## 1. Real GDP ## Source details **Canonical URL:** [1. Real GDP](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp03241.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp03241.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp03241.pdf.json) --- ### I. Introduction — scope of cooperation - The paper assesses cooperation between the Fund and the Baltic countries (Estonia, Latvia, Lithuania) over the past decade following independence in August 1991. - Forms of cooperation documented: - Acquaintance and membership missions in late 1991 and early 1992. - Two or three follow-up staff visits to discuss policy formulation and implementation. - Establishment of resident representative offices in all three countries in mid-1992. - Technical assistance (short-term missions, long-term resident advisors, classes/courses). - Training via the IMF Institute (INS) and the Joint Vienna Institute (JVI). - Technical assistance concentrated mainly in the fiscal, financial, statistical, and legal areas. - Cooperation evolved from program financing and intensive TA to surveillance mode as EU accession neared. ### Phases of transition in the Baltics - economic stabilization 1992–1993 - consolidation and economic recovery 1994–mid-1998 - recession—the effects of the Russia crisis mid-1998–1999 - recovery and preparation for EU accession 2000–present ### II. Economic stabilization — initial conditions and policy aims - Initial shocks and constraints: - Collapse of Soviet central planning produced disruptions in trade and financial channels, shortages, loss of export markets, and dysfunctioning payments and monetary arrangements. - Severe terms of trade shock in early 1992 as Russia moved to world market prices for energy and raw material exports to the Baltics. - The terms of trade deteriorated by over 20 percent of GDP for the Baltic countries. - This deterioration contrasted with the three to five percent of GDP deterioration faced by Eastern and Central European countries after the dissolution of the Council for Mutual Economic Assistance. - Economic situation in early 1992: sharply falling output, rapid price increases, sharply falling real incomes. - Policy objective: achieve rapid economic stabilization while initiating transition to a market economy. - Main policy elements: - Tight monetary and fiscal policies to bring down inflation. - Structural measures aimed at institution building and rationalization of economic incentives. ### Fund role and policy implementation - Fund involvement: - Staff assisted in formulating programs supported financially by stand-by arrangements (SBAs) and the structural transformation facility (STF). - Resident representatives facilitated continuous dialogue and were often crucial in program implementation; they explained Fund policy advice and responded immediately to authorities’ questions. - Currency strategy: - Tight anti-inflationary monetary policies required introduction of own currencies to insulate from FSU inflationary impulses and to enable sovereign monetary and exchange rate policies. - Fund staff initially urged caution—stressing the need for supporting economic policies before currency reform. - Estonia introduced the kroon in June 1992 under a currency board arrangement (CBA); Estonian authorities proceeded despite initial Fund advice to wait for an SBA. ### Box 1 — timeline and instruments (selected highlights) - Timeline highlights: - First formal IMF contact: Deputy Managing Director met Baltic delegations on September 22–25, 1991. - Acquaintance missions: November 1991. - Membership missions: January/February 1992. - Baltic countries formally joined the IMF in April/May 1992. - Resident Representatives stationed mid-1992. - First stand-by arrangements approved September/October 1992. - Instruments used and descriptions: - Stand-by arrangements (SBAs): financial resources pledged in support of policy programs; funds disbursed in stages subject to performance criteria and periodic reviews. - Temporary structural transformation facility (STF): introduced in 1993 specifically to assist transition economies. - Precautionary SBAs: authorities declare they do not intend to borrow but are entitled to do so if needed, assuming policies are “on track”. - Extended financing facility (EFF): medium-term (usually three years) financing with heavy emphasis on structural policies. - Surveillance via Article IV consultations as EU accession approached. ### IMF arrangements with the Baltics — selected entries (SDR amounts preserved) - Estonia: - Stand-by | Approval Date 9/16/1992 | Expiration 9/15/1993 | Amount Approved (SDR million) 27.9 | Amount Drawn (SDR million) 27.9 - STF | Approval Date 10/27/1993 | Expiration N/A | Amount Approved (SDR million) 11.6 | Amount Drawn (SDR million) 11.6 - Stand-by | Approval Date 10/27/1993 | Expiration 3/26/1995 | Amount Approved (SDR million) 11.6 | Amount Drawn (SDR million) 11.6 - STF | Approval Date 1/9/1995 | Expiration N/A | Amount Approved (SDR million) 11.6 | Amount Drawn (SDR million) 11.6 - Stand-by | Approval Date 4/11/1995 | Expiration 7/10/1996 | Amount Approved (SDR million) 14.0 | Amount Drawn (SDR million) - - Stand-by | Approval