Transcript of a Conference Call on the Completion of the First Review Under Latvia's Stand-By Arrangement

August 28, 2009

With Anne-Marie Gulde, Senior Adviser in the European Department, and Mark Griffiths, Mission Chief for Latvia
Friday, August 28, 2009

MS. NARDIN: Good morning everybody, and a special welcome to the journalists who are participating in this conference call in our resident representative's office in Riga. My name is Simonetta Nardin and I am from the External Relations Department of the IMF. This morning we are here with Anne-Marie Gulde-Wolf, advisor in the European Department, and Mark Griffith, deputy division chief, to discuss the approval by the IMF Executive Board of the first review under the stand-by arrangement with Latvia.

MS. GULDE-WOLF: Thank you, The Executive Board completed the first review yesterday. This enabled immediate disbursement of about €195.2 million or about US$278.5 million, bringing the level of total disbursements from the IMF under the stand-by arrangement to €780.7 million.

As you know, the IMF support is part of a coordinated package together with the European Union, the World Bank, Nordic countries and other program partners. The program was originally approved in December 2008. Latvia's economic strategy is centered around keeping the exchange rate peg and achieving euro adoption as soon as possible. However, given the very dramatic economic downturn that we have seen over the last couple of months, we had to be flexible to overcome the crisis. In these circumstances, the program had to be revised.

I would like to just mention a few changes. Probably the most important is that the fiscal deficit ceiling has been revised upward to up to 13 percent from the original target that was 5 percent. This allows for 1 percent of GDP in additional resources for social safety nets. The authorities are firmly committed to putting the budget deficit on a rapidly declining path starting from 2010 and have outlined measures to this effect. Corrective measures will be both needed on the spending side, so there will be some reduction in expenditures, but revenue measures will also be critical. The exact nature of the budgetary changes will be subject to the next review mission.

As we have said before, this is a very challenging program. We and the other program partners are supporting the Latvian authorities in their efforts to overcome the difficulties. It is important, however, that this policy package also received broad support within the Latvian Coalition. We want to underline again that the package in its challenging nature has been designed as a way to enhance economic efficiency while at the same time making sure that the burden is equally shared among all members of society and does not fall excessively on the poor. Thank you.

Question: You mentioned that the budget ceiling has been raised to 13 percent. What is that in the E.U. methodology? Is that an 11 percent budget deficit of GDP? You said 1 percent for social spending. What exactly is that? Is that extensions of unemployment benefits? Is that public works programs? Is that guaranteed minimum income?

MS. GULDE-WOLF: Thank you very much. As you know, the methodology used by the European Union and the IMF cash accounting is not exactly equivalent. It depends especially on the treatment of net lending. We do not have an exactly corresponding number at this stage, but as you indicated, it would be lower probably around that ball park, but it would need to come out exactly on what the exact net lending figures would be.

MR. GRIFFITHS: There are quite a few extra things here. I think the guaranteed minimum income, the government is considering that, the basic payments. Also helping people with co-payments for health care, the poorest people, to make sure they can get that. Helping the young kids, the 6-year-olds, go to school and keeping their curriculum and schooling for them. In addition, there are active labor market polices, and here we are working with the European Union and the European Social Fund to help with active labor market policies. Therefore, you are right, these are the kinds of measures we have in mind or the authorities have in mind on the safety net.

Question: Our sources from the government made a statement that the IMF and the European Commission still have strong disagreements about the Latvian currency peg to the euro. Could you confirm or deny this?

MS. GULDE-WOLF: The current program is based on the maintenance of the exchange rate regime. This is what the IMF's Executive Board has agreed to. MR. GRIFFITHS: All institutions have the same goals of overcoming this crisis and putting Latvia back on track for growth and prosperity. We have worked very closely with the European Commission and of course with the Latvian government, and we all share the same goals here.

Question: I wonder if you could give some projections about economic growth for 2010 and for the fiscal deficit in 2010 and for unemployment.

MS. GULDE-WOLF: The program at this stage is based on the assumption that there will still be some reduction in output in 2010, probably around 4 percent.

MR. GRIFFITHS: For 2009, we have a fiscal deficit ceiling of 13 percent of GDP. It is not clear that the authorities will actually hit that number. The program has been designed to allow a higher deficit just in case for extra safety net spending in case of the downturn and that kind of thing. It does not mean the authorities will hit 13, they may come in with a lower number, but this program is robust and it is strong enough to allow that to be flexible in response to these weaker conditions.

For 2010, we expect to have some similar flexibility, the key in setting that target will be where we are in 2009, but the key then will be for sustained deficit reduction over the medium-term and hitting the Maastricht criteria rather than a precise number right now on the deficit.

