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Press conference by Ilmars Rimsevics, Governor of the Bank of Latvia
Introductory Statement
Ilmars Rimsevics
Governor, Bank of Latvia
16 July 2009
At today's regular meeting, the Council of the Bank of Latvia focused
on the latest developments in the economy of Latvia and made decisions
regarding further course of the monetary policy. The main conclusions
of this meeting are as follows.
A number of developments in the previous months suggest that initial
signs of an eventual economic stabilisation process might have begun to
outline. I would like to note that these are the first green shoots on
the background of economic downturn, as imbalances amassed during the
years of buoyant growth have abated considerably.
Mention should first be made of inflation,
which is dropping persistently, to 3.4% in June. The pace of price
rises has rebounded to its 2003 level when the signs of economic
overheating, already then highlighted by the Bank of Latvia, became
first visible. In June, prices dropped 0.5%, broadly across almost all
consumption groups. In line with falling costs and tightening
competitiveness in the situation of weakening demand, producer prices
were declining for several consecutive months. The annual producer
price drop was 4.8% in May.
Downslide in inflation is likely to continue also in the second half of
the year. Therefore, the forecast for the average annual inflation for
2009 remains unchanged (3.0%-3.5%).
Secondly, a notable improvement has been observed in the current
account of the balance of payments. Although in the
third quarter of 2007 the current account deficit still hovered at 25%,
its gradual contraction resulted in a surplus
in the first quarter of the current year. According to preliminary
data, the surplus augmented in April and May, reaching 222.6 million
lats. Improvements have been recorded across all current account items.
They were primarily on account of rapidly contracting domestic demand.
In 2009 overall, a modest current account surplus in the amount of 1.3%
of GDP, i.e. above bank's current projection of 0.5% of GDP, is
expected.
In April and May, the balance of trade in goods
continued to improve, with more rapid import than export deceleration.
Major export areas, among them agricultural and food products as well
as chemical products, proved more resilient to the overall downturn in
trade: their exports did not lose much of the last year's volume. The
outlook for exports for the
second half of the year will depend on both external and internal
developments. On the one hand, Latvia's major trade partner countries
still experience a weak domestic demand, unlikely to rebound by the end
of the year and boost the recovery of exports. On the other hand, input
costs in Latvia decrease and, with export guaranties commencing,
enterprises would be able to compete more effectively also in those
markets, particularly in the circumstances of international insurers
turning away from Latvia.
As has been reiterated, an active export boosting policy should be
among the government's focal priorities, because exports underpin the
economic recovery prospects.
In the second quarter, GDP components
were characterised by some other positive features. Thus, for instance,
after a continuous downturn
- manufacturing output increased slightly,
- retail trade contractions seemed to ease,
- consumer and producer confidence indicators improved.
The upsurge in unemployment rate has likewise abated and
producers' expectations regarding employment in the main economic
sectors have left the former record low territory. At this juncture, it
might be premature to make conclusions about how sustainable these
positive developments are, for they have to become more balanced for us
to ascertain with confidence that the economic recovery is under way
and to watch the Latvian economy creep out of the hole.
So far, the recovery of the economic activity has not been as yet
backed by a boost in lending. For
positive changes to set in, economic policymakers still have homework
to be done. I will deal with it further on in connection with the
budget plan for 2010. At this point, lending continues to shrink and,
according to preliminary information, in June recorded a slight decline
of 0.5% on a monthly basis; an annual drop in loans (0.2%) both to
households and business has been recorded for the first time. It was
underpinned by two aspects. First, bank lending policies generally
become more conservative in crisis situations, and, second, the demand
for loans has contracted as uncertainty about the prospects of economic
growth prevails.
It is the minimisation of this uncertainty that is to be achieved in
summer. While
- an agreement with the International Monetary Fund on the further progress of economic stabilisation programme is not achieved,
- the budget plan for 2010 is not adopted or its principles clearly defined, and
- an economic warming programme is not launched,
Now let me pass over to the budget issue. The budget expenditure for the current year has been cut by 500 million lats. As a result, the foundation of the national economy is being rebuilt step by step to put an end to spending as-yet-unearned money. In order to achieve it gradually, without a sharp reduction of 1.5 billion lats within one day, borrowing from international institutions to cover budget deficit was equally significant.
The budget deficit of this year may rise to 9.5%-10.0% of GDP (according to the Maastricht criteria calculation methodology). We must be fully aware that financing in the amount of 1.3 million lats to cover this deficit is not available for Latvia from a free financial market. Likewise, we must realise that cuts in expenditure will undeniably erode the economic activity in the second half of the year. In order to keep the GDP drop away from the critical 18%-19% margin in 2009, adequate business enhancement measures should be launched.
The process of a further reduction of expenditure should rely on clearly defined and well-assessed structural reforms that would minimise the upcoming expenditure base and a lesser focus should be placed on ad hoc measures. Only a part of the currently approved austerity measures will have a positive future effect on the budget, which means that already in the budget process of 2010 decisions will have to be made on new unpopular solutions. Regretfully, as we have already pointed out, there is no sweet remedy in store any more.
Despite first signs of potential economic stabilisation recorded in the previous months, both the financial market and real economy are to a large extent jeopardised by the high uncertainty about the budget for 2010. It undermines the bank lending appetite, corporate investment behaviour, and consumer spending habits, at the same time eroding the desire of foreign investors and companies to work together with Latvia. Uncertainty and doubt adversely affect also the lats interbank market, causing substantial credit interest rate fluctuations with a negative impact on loans taken by businesses and households. These market sentiments have clearly and painfully spilled over to the daily economic developments. Unfortunately, Latvia is not trusted and its foreign partners are anticipating autumn with concern. That is why the 500 million lats reduction should be explicitly and accurately communicated. Under these circumstances, the Bank of Latvia does not support the raising of any taxes.
We must also be aware that only a minor step has been made towards putting the state budget matters in order and it is the effectiveness and a clear vision of how fiscal matters should be addressed that will to a great extent determine the economic progress in the upcoming period.
Before summing up, let me deal briefly with the Parex bank taken over by the state. In this respect, the government's communication with foreign investors on selling the bank is of paramount importance at the current juncture; likewise, in order to retrieve the invested state funds, the elaboration of price assessment principles ranks important as well.
To conclude, taking into account the signs of recommencing stabilisation process on the backdrop of a further downturn in the economic activity and the monetary policy stimulus package previously launched by the Bank of Latvia, at today's meeting the Council of the Bank of Latvia resolved to leave unchanged both interest rates and minimum reserve requirement for the banking sector set by the Bank of Latvia.