Date 7/29/1996 | Expiration 8/28/1997 | Amount Approved (SDR million) 14.0 | Amount Drawn (SDR million) - - Stand-by | Approval Date 12/17/1997 | Expiration 3/16/1999 | Amount Approved (SDR million) 16.1 | Amount Drawn (SDR million) - - Stand-by | Approval Date 3/1/2000 | Expiration 8/31/2001 | Amount Approved (SDR million) 29.3 | Amount Drawn (SDR million) - - Latvia: - Stand-by | Approval Date 9/14/1992 | Expiration 12/13/1993 | Amount Approved (SDR million) 54.9 | Amount Drawn (SDR million) 54.9 - STF | Approval Date 12/15/1993 | Expiration 3/14/1995 | Amount Approved (SDR million) 45.8 | Amount Drawn (SDR million) 45.8 - Stand-by | Approval Date 12/15/1993 | Expiration 3/14/1995 | Amount Approved (SDR million) 22.9 | Amount Drawn (SDR million) 9.2 - Stand-by | Approval Date 4/21/1995 | Expiration 5/20/1996 | Amount Approved (SDR million) 27.5 | Amount Drawn (SDR million) - - Stand-by | Approval Date 5/24/1996 | Expiration 8/23/1997 | Amount Approved (SDR million) 30.0 | Amount Drawn (SDR million) - - Stand-by | Approval Date 10/10/1997 | Expiration 4/9/1999 | Amount Approved (SDR million) 33.0 | Amount Drawn (SDR million) - - Stand-by | Approval Date 12/10/1999 | Expiration 4/9/2001 | Amount Approved (SDR million) 33.0 | Amount Drawn (SDR million) - - Stand-by | Approval Date 4/20/2001 | Expiration 12/10/2002 | Amount Approved (SDR million) 33.0 | Amount Drawn (SDR million) - - Lithuania: - Stand-by | Approval Date 10/21/1992 | Expiration 9/20/1993 | Amount Approved (SDR million) 56.9 | Amount Drawn (SDR million) 56.9 - STF | Approval Date 10/27/1993 | Expiration N/A | Amount Approved (SDR million) 25.9 | Amount Drawn (SDR million) 25.9 - Stand-by | Approval Date 10/22/1993 | Expiration 10/24/1994 | Amount Approved (SDR million) 25.9 | Amount Drawn (SDR million) 5.2 - STF | Approval Date 4/8/1994 | Expiration N/A | Amount Approved (SDR million) 25.9 | Amount Drawn (SDR million) 25.9 - EFF | Approval Date 10/24/1994 | Expiration 10/23/1997 | Amount Approved (SDR million) 134.6 | Amount Drawn (SDR million) 134.6 - Stand-by | Approval Date 3/8/2000 | Expiration 6/7/2001 | Amount Approved (SDR million) 61.8 | Amount Drawn (SDR million) - - Stand-by | Approval Date 8/30/2001 | Expiration 3/29/2003 | Amount Approved (SDR million) 86.5 | Amount Drawn (SDR million) - ### Introduction of national currencies and IMF cooperation - First formal contact with the IMF: Deputy Managing Director Richard Erb met in Tallinn with delegations on September 22–25, 1991. - Estonia: - Introduction of the kroon in June (reference: "time of the introduction of the kroon in June"). - A fiscal tightening in the order of 5–6 percent of GDP was agreed informally one week before the currency reform. - An SBA was in place only in September 1992; the Fund expressed support in a joint press release at the time of the kroon introduction. - Latvia: - Left the ruble area in July 1992 when the Latvian ruble (introduced in May 1992 and initially circulating alongside the ruble at a rate of 1:1) became the sole legal tender. - The Latvian lats gradually replaced the Latvian ruble beginning in March 1993; conversion concluded in June 1993. - The lats was initially allowed to float, appreciated significantly, and was informally pegged to the SDR in February 1994. - Lithuania: - Left the ruble area in October 1992 when the interim currency, the talonas, was declared sole legal tender. - Timing forced by Russia’s introduction of a new system of correspondence accounts on October 1, 1992. - Monetary discipline initially weak; the talonas depreciated sharply and inflation remained high. - Monetary policy tightened sharply from May 1993 onward, anticipating the introduction of the litas in June 1993. - The litas appreciated and later stabilized against the US dollar. ### Monetary regimes and institutional arrangements - Currency board arrangement (CBA) features: - Base or central bank money could be created only against convertible foreign currency. - No scope for discretionary monetary policy; no central bank credit to Government or enterprises; lending to banks only under exceptional circumstances to protect overall banking sector soundness. - Lithuania introduced a currency board arrangement on April 1, 1994, to insulate monetary policy from political pressure. - Estonia and Lithuania maintained currency board arrangements; Latvia maintained an exchange rate peg of the lats to the SDR. ### Fiscal adjustment, structural reform, and technical assistance - Fiscal policy focus: - Fiscal restraint achieved mainly through expenditure reductions, frequently cuts in subsidies. - Revenue was largely maintained in relation to GDP, except in Lithuania. - Tax policy measures: simple sets of tax rates (largely flat rates), limiting or eliminating tax exemptions, and strengthening tax administration. - Structural policy priorities: - Early price and trade liberalization; creation of a two-tier banking system. - Beginning of privatization and enterprise reform; establishment of legal and institutional framework for commercial activity. - Estonia established a system without trade restrictions, tariffs, or other barriers. - Technical assistance and capacity-building: - Fund, World Bank, and others provided technical assistance; Fund staff coordinated TA from other international institutions and bilateral providers. - Placement of long-term experts in central banks and ministries of finance increased. - Statistical resident representative placed in the mid–1990s to assist in developing reliable statistics. - Training at JVI and the IMF Institute in Washington was used to build technical capacity. ### Economic outcomes: stabilization, consolidation, recession, and recovery - Short-run outcomes: - Inflation fell rapidly after monetary tightening. - Output decline steep over 1991–1994; steepest decline occurred before stabilization policies were implemented. - Output stabilized quickly as stabilization policies took hold; positive real economic growth recorded in the Baltics from 1994/95. - Russia achieved positive growth only from 1999, apart from a temporary and minor recovery in 1997. - Consolidation and recovery (1994–mid-1998): - Continued tight financial policies and determined structural reform. - Use of the EFF in Lithuania and precautionary SBAs in Estonia and Latvia; Lithuania chose the medium-term EFF to speed structural reform. - Banking sector restructuring, privatization, enterprise reform, and legal infrastructure were key structural areas. - Inflation fell to single digits; GDP growth accelerated sharply, reaching double digits in Estonia in 1997, and close to double digits in Latvia and Lithuania. - Large current account deficits accompanied recovery, largely financed through foreign direct investment (FDI). ### Banking sector crises and financial sector impact - Banking crises timeline and effects: - Estonia in late 1992/early 1993; Latvia in 1995; Lithuania in late 1995/early 1996. - Early crisis responses: government intervention, central bank moratoria, closure or liquidation of several large banks. - About one third of the broad money stock was destroyed during these banking crises. - Low financial intermediation meant even large bank failures had limited systemic effects and limited negative impact on output and incomes. - Subsequent focus on strengthening regulatory and supervisory systems with TA from Fund, World Bank, EBRD, and EU Phare. ### Russia crisis effects (mid-1998–1999) - Trade exposure to Russia/CIS in 1997 (export shares): - Estonia: export shares with Russia and the CIS ranged from over 15 and over 20 percent, respectively. - Latvia: 20 and 30 percent. - Lithuania: 25 and 45 percent. - Crisis consequences: - Exports fell; economies moved into recession; fiscal easing followed and deficits rose. - Estonia: budget deficit rose from close-to-balance in 1998 to almost 5 percent of GDP in 1999 (partly following pre-election spending). - Latvia: budget deficit rose from 1 percent of GDP in 1998 to 4 percent in 1999. - Lithuania: fiscal deficit rose from 3½ percent of GDP in 1998 to 8½ percent in 1999; selective support to industry and agriculture and use of privatization proceeds for restitution of frozen savings were policy features. - Monetary regimes were left unchanged. ### Political and programmatic responses - Lithuania initially did not seek a new IMF arrangement after the EFF expired in October 1997; later sought a precautionary SBA and negotiated one in early 2000 after extended negotiations. - Precautionary SBAs in Estonia and Latvia lapsed when fiscal deficits exceeded targets; new precautionary arrangements were in place again in early 2000 after resumed discussions. - Political lesson: fiscal weakening did not pay off electorally—governments responsible for easy fiscal policy lost subsequent elections in all three countries. ### Cooperation modalities, surveillance, and the present phase - Cooperative mechanisms: - Frequent (usually quarterly) staff missions to negotiate and follow through on Memoranda of Economic Policies (MEPs). - Continuous contact via resident representatives who played crucial implementation and communication roles. - Writing of technical and analytical notes to convey IMF policy advice to policymakers and the public. - Evolving relationship and EU accession context: - Focus shifted toward preparing for EU accession; EU accession became the new anchor for policymakers. - Estonia moved from formal IMF arrangement to surveillance mode: precautionary arrangement expired in August 2001; authorities chose annual Article IV consultations plus resident representative contacts and extra staff visits. - Article IV consultations increasingly targeted specific topics: currency board arrangements and hard currency pegs for EU accession countries; medium term fiscal issues related to EU and NATO accession; competitiveness assessments; financial market studies. - Latvia experienced program slippage in mid-2000; a follow-up program negotiated in early 2001 encountered review delays due to a 2002 budget inconsistent with program targets, but agreement on indicative budget deficit targets for the first half of 2002 was reached and adhered to, allowing program reviews to be concluded in mid-2002. ### Evolution of Fund relations and current mode of cooperation (2002–2003) - The SBA expired in December 2002; the new government decided not to