MS. GULDE-WOLF: As you know, the budget is being designed and in this coming month we will work closely with the government on this process, so the details are still being worked out, and the exact budgetary framework will be set out in the next review. This will be the core element of the next review. You were asking about unemployment. We generally do not forecast or program unemployment figures. Unemployment has increased significantly, and given the continued expectation that the recession is not over yet, we fear that unemployment might even increase. We hope that including with the measures that are in the Letter of Intent, including active labor market measures, the increase in unemployment, if it happens, will be as small as possible. The Baltic countries, and Latvia in particular, have very flexible markets and we hope that this is one element that will help make the labor market effects of this recession less severe than in other countries.

MR. GRIFFITHS: We are concerned about the possibility of a rise in unemployment and that is why the program has been designed to try to minimize that and also to protect those who might become unemployed, to help them with health payments and active labor market policies. We have worked very hard on that.

Question: I wonder if you could add to that. When you mentioned these enhanced revenue measures, what are you expecting and when? Can you elaborate, Anne-Marie, on the flat tax modification proposal?

MS. GULDE-WOLF: On the exact measures going forward, we will look at that in the context of our work leading up to the 2010 budget. There will be a staff visit beforehand. At this stage, we do not have a worked-out proposal. However, in the Letter of Intent, in terms of the revenue measures it is mentioned that the authorities may be willing to look at a revision of the current income text framework including possibly looking at a progressive income tax, but these are issues that we will need to discuss with the government and the authorities in more detail.

MR. GRIFFITHS: The authorities are committed to increasing the real estate tax. They are working on that, and that is part of the measures. Then there are other tax increases they are considering as a fallback or as a last resort, and they are working very hard to take other measures and other structural reforms instead. We will work closely with them if taxes have to be increased, a progressive personal income tax and a possible VAT increase. We will work closely with them if it is needed, including at the technical level.

Question: According to the initial schedule, Latvia had to receive four payments from the Fund this year. This one would be the second. What about the rest of the loans? And could there be any additional conditions from the Fund to get it?

MS. GULDE-WOLF: The next review mission will take place in late October-November, and with the completion of the review if it would go smoothly through, it would go the Board in December and that would be the next installment. So the fact that it took a longer time to complete this review has pushed some of the payments further back, but it has not reduced the amount.

Question: The Latvian government has said that it is planning to present the 2010 budget to parliament on December 1, which is later than it was originally expected. Is that a concern that things are going to get delayed again as they did with the first review, or is that more or less on line with your expected timescale as well?

MS. GULDE-WOLF: I think that is still consistent with our timescale. What we are most concerned with is to have a quality budget process, to have sufficient time to elaborate and get the support of the social partners, and so at this stage within that timeframe I think we will be able to work with the authorities and we clearly do not want to push an excessive time schedule. Obviously, it should not go way beyond that, but at this stage, I think this is what we expected and what we can support.

Question: Maybe I could get in one more question. The Latvians have been working on a scheme to help borrowers who have got problems with their payments to banks. Is that something that the IMF is still supporting and do you see this scheme actually happening because I guess it needs funding. Are you expecting the Latvians to take that funding from the IMF loan or the E.U. loan? Can you talk about that a little bit?

MS. GULDE-WOLF: We are looking at this scheme right now. I think that on the principle that there may have to be some debt restructuring, this is something that we have discussed with the authorities, the aim being twofold. One, to avoid debt-weight losses from excessive debt overhang and from the very slow speed of debt workout, but also from avoiding excessive social tensions for borrowers that are due to the economic problems and not able to service their loans. The exact nature of the scheme and how it works and the budgetary envelope that would be necessary, those are clearly critical elements in whether or not we are supporting this particular scheme. I cannot say anything on the current scheme right now, but I think on the principle that debt restructuring might be a necessary element to achieve a faster return to growth, this is something that we have learned from previous crises and that we are very interested in working with the authorities on.

Question: When do you expect to make public the Letter of Intent?

MS. GULDE-WOLF: This is now a technical process that involves the authorities as much as us. The authorities have to decide when they want to publish. Then it will take a couple of days in Washington just for the technical side. We expect this to happen within the next I would say week or two at the latest.

Question: What needs to be done before the second assessment can be completed? Is that structural reform or is it just the 2010 budget?

