ahead of schedule.
The proposed research aims to put Latvia’s adjustment in the perspective of adjustment in other countries with similar circumstances and assess the prospect for growth.
Other countries to which Latvia could be compared are either countries with high current account deficits before the crisis or countries that had to request financial assistance from the EU and IMF for other reasons. Countries with both fixed exchange rates (eg Bulgaria, the other two Baltic countries and Ireland – a euro area member) and flexible exchange rates (eg Hungary, Iceland, Romania and Ukraine) will be considered. The systematic comparison of Latvia with the other countries aims to assess pre-crisis vulnerabilities, crisis-management measures and economic outcomes.
The swift turn to current account surpluses during the first few years of the crisis could be the result of financing constraints, negative output gap, and the disappearance of unsustainable consumption and investment booms (or a combination of these three explanations). But these tree explanations have different implications for economic recovery and for the need for further adjustment. Unit labour costs have declined in Latvia during the past three years. Using a panel models, the project aims to assess which of the three explanations may explain the swift adjustment of the current account and whether the recent improvement in competitiveness is sufficient to drive resources from the non-tradable to the tradable sector and to sustain economic growth.
Therefore, Bruegel’s briefing paper that will be presented during the workshop on 1st March 2012 intends to propose:
• A systematic comparison of Latvia with some selected countries in light of pre-crisis vulnerabilities and crisis management measures;
• An assessment of the growth prospects of Latvia;
• Policy recommendations.
Bruegel lead: Zsolt Darvas
Duration of the project: December 2011 – April 2012
Funding organization:
Publications: the paper will be available on this page in the coming months