seek a further formal arrangement. - Precautionary SBAs were in place in Lithuania from early 2000; the last precautionary SBA expired at the end of March 2003 and was not followed by another one. - Since the end of March 2003, all three Baltic countries moved from formal arrangements to surveillance mode concentrated on Article IV consultations. - Future cooperation will concentrate on the annual Article IV consultations, supported by additional staff visits likely focused on budget preparations. - Local resident representation changes: - It was decided not to replace the resident representative to Estonia and Latvia when his term expired in January 2003; local offices will be maintained at least until after EU accession. - For the time being, there will still be a resident representative in Lithuania (shared with Belarus). ### Key policy challenges and Fund advisory focus - Important near-term policy issue: how to accommodate the public expenditures required for EU accession within the fiscal requirements for an early entry into the euro area. - Policy advice on budgetary issues will remain important given the large external current account deficits in all three Baltic countries. - Fund advice increasingly appears in analytical papers on policy issues of particular relevance for the Baltics and forms an important part of Article IV reports. - Fund staff engaged directly with EU officials; an outcome was wider acceptance by the EU Commission and the European Central Bank that fixed exchange rates and currency board arrangements can be compatible with ERM II. ### Technical assistance, transparency, and standards - Role of technical assistance has diminished in recent years, though assistance continued in specific cases (assessment of tax systems, expenditure reviews). - Reports on Standards and Codes (ROSCs) have been or are being prepared for the Baltic countries in the fiscal, financial, and statistical areas. - Baltics supportive of greater transparency through publishing staff reports, final mission statements, memoranda of economic policies, and ROSCs. - Authorities found public disclosure useful for explaining policy choices to the public and signaling international support for policies. - Example of public disagreement: Latvia published a disagreement when Fund staff urged more restrained fiscal policy than authorities wished to pursue. ### Perspectives of Baltic policymakers on Fund cooperation - Over 20 current and former senior officials were interviewed; unanimity emerged on several points: - Fund support in the early days was viewed as crucial for legitimacy, credit ratings, and access to world capital markets. - The catalytic nature of Fund resources was emphasized; actual borrowing was small by conventional standards, but availability and the “seal of approval” mattered. - Officials generally did not view the Fund as coercive; threats were not used and flexibility was appreciated when needed. - The Fund’s teaching role in macroeconomics and technical assistance (e.g., assembling first central bank balance sheets, balance of payments, budgeting) was repeatedly praised: “The Fund put us on the learning curve.” - Mission chiefs and resident representatives were frequently singled out for their role in explaining macroeconomics and convincing authorities of policy logic. - MEPs and Letters of Intent were used domestically as tools to secure political support and to prevent contradictory legislation; these documents were often published promptly and remain visible. ### Key lessons and policy implications - Close cooperation between Fund staff and national authorities—through frequent missions, resident representatives, and TA—was crucial for designing and implementing stabilization and structural reforms. - Political commitment by authorities to IMF-advised policies was essential; delayed commitment (as in Lithuania initially) led to delayed stabilization. - Technical assistance effectiveness depended on whether authorities sought it willingly and on the practical, hands-on quality of experts. - Rapid disinflation with tight policies had negligible short-term output cost in the Baltics; stabilization was a precondition for recovery. - Resistance to trade protection and maintenance of liberal trade regimes were recurrent IMF policy positions; achieving politically difficult structural reforms often required performance criteria in programs. - Central lesson: Fund involvement works best when authorities and the public are convinced that Fund advice is in the country’s best interest; ownership and political will were essential to the Baltics’ success. *Source: _wp03241 - 1. Real GDP ...............................................................................................................................