MR. GRIFFITHS: I think the 2010 budget is a very important part, Aaron, so we'll be looking for some good structural measures in that and some move toward deficit reduction, and so that will be key. There are a few other structural benchmarks in the letter of intent, which you will see soon. And also, the usual targets on measures of the money supply and on reserves, that kind of thing, the standard things in Fund programs. Yes, I think the budget is key, but there are a few other things as well to make sure that the reforms are there and that there's the prospect that this program is succeeding and that growth is returning, these kinds of things. We have those measures in place.

Question: Mr. Strauss-Kahn's statement talked about additional fiscal consolidation. I was wondering if, one, you could explain that, and two, separately whether the IMF expects any further bailouts of banks or mergers of Latvian banks. Also the effect of this program on not only Latvian banks, but let's see the Swedish banks that are exposed there and whether the idea of the government helping consumers pay banks, is it a matter of the banks restructuring the debt of consumers or of funds going to consumers in order to have the banks receive 100 percent of what's owed to them.

MS. GULDE-WOLF: Those are a lot of questions. Let me start maybe on the fiscal consolidation. Clearly, this is a part of the program as we had explained before. The decline in economic output in Latvia following a boom has a severe impact on the way the budget has to be structured and in looking at the next budget we are looking at how the budget can be made consistent with the economic realities in the country. This will involve possible further structural reform in spending and possibly revenue measures.

Clearly the issue of banks and possible further banking problems is critical in the forward-looking strategy of where we are going to go. There has already been significant progress made in stabilizing the financial sector. At this stage, the sector as a whole is well capitalized and liquid. With the continuing economic problem it is very important to keep vigilance in the financial sector. Also it cannot be ruled out that there might be problems emerging. The authorities are working on improving their bank resolution framework, so we are reasonably confident that any problems that will be emerging in this improved framework can be addressed.

MR. GRIFFITHS: I think the financial sector has really stabilized since the end of last year, and a number of banks have taken measures to increase capital to strengthen their position in Latvia, so I think they are making a lot of progress there and I think the authorities have worked very hard there. So I think things are getting better there.

Question: Latvian Prime Minister Valdis Dombrovskis stated several times that until this time all budget cuts and structural reforms requested by the IMF or the European Commission might lead the economy to contract even deeper. Could you comment on this statement?

MR. GRIFFITHS: This is the authorities’ program supported by the European Commission, the IMF and other program partners. As to the fiscal deficit, the program allows for considerable increase in the fiscal deficit to as much as 13 percent of GDP. That is a large number and we are making every effort to minimize the effect of the recession and to make it less. The program actually has been very flexible and very sensitive to the concerns which you are raising and which the prime minister is raising. We are trying to cushion the impact of the recession. I think the concerns you have raised are valid and we are trying to address those.

Question: Thank you. Mark, you have addressed the euro adoption issue and I just wanted to draw you out a bit on that in terms of the exit strategy. Many continue to say that the overvaluation of the currency remains a problem. I think the approval of the Fund must suggest that you believe internal devaluation is succeeding, that the compression of wages, et cetera, is thus far on track. But what do you have in mind in terms of when realistically they can get in compliance with Maastricht Criteria with debt at such a high level and certainly the budget deficit not coming into the 3 percent range anytime soon?

MR. GRIFFITHS: The recession is deeper and things are harder, but there has been some success on the external side. The current account is moving now into significant surplus, so the strategy is showing some signs of success there and I think that part is working, and working surprisingly fast, much more rapidly than was anticipated when the program was launched.

In terms of exit strategy to the euro, yes, it will be important for the fiscal deficit to be reduced over the medium-term and that will be key for the Maastricht Criteria and the exit strategy. The debt ratio will be somewhat higher, but the 60 percent criteria is a reference value and the key is to be approaching that value, and over the medium-term debt will certainly be declining and they should meet these criteria in the next few years.

Question: I was wondering what will happen if at the end of the year our budget deficit will be more than 13 or 14 percent than agreed on the program.

MS. GULDE-WOLF: Like always in program reviews, we will access at the time the circumstances under which the deviation from the target has occurred, and we cannot say at this stage how we would access that. That clearly will depend on what the main factors behind the deviation are.

MR. GRIFFITHS: Exactly. Thirteen percent I think is a high number, which responds to the situation in Latvia, and as Anne-Marie said, of course we will look at the conditions. But we do assess things depending on how the economy develops. We do reassess. Just as this deficit target was initially five, and now we have raised it significantly because of the world economy and because the recession in Latvia has been much deeper.

MS. GULDE-WOLF: But we should add here that we are confident that the government is able to meet this target and that they have a program with measures that are consistent with that target and that they are working seriously to work meeting it, and I think is what we expect here.

MS. NARDIN: I would like to at this point thank everybody who has participated in this conference call, especially our journalist and colleagues in Riga.


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