Transcript

Transcript of a Conference Call on Staff-Level Agreement on First Review of Latvia's Stand-By Arrangement

July 30, 2009

MS. GAVIRIA: Hello everyone. I am Angela Gaviria with the External Relations Department of the IMF. Welcome to this conference call on the staff-level agreement on the first review of Latvia's stand-by arrangement. Let me introduce our lead speaker, We will start with Anne-Marie who has some brief remarks to make, and then we will be happy to take your questions.

MS. GULDE: Thank you, Angela. I just want to say that the mission has reached staff level-agreement today, endorsed by the IMF's management, with the authorities of Latvia on a policy package that could lead to the completion of the first review under the stand-by arrangement. The completion would be achieved once this letter of intent and accompanying staff report have been reviewed by the Executive Board. We expect that this review at the Executive Board is going to take place in the next couple of weeks.

As you know, the IMF support is part of a coordinated package together with the European Union, the World Bank and the Nordics as the European Union has today disbursed its second tranche of 1.2 billion. At the outset, I would like to say that this is a challenging program. We are supporting the Latvian authorities in their effort to overcome the current economic difficulties in the country. It is important that this policy package is supported by all the Latvian coalition partners. As I mentioned, it is a challenging package but it has been designed in a way to both enhance economic efficiency and to make sure that the burden is not excessively set on the poor. I think with these introductory words, maybe we are open to your further questions.

MS. GAVIRIA: Thank you, Anne-Marie. We can answer your questions now. Do we have any questions in line?

Question: It was reported that you are asking for a further reduction in the budget deficit of 8.5 percent. Is that accurate? When you say it is not put on the poor, most of the sacrifices have been made by government employees because their wages are going down. Is this further along those lines?

MS. GULDE: Let me just start with taking up your questions on the overall deficit. As you know, supplementary budget has been passed in June. The effort that has been made in the context of this review was to flesh out some measures that could make this supplementary budget sustainable. You were referring to the specific measures, in particular referring to the wage cuts in the public sector. It's difficult to say that this is the main sacrifice. As you know, there is an issue of bringing the fiscal deficit to a sustainable level and wages in the public sector had been increasing very significantly over the past couple of years. So even with these measures, wage levels are going down to about the level of 2007.

Question: What about the 8.5 percent? Is that the right number?

MS. GULDE: There is an issue that has to be kept in mind: the level of deficit for the European Union is specified in ESA terms whereas the IMF calculates on cash terms, so there are some differences in the numbers that are being quoted.

MR. GRIFFITHS: There are some differences in the numbers. The authorities have a target with the European Union of 10 percent deficit this year and 8.5 next year on the European Union definitions. Our numbers are slightly different. It is not correct to say that an 8.5 percent adjustment is needed. That is not right. It is more than that.

On the burden for the poor, there is a limit to how much detail we can go into at this stage because the letter of intent has not been reviewed and we have not had the board meeting yet. But I think part of the work of this mission has been to look at that supplementary budget that has been passed a few weeks ago and to try to ease the impact on the poorest people. So we're looking now for some slight easing of the fiscal deficit this year to increase basic income payments, those guaranteed minimum income payments for the poor, to make sure that local governments have funding for that; to also help the poorest people when they're making health co-payments to really help them do that with government support; and also some children—to protect some of the younger kids to make sure they can still go to school. So we tried to do that, to modify the budget to include all those things and tried to ease the adjustment on the poor.

Question: If 8-1/2 percent isn't correct, can you give us a simple number about what you actually asked for and they agreed to?

MR. GRIFFITHS: I'm in a bit of a paradox here. We are actually allowing a wider deficit this year, slightly wider, because we're concerned about the social impact of the supplementary budget, so there's a bit of a paradox. For next year there is some considerable fiscal adjustment needed. The government is already committed to 4 percent of GDP in its commitment to the E.C. We're looking at the baseline in the economy and we see some deterioration, so possibly some more measures than that will be needed. But actually, that's just to get the deficit on a declining path. We're not looking for very aggressive deficit reductions given the emergency. There is a huge recession. We need some flexibility in the fiscal targets and we try to respond with that.

Question: I was wondering what is the main cause of the delay in these discussions. Number two, I assume that the next disbursement is the second tranche under the loan program. My third question is have you reviewed your growth figures under this revised program for Latvia?

MS. GULDE: We felt that we needed more specificity on the measures that were agreed under the supplementary budget. We had not had the chance to see credible measures. The authorities had committed to very significant reductions in headline deficit figures, but we were concerned that in the way this was supposed to be implemented would be one of measures and across-the-board cuts that would neither be efficient and that would risk to affect the poor most. So we wanted to be assured that the measures that were being considered would be implementable and sustainable. While the E.U. has gone ahead with their agreement, they very much were supportive of our efforts. They were with us in Riga now and they have also been looking at getting more specificity. So they were very supportive of the need to do further work to make this a credible and sustainable package. Mark, maybe you can give the specificity.

MR. GRIFFITHS: There has been very strong cooperation with the European Commission who joined us on this mission and also the World Bank who helped us with the safety net measures. On the growth forecast this year, as you know, first-quarter growth negative 18 percent year on year and we're projecting something similar for the year as a whole. For 2010, our forecast is minus 4 percent. That's been agreed with the authorities. It's close to other forecasters. However, of course in Latvia a lot depends on what happens in the world economy, so if the world rebound is a bit stronger, than Latvia could be pulled up, too, so we're looking very much to that.