* ### 1. Real GDP ............................................................................................................ ### 1. Real GDP ### I. INTRODUCTION — scope of cooperation - The paper assesses cooperation between the Fund and the Baltic countries (Estonia, Latvia, Lithuania) over the past decade following independence in August 1991. - Forms of cooperation documented: - Acquaintance and membership missions in late 1991 and early 1992. - Two or three follow-up staff visits to discuss policy formulation and implementation. - Establishment of resident representative offices in all three countries in mid-1992. - Technical assistance (short-term missions, long-term resident advisors, classes/courses). - Training via the IMF Institute (INS) and the Joint Vienna Institute (JVI). - Technical assistance concentrated mainly in the fiscal, financial, statistical, and legal areas. - Cooperation evolved from program financing and intensive TA to surveillance mode as EU accession neared. ### Phases of transition in the Baltics (as defined in the text) - economic stabilization 1992–1993 - consolidation and economic recovery 1994–mid-1998 - recession—the effects of the Russia crisis mid-1998–1999 - recovery and preparation for EU accession 2000–present ### II. ECONOMIC STABILIZATION — initial conditions and policy aims - Initial shocks and constraints: - Collapse of Soviet central planning produced widespread disruptions in trade and financial channels, shortages, loss of export markets, and dysfunctioning of payments and monetary arrangements. - Severe terms of trade shock in early 1992 as Russia moved to world market prices for energy and raw material exports to the Baltics. - The terms of trade deteriorated by over 20 percent of GDP for the Baltic countries. - This deterioration contrasted with the three to five percent of GDP deterioration faced by Eastern and Central European countries after the dissolution of the Council for Mutual Economic Assistance. - Economic situation in early 1992: sharply falling output, rapid price increases, sharply falling real incomes. - Policy objective: achieve rapid economic stabilization while initiating transition to a market economy. - Main policy elements: - Tight monetary and fiscal policies to bring down inflation. - Structural measures aimed at institution building and rationalization of economic incentives. ### Policy implementation and Fund role - Fund involvement: - Staff assisted in formulating programs supported financially by stand-by arrangements (SBAs) and the structural transformation facility (STF). - Resident representatives facilitated continuous dialogue and were often crucial in program implementation; they helped explain the logic of Fund policy advice and respond immediately to authorities’ questions. - Currency strategy: - Tight anti-inflationary monetary policies required introduction of own currencies to insulate from FSU inflationary impulses and to enable sovereign monetary and exchange rate policies. - Fund staff initially urged caution—stressing the need for supporting economic policies before currency reform. - Estonia introduced the kroon in June 1992 under a currency board arrangement (CBA). The Estonian authorities proceeded despite initial Fund advice to wait until a stand-by arrangement was in place. ### Box 1 summary points (membership, missions, instruments) - Timeline highlights: - First formal IMF contact: Deputy Managing Director met Baltic delegations on September 22–25, 1991. - Acquaintance missions: November 1991. - Membership missions: January/February 1992. - Baltic countries formally joined the IMF in April/May 1992. - Staff missions to negotiate financial cooperation: April/May, June/July, and August/September 1992. - Resident Representatives stationed mid-1992. - Managing Director visited all three in August 1992. - First stand-by arrangements approved September/October 1992. - Instruments used and descriptions: - Stand-by arrangements (SBAs): financial resources pledged in support of policy programs; funds disbursed in stages subject to performance criteria and periodic reviews. - Temporary structural transformation facility (STF): introduced in 1993 specifically to assist transition economies. - Precautionary SBAs: authorities declare they do not intend to borrow but are entitled to do so if needed, assuming policies are “on track”. - Extended financing facility (EFF): medium-term (usually three years) financing with heavy emphasis on structural policies. - Surveillance via Article IV consultations as EU accession approached. ### Text Box Table 1 — IMF Arrangements with the Baltics (selected entries by country) - Estonia (Type of Arrangement | Approval Date | Expiration or Cancellation Date | Amount Approved (SDR million) | Amount Drawn (SDR million)) - Stand-by | 9/16/1992 | 9/15/1993 | 27.9 | 27.9 - STF | 10/27/1993 | N/A | 11.6 | 11.6 - Stand-by | 10/27/1993 | 3/26/1995 | 11.6 | 11.6 - STF | 1/9/1995 | N/A | 11.6 | 11.6 - Stand-by | 4/11/1995 | 7/10/1996 | 14.0 | - - Stand-by | 7/29/1996 | 8/28/1997 | 14.0 | - - Stand-by | 12/17/1997 | 3/16/1999 | 16.1 | - - Stand-by | 3/1/2000 | 8/31/2001 | 29.3 | - - Latvia (Type of Arrangement | Approval Date | Expiration or Cancellation Date | Amount Approved (SDR million) | Amount Drawn (SDR million)) - Stand-by | 9/14/1992 | 12/13/1993 | 54.9 | 54.9 - STF | 12/15/1993 | 3/14/1995 | 45.8 | 45.8 - Stand-by | 12/15/1993 | 3/14/1995 | 22.9 | 9.2 - Stand-by | 4/21/1995 | 5/20/1996 | 27.5 | - - Stand-by | 5/24/1996 | 8/23/1997 | 30.0 | - - Stand-by | 10/10/1997 | 4/9/1999 | 33.0 | - - Stand-by | 12/10/1999 | 4/9/2001 | 33.0 | - - Stand-by | 4/20/2001 | 12/10/2002 | 33.0 | - - Lithuania (Type of Arrangement | Approval Date | Expiration or Cancellation Date | Amount Approved (SDR million) | Amount Drawn (SDR million)) - Stand-by | 10/21/1992 | 9/20/1993 | 56.9 | 56.9 - STF | 10/27/1993 | N/A | 25.9 | 25.9 - Stand-by | 10/22/1993 | 10/24/1994 | 25.9 | 5.2 - STF | 4/8/1994 | N/A | 25.9 | 25.9 - EFF | 10/24/1994 | 10/23/1997 | 134.6 | 134.6 - Stand-by | 3/8/2000 | 6/7/2001 | 61.8 | - - Stand-by | 8/30/2001 | 3/29/2003 | 86.5 | - *Source: _wp03241 - 1. Real GDP ...............................................................................................................................