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“Successful” IMF funding to Latvia winds down

By Anatol Steven. 15.02.2012

IMF meeting
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IMF praises Latvia’s “huge adjustment” and return to growth

When Latvia asked for financial support from the IMF and the European Union in December 2008, it was one of the first countries to suffer the full consequences of the global economic crisis. Its decision to keep its currency pegged to the euro meant it had to go through a painful process of internal devaluation – cutting wages and prices – as a means to restore competitiveness and growth.
Today, three years later, the IMF says that Latvia has successfully completed its EU- and IMF-supported program. The peg remains intact, international reserves have recovered, and Latvia regained access to international capital markets in 2011, issuing a $500 million bond.
The fiscal deficit is now much lower, and the country is within reach of qualifying for euro adoption. The economy grew by some 5% in 2011, led by a rebound in exports.
For 2012, the IMF is now forecasting less growth, at 1.5%, and that forecast is subject to considerable uncertainty because of the crisis in the eurozone. But growth is expected to rise to 2.5% in 2013.
In an interesting interview posted on the IMF’s website, three people closely involved in the Latvia program during the past three years – IMF mission chief Mark Griffiths, resident representative David Moore, and mission team member Magnus Saxegaard – discuss Latvia’s achievements and look at the challenges that are still ahead. We publish excerpts below. The full interview can be found here: http://www.imf.org/external/pubs/ft/survey/so/2012/INT020712A.htm

IMF Survey online: Latvia was one of the first countries to seek IMF support during the global financial crisis. Now, three years later, the economy is growing again and the program has ended. As mission chief for the past 3 years, what do you regard as the main achievements of the program?
Griffiths: The last few years have been incredibly challenging, but through their program the Latvian government and the Latvian people have made considerable progress in stabilizing the economy and restarting growth.
First, Latvia’s economy is now much less vulnerable. Current account deficits, which used to be over 20 percent of GDP, are now much lower: in 2009 and 2010 the current account was actually in surplus. The banking system is much more stable. Latvia has had problems recently with the failure of a local bank, Latvijas Krajbanka. But even though we believe the situation could have been handled better, it was not as destabilizing as when Parex Bank went bankrupt in late 2008.
Second, the exchange rate peg has survived. At the start of the program, many feared that if Latvia’s peg fell, others would fall too, spreading the crisis from Latvia to the rest of central Europe. So Latvia’s strong efforts back in 2008 and 2009 helped protect central Europe from contagion.
Third, Latvia used its international support program to implement huge fiscal adjustment― over the program period, expenses were cut and revenues raised to the tune of about 15 percent of GDP. Many doubted such a huge adjustment would be possible, but Latvia managed. Financial support from the IMF and the European Commission was crucial, but Latvia did not waste this money. Instead, the government seized the opportunity to implement important structural reforms and adjust.
Finally, I am very proud of our work with the World Bank to strengthen the safety net. Had it not been for these joint efforts with the government, the crisis would have been even harder on vulnerable groups, especially the poor and the unemployed.

IMF Survey online: Is it possible to speak of success when unemployment is close to 15 percent, and the economy still is nowhere near recovering from the steep GDP decline it experienced in 2008-2009?
Moore: A balanced assessment should reflect both Latvia’s hard-won achievements and that Latvia still suffers from high unemployment, with poverty rates and measures of inequality among the highest in the European Union. Output remains well below pre-crisis levels, but this was probably unavoidable given how large the imbalances were before the crisis, and since much of the rapid growth during the boom was unsustainable.
But Latvia turned the corner some two years ago. The economy has since grown steadily, and last year’s third quarter numbers were strong, so growth in 2011 could be somewhat above 5 percent. And inflation appears to have peaked. We expect slower growth this year because of problems elsewhere in Europe, but Latvia has done its part.

IMF Survey online: How exposed is Latvia to the crisis in the eurozone?
Moore: As our Managing Director recently warned, no country is immune in the current crisis. Developments in the European Union and the eurozone are bound to affect Latvia. Latvia pegs its exchange rate to the euro, roughly half its exports go to the eurozone or to countries pegged to the euro, so the country’s economic future is closely intertwined with that of the European Union as a whole.
On the positive side, Latvia’s policy efforts during the past few years—as well as efforts by Latvian businesses to restructure and adapt—have kept the country relatively insulated from these recent tensions. Unlike three years ago, Latvia’s credit default swap spreads are broadly in line with those of other central and eastern European countries, and well below those of the crisis countries in the euro area—so Latvia is much better placed to cope with the current uncertainties.

[pictured: Latvian President Andris Bērziņš meets Christine Lagarde, head of the International Monetary Fund, on the first day of a working visit to the US in September 2011; courtesy Latvijas valsts prezidents]

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