In terms of the disbursement, this is the first review, but you're right, this would be the second disbursement, and it will come in a few weeks' time if the board agrees on this review.

Question: You mentioned that the burden should not fall excessively on the poor. Does this mean the IMF is in favor of a progressive tax? Number two, I have a question about the exit strategy of the program. If debt-to-GDP ratios are expected to go above 60 percent, what is the real exit strategy? Is the euro still the exit strategy?

MS. GULDE: Thank you. You know that Latvia has a tradition of a flat income tax. We have been reviewing this in the context of this program review. Our view is that Latvia has a tax structure that may not be fully suited to an economy that is not growing as fast as Latvia grew. We feel in fact that a progressive income tax could be one of the elements in the fiscal adjustment. It could help to increase revenues while putting more of the burden on higher income groups. Clearly, a progressive income tax needs to be designed very carefully and if the authorities will go that way, we would be able to help them in the design of this tax or the E.U. would be available to help in whatever technical need there is. But, yes, the idea of moving away from the flat to a progressive tax is very much one of the measures that we are looking at.

Your question on the exit strategy and on the stock is debt is a valid one. The 60 percent public debt limit is part of the Maastricht Criterion. Exiting to the euro is the lynchpin of the authorities' strategy, so this again is part of the reason why the fiscal package needs to be designed with keeping debt sustainability I mind and keeping in mind the keep public debt at a manageable level.

Question: Some of the costs that have been mentioned for debt-to-GDP ratios include restructuring costs for the financial sector. What does that entail or what is thought about that? Is that going to be recapitalization of banks or what goes into the estimates?

MR. GRIFFITHS: That's a good question. That's just a rough estimate based on experience of other countries that had similar deep recessions. They typically have some costs of bank restructuring, but the specific mechanisms haven't been worked out. Clearly, in Latvia, a large part of the banking system is foreign owned and so that much of the costs may not be borne by the government, but it could be borne by other countries, by the parent banks. It's not a clear mapping in Latvia's case. There's a lot of uncertainty attached to that estimate, much more so than in larger economies with domestically owned banking systems.

Question: But you have an estimate that goes to high as 80 percent of GDP next year. Is that correct?

MR. GRIFFITHS: Not next year. On the Maastricht Criteria, my understanding is 60 percent is a reference value and it's important to be approaching that. Countries in the Euro Area have had debts that rose above that and have debt ratios above that, so the key is to get debt on a declining path. We're pretty convinced that if the authorities take the measures they've signed up to that that's what they can deliver and that euro adoption can be a reality.

Question: I just want to make sure I got this right because I got a little confused on the numbers. Were you saying back to the fiscal deficit again in 2010 that the government was looking for by the way you calculate it a 4 percent fiscal deficit and it might be higher or might be tighter than that? And on the specificity, the two things that I think you've mentioned are cuts in government wages and a possible to progressive taxes from the flat tax. Are there other specifics that you could name?

MS. GULDE: Let me just clarify on the level of the deficit. We are looking not at 4 percent. Four percent was one part of the adjustment that was considered. As you know, the 2010 budget has not been fully specified yet. That will be done in the fall and we will be working with the authorities on the exact specification of that budget. But given where we are now, we think it would be unrealistic to look at a budget deficit of the magnitude that you were looking at. What we do know is that the authorities have a euro adoption strategy, which so far looks at 2012 where they would want to meet the Maastricht Criterion, so they would want to look at 3 percent by 2012, and we're starting out from 2009 on a cash basis of a deficit of around 13 percent. We were looking at a lower deficit in 2010 than in 2009.

Question: On the specifics, the two that you mentioned were government wages and a progressive income tax. Were there other things you can cite?

MR. GRIFFITHS: I'm not sure how much we can go into specifics. It's clear that as part of the letter of intent the government has agreed to specific measures, these kinds of guidelines to help them form the 2010 budget. Clearly, the authorities have made a case that they're looking as much as possible for expenditure cuts and less on tax increases, but I think it's probably better to wait until this thing is released to have all the details. But we're working on that together and what we have in the letter of intent I think is a great foundation for the 2010 budget process, which the authorities are now starting to deliver their fiscal adjustment.

Question: How much savings do you think would be reasonable to put the budget on a sustainable road? The other one is do you have more general comments with whether you think the economy is doing better than you expected, worse than you expected, and where the biggest challenges are?

MS. GULDE: I think it's difficult to give a full monetary figure of what needs to be achieved. As you know, we tend to think in terms of percent of GDP. The Latvian authorities did commit with the European Union to a nominative give of 500 million lats plus some additional measures that are going to be specified in line of what needs to be done to be sustainable. As Mark said, these specifics will be in the letter of intent.

You were asking more generally as to whether the economy is doing better or worse. Unfortunately, the economy is doing a lot worse than what we anticipated at the time when the initial program was designed in December 2008. There has been a lot faster and a lot deeper contraction of domestic demand in the context of also a more challenging international environment. The main fallout from that was as very severe fall in fiscal revenues, which have led us to the problem that we are facing now that we have to redesign the fiscal path and adjust to a situation where needed expenditures have not fallen or even increased due to the crisis-related outlays with the severe collapse of revenues.

I think one area that we should mention where we have seen some progress is the financial sector. You may recall that at the time when the program was designed we were in the situation where we had one domestically owned bank that was very weak. Significant measures have been taken to strengthen that bank together with the EBRD. So the financial threats have to a very significant degree been addressed as part of the program.