* ### introduction of the kroon, they and Fund staff agreed to closely cooperate in the run-up to the ### _wp03241 - introduction of the kroon, they and Fund staff agreed to closely cooperate in the run-up to the ### Introduction of national currencies and IMF cooperation - First formal contact with the IMF: Deputy Managing Director Richard Erb met in Tallinn with delegations from the three Baltic countries on September 22–25, shortly after independence was regained. - Estonia: - Introduction of the kroon in June (introduction date referenced as "time of the introduction of the kroon in June"). - Fund staff worked closely with Estonian authorities on technical details of the monetary reform and on a stabilization program. - A fiscal tightening in the order of 5–6 percent of GDP was agreed informally one week before the currency reform. - A stand-by arrangement was in place only in September 1992, but the Fund expressed support in a joint press release at the time of the kroon introduction. - Latvia: - Left the ruble area in July 1992 when the Latvian ruble (introduced in May 1992 and initially circulating alongside the ruble at a rate of 1:1) became the sole legal tender. - The Latvian lats gradually replaced the Latvian ruble beginning in March 1993; the conversion was concluded in June 1993. - The lats was initially allowed to float, appreciated significantly, and was informally pegged to the SDR in February 1994. - Lithuania: - Left the ruble area in October 1992 when the interim currency, the talonas, was declared sole legal tender. - The timing was forced by Russia’s introduction of a new system of correspondence accounts on October 1, 1992. - Monetary discipline was initially weak; the talonas depreciated sharply and inflation remained high. - Monetary policy was tightened sharply from May 1993 onward, in anticipation of the introduction of the litas in June 1993. - The litas appreciated and later stabilized against the US dollar. ### Monetary regimes and institutional arrangements - Currency board arrangement (CBA) features: - Under a CBA, base or central bank money could be created only against convertible foreign currency. - No scope for discretionary monetary policy; no central bank credit to Government or enterprises; lending to banks only under exceptional circumstances to protect overall banking sector soundness. - Lithuania introduced a currency board arrangement on April 1, 1994, to insulate monetary policy from political pressure. - Estonia and Lithuania maintained currency board arrangements; Latvia maintained an exchange rate peg of the lats to the SDR. ### Fiscal adjustment, structural reform, and technical assistance - Fiscal policy focus: - Fiscal restraint achieved mainly through expenditure reductions, frequently cuts in subsidies. - Revenue was largely maintained in relation to GDP, except in Lithuania. - Tax policy measures: simple sets of tax rates (largely flat rates), limiting or eliminating tax exemptions, and strengthening tax administration. - Structural policy priorities: - Early price and trade liberalization; creation of a two-tier banking system. - Beginning of privatization and enterprise reform; establishment of legal and institutional framework for commercial activity. - The Baltics created highly open trade systems; Estonia established a system without trade restrictions, tariffs, or other barriers. - Technical assistance and capacity-building: - Fund, World Bank, and others provided technical assistance; Fund staff coordinated technical assistance from other international institutions and bilateral providers. - Placement of long-term experts in central banks and ministries of finance increased (see Table 1 referenced for TA mission counts). - Statistical resident representative placed in the mid–1990s to assist in developing reliable statistics. - Training at the Joint Vienna Institute (JVI) and the IMF Institute in Washington was used to build technical capacity. ### Economic outcomes: stabilization, recession, and recovery - Short-run outcomes: - Inflation fell rapidly after monetary tightening (Figure 2 referenced). - Output decline was very steep over 1991–1994 (Figure 1 referenced); the steepest decline occurred before stabilization policies were implemented. - Output stabilized quickly as stabilization policies took hold; positive real economic growth recorded in the Baltics from 1994/95. - Russia achieved positive growth only from 1999, apart from a temporary and minor recovery in 