IMF Survey: Latvia's Successful Recovery Not Easy to Replicate

IMF News, June 11, 2012

Source details

Canonical URL: IMF Survey: Latvia's Successful Recovery Not Easy to Replicate

Latvia suffered a combined GDP decline of almost 25 percent during the global economic crisis and unemployment surged from 6 percent to 21 percent.
By Q1 2012:
- Latvia’s economy grew at 6.8 percent, the fastest pace in the European Union.
- Unemployment declined to 16 percent.
Population context: Latvia’s population is described as "just over 2 million people."

Policy decision: Latvia chose to keep the peg to the euro rather than devalue.
- IMF chief economist Olivier Blanchard stated he had been skeptical that adjustment could succeed without devaluation but acknowledged he had been wrong.
- The IMF and its partners proceeded because of the Latvian authorities’ strong will to keep the peg and a commitment from the European Union and Nordic countries.
External support:
- International support package totaled €7.5 billion.
- Latvia’s European partners provided about two-thirds of the €7.5 billion international support package.
Fiscal consolidation:
- In the first year of its program, Latvia implemented fiscal adjustment of more than 8 percent of GDP.
- Total adjustment for the whole program was around 15 percent of GDP.
- The adjustment produced a deep recession but restored confidence and allowed Latvia to return to international capital markets, issuing two eurobonds since mid-2011.

Pro-frontloading arguments:
- Olivier Blanchard: while a slower pace of fiscal adjustment might have been preferable economically, frontloading before fatigue set in proved effective.
- Jörg Asmussen: "The Baltic experience shows that speed is of the essence when it comes to fiscal consolidation."
- Prime Minister Valdis Dombrovskis: restoration of financial stability is a precondition for economic growth; markets were not prepared to finance budget deficits at the time.
Social concerns and trade-offs:
- Sharan Burrow highlighted social costs: "more than 27 percent of people right here in Latvia who are severely in poverty, materially deprived," "10 percent of your population leaving the country," and "wages during these measures fell by 19 percent on average."
- Christine Lagarde emphasized the need to protect the vulnerable: "There is an urgent need to create jobs—for young people, for the long-term unemployed, for those nearing retirement age who will find it difficult to retrain. A greater push to reduce inequality would also help a lot…This means smarter investment in education, a move towards more progressive taxation, and a stronger—but well targeted—social safety net."

Latvia is close to fulfilling euro convergence criteria but is struggling to bring down inflation to the required level.
Olli Rehn: "Latvia is not yet fulfilling all the convergence criteria," referring to the most recent convergence report published by the European Central Bank.
External perspectives:
- Anders Borg: "If the European Union says that Latvia cannot join the eurozone, then tell me which country is capable of doing so."
- Rehn: Latvia’s achievements are "a beginning of a longer journey to what’s a sustainable economy model," important for possible euro adoption and economic welfare.

Central lesson: high level of ownership and determination by Latvian authorities was the most important factor in success.
- Lagarde: "At a very basic level, everybody knew what needed to be done. They understood that the huge spike in spending in the years leading up to the crisis could not be sustained."
- Lagarde: "But what really made it work was the high level of ownership—this was your program, your objectives, your future on the line. Our role was simply to help."
Replicability caveat: many facilitating factors in the Baltics (strong ownership, strong external support, willingness to frontload adjustment) may not be present elsewhere in Europe, so replication is uncertain.

IMF Survey online — June 11, 2012.