1997. - Consolidation and recovery (1994–mid-1998): - Continued tight financial policies and a determined push on structural reform. - Use of the EFF in Lithuania and precautionary SBAs in Estonia and Latvia; Lithuania chose the medium-term EFF to speed structural reform. - Banking sector restructuring, privatization, enterprise reform, and legal infrastructure were key structural areas. - Inflation came down to single digits; GDP growth accelerated sharply, reaching double digits in Estonia in 1997, and close to double digits in Latvia and Lithuania. - Large current account deficits accompanied recovery, to a large extent financed through foreign direct investment (FDI). - Banking sector crises and financial sector impact: - Banking crises emerged in Estonia in late 1992/early 1993, in Latvia in 1995, and in Lithuania in late 1995/early 1996. - Early crisis responses: government intervention, central bank moratoria, closure or liquidation of several large banks. - About one third of the broad money stock was destroyed during these banking crises. - Due to low financial intermediation, even large bank failures had limited systemic effects and limited negative impact on output and incomes. - Subsequent efforts focused on strengthening regulatory and supervisory systems with TA from Fund, World Bank, EBRD, and EU Phare. - Russia crisis effects (mid-1998–1999): - Crisis hit in August 1998; trade exposure to Russia/CIS in 1997: - Estonia: export shares with Russia and the CIS ranged from over 15 and over 20 percent, respectively. - Latvia: 20 and 30 percent. - Lithuania: 25 and 45 percent. - Exports fell; economies moved into recession; fiscal easing followed and deficits rose. - Estonia: budget deficit rose from close-to-balance in 1998 to almost 5 percent of GDP in 1999 (partly following pre-election spending). - Latvia: budget deficit rose from 1 percent of GDP in 1998 to 4 percent in 1999. - Lithuania: fiscal deficit rose from 3½ percent of GDP in 1998 to 8½ percent in 1999; selective support to industry and agriculture and use of privatization proceeds for restitution of frozen savings were policy features. - Monetary regimes were left unchanged. - Political and programmatic responses: - Lithuania initially did not seek a new IMF arrangement after the EFF expired in October 1997; later sought a precautionary SBA and negotiated one in early 2000 after extended negotiations. - Precautionary SBAs in Estonia and Latvia lapsed when fiscal deficits exceeded targets; new precautionary arrangements were in place again in early 2000 after resumed discussions. - Political lesson: fiscal weakening did not pay off electorally—governments responsible for easy fiscal policy lost subsequent elections in all three countries. ### Cooperation modalities, surveillance, and the present phase - Cooperative mechanisms: - Frequent (usually quarterly) staff missions to negotiate and follow through on Memoranda of Economic Policies (MEPs). - Continuous contact via resident representatives who played crucial implementation and communication roles. - Writing of technical and analytical notes to convey IMF policy advice to policymakers and the public. - Evolving relationship and EU accession context: - Focus shifted toward preparing for EU accession; EU accession became the new anchor for policymakers. - Estonia moved from formal IMF arrangement to surveillance mode: precautionary arrangement expired in August 2001; authorities chose annual Article IV consultations plus resident representative contacts and extra staff visits. - Article IV consultations increasingly targeted specific relevant topics: currency board arrangements and hard currency pegs for EU accession countries; medium term fiscal issues related to EU and NATO accession; competitiveness assessments; financial market studies. - Latvia experienced program slippage in mid-2000; a follow-up program negotiated in early 2001 encountered review delays due to a 2002 budget inconsistent with program targets, but agreement on indicative budget deficit targets for the first half of 2002 was reached and adhered to, allowing program reviews to be concluded in mid-2002 (program review timing and conclusion referenced in the text). ### Key lessons and policy implications - Close cooperation between Fund staff and national authorities—through frequent missions, resident representatives, and TA—was crucial for designing and implementing stabilization and structural reforms. - Political commitment by authorities to IMF-advised policies was essential; delayed commitment (as in Lithuania initially) led to delayed stabilization. - Technical assistance effectiveness depended on whether authorities sought it willingly and on the practical, hands-on quality of experts. - Rapid disinflation with tight policies had negligible short-term output cost in the Baltics; stabilization was a precondition for recovery. - Resistance to trade protection and maintenance of liberal trade regimes were recurrent IMF policy positions, and achieving politically difficult structural reforms (e.g., agricultural protection reductions) often required performance criteria in programs. *Source: _wp03241 - introduction of the kroon, they and Fund staff agreed to closely cooperate in the run-up to the currency reform.* ### 2002. The SBA expired in December 2002 and, as in Estonia earlier, the new government ### The SBA expired in December 2002 and, as in Estonia earlier, the new government decided not to seek a further formal arrangement ### Evolution of Fund relations and current mode of cooperation - The SBA expired in December 2002 and the new government decided not to seek a further formal arrangement. - Precautionary SBAs were in place in Lithuania from early 2000; the last precautionary SBA expired at the end of March 2003 and was not followed by another one. - Since the end of March 2003, all three Baltic countries have moved from formal arrangements to a surveillance mode concentrated on Article IV consultations. - Future cooperation will concentrate on the annual Article IV consultations, supported by additional staff visits likely focused on budget preparations. - Local resident representation changes: - It was decided not to replace the resident representative to Estonia and Latvia when his term expired in January 2003; local offices will be maintained at least until after EU accession. - For the time being, there will still be a resident representative in Lithuania (shared with Belarus). ### Key policy challenges and Fund advisory focus - Important near-term policy issue: how to accommodate the public expenditures required for EU accession within the fiscal requirements for an early entry into the euro area. - Policy advice on budgetary issues will remain important given the large external current account deficits in all three Baltic countries (Figure 4). - Fund advice increasingly appears in analytical papers on policy issues of particular relevance for the Baltics and forms an important part of Article IV reports. - Fund staff have also engaged directly with EU officials; an outcome was wider acceptance by the EU Commission and the European Central Bank that fixed exchange rates and currency board arrangements can be compatible with ERM II. ### Technical assistance, transparency, and standards - The role of technical assistance has diminished in recent years, though assistance has continued in specific cases (assessment of tax systems, expenditure reviews). - Reports on Standards and Codes (ROSCs) have been or are being prepared for the Baltic countries in the fiscal, financial, and statistical areas. - The Baltics have been supportive of greater transparency through publishing staff reports, final mission statements, memoranda of economic policies, and ROSCs. - Authorities found public disclosure useful for explaining policy choices to the public and signaling international support for policies. - Example of public disagreement: Latvia published a disagreement when Fund staff urged more restrained fiscal policy than authorities wished to pursue. ### Perspectives of Baltic policymakers on Fund cooperation - Over 20 current and former senior officials were interviewed; a large amount of unanimity emerged: - Fund support in the early days was viewed as crucial for legitimacy, credit ratings, and access to world capital markets. - The catalytic nature of Fund resources was emphasized; actual borrowing was small by conventional standards, but availability and the “seal of approval” mattered. - Officials generally did not view the Fund as coercive; threats were not used and flexibility was appreciated when needed. - The Fund’s teaching role in macroeconomics and technical assistance (e.g., assembling first central bank balance sheets, balance of payments, budgeting) was repeatedly praised: “The Fund put us on the learning curve.” - Mission chiefs and resident representatives were frequently singled out for their role in explaining macroeconomics and convincing authorities of policy logic. - MEPs and Letters of Intent were used domestically as tools to secure political support and to prevent contradictory legislation; these documents were often published promptly and remain visible (National Museum of Lithuania requested original copies). ### Assessment of outcomes and lessons - Cooperation evolved from stabilization with financial support to consolidation and recovery (precautionary arrangements), to surveillance as EU accession neared. - The Fund’s imprimatur facilitated access to international capital markets; financial support was catalytic rather than large. - The policy advice and technical assistance were viewed as particularly important; Baltic authorities largely adopted Fund advice and demonstrated strong ownership. - Factors contributing to Baltic success (as identified by interviewees) included: collective memory of pre-WWII market economies; strong desire to rejoin Europe; diasporas providing assistance; relatively less corruption; and early willingness to accept IFI assistance. - Central lesson: Fund involvement works best when authorities and the public are convinced that Fund advice is in the country’s best interest; ownership and political will were essential to the Baltics’ success. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp03241.pdf* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2003/_wp03241.pdf_