The Bank of Latvia » For All » Information to the Public » Press conferences by Ilmars Rimsevics, Governor of the Bank of Latvia » 2009 » September
Press conference by Ilmars Rimsevics, Governor of the Bank of Latvia
10 September 2009
The Bank of Latvia Council, at its regular meeting today, discussed the latest developments in the Latvian economy and took decisions regarding the future direction of monetary policy. The main conclusions are as follows:
Both positive developments and uncertainties were observed in resent months. First, certain signs of further economic stabilisation can be observed in Latvia: in the context of easing effects of overheating and macroeconomic imbalances, the current account deficit has already been replaced by a surplus and inflation continues to abate. Second, some industries signal the beginning of the revival.
Here we can mention wood, wood products, as well as chemical products: their production has already exceeded the level of the previous year. Conversely, there still persist ambiguous plans for reducing the budget deficit in 2010 and uncertainty regarding the future developments in external markets.
The macroeconomic balance that is determined by both the
internal balance (as measured by inflation and labour market) and the
external one (as measured by the current account or export-import
ratio) serves as a decisive factor for the development of a small and
open economy. To ensure balance, the central government should
implement an adequate budget policy, - also a reasonable lending policy
and growth in lending play an important role.
As we know, this balance was not ensured in previous years due to overspending funds and failing to hinder the excessively rapid growth encouraged by domestic consumption with the help of adequate fiscal measures. Thus external imbalances also strengthed with exports considerably lagging behind imports. When the bubble bursts, the negative effects of the accelerated growth disappear - the excessive upsurge of the inflation rate slows down, the difference between wages and salaries and labour productivity narrows, and the current account turns positive. Moreover, in June exports of goods and services already exceeded imports. Now I will discuss each issue in more detail.
As already projected before, inflation continues to abate, reaching 1.8% in August. At the same time, the average annual inflation, an indicator vital as a criterion for the euro changeover, is still soaring at 7.9%. The forecast of the average annual inflation for this year remains unchanged, at 3.0%-3.5%.
The positive trends that persist in the external sector are promising, - according to preliminary data in June this year Latvia's exports exceeded imports for the first time since 2000: with the surplus in the services account fully covering the deficit in the goods account that has considerably decreased. It is evident that the deficit in the goods account has, meanwhile, dropped notably on account of shrinking imports, i.e. a weak domestic demand. The fall in exports, on the other hand, which was fuelled by sluggish foreign markets, has been less pronounced. In the months to come, it is the foreign market activity that will underpin the growth of Latvian exports; one should likewise expect the stabilisation of the global economic environment to be sustained, and there are certain signs in support of it. Improvements in export opportunities and the external environment will also depend on restored competitiveness as a result of falling prices and lower costs as well as corporate solutions. It should be noted that in comparison with the end of 2008 Latvia's export share in some foreign markets, e.g. in Russia, Lithuania, Estonia, Finland, Denmark, Sweden and Germany, has expanded.
Latvia's current account surplus also depends on the income account surplus. With the current trends in the export-import ratio and income account persisting, a current account surplus of around 5%-6% of GDP can be projected for 2009, suggesting that Latvia earns more foreign currency than it spends.
The contraction in retail trade is not so pronounced and the consumer sentiment index, albeit low, is improving. Although the development of manufacturing is volatile - the latest available data for July record a downturn again in comparison with the previous month following acceleration in June; nevertheless the dynamics of the sectors differs. Several sectors are recording a notable growth, e.g. the manufacture of wood and wood products, textiles, other transport vehicles, chemical products, computers, electronic equipment and optical instruments, as well as furniture. In addition, it is worth mentioning that the manufacture of wood and wood products, as well as the chemical products has already exceeded the level of the previous year.
As noted above, further expansion of economic activity will largely depend on restored confidence in macroeconomic stability, i.e. in government's policy. Clear and prompt budget adoption for 2010 would ensure a more dynamic economic recovery. Even though the overall economic downturn in 2009 is likely to be dramatic (approximately 18%-19% of GDP), the economy may have already buttomed out at this junction.
The revival of the external demand along with the adopted and already launched economic stimulus package measures (the utilisation of the EU funding included) promise a gradual improvement in GDP via a more moderate year-on-year decline; a year-on-year increase in GDP could be expected towards the end of 2010.
I would like to mention some other macroeconomic indicators that, on the one hand, suggest weak economic activity but, on the other hand, - the restoration of the macroeconomic balance. Unfortunately, the unemployment rate continues to move up, albeit at a more moderate rate than at the beginning of the year, reaching 12.2% in August. In the second quarter, lay-offs continued to hit low-skilled individuals primarily. These are excessively high indicators that result from the correction of previous imbalances, but on the positive side, free labour force is currently available in the market (that was a serious problem for businesses in previous years).
Let's turn to lending. The total amount of loans granted is gradually declining, while lending continues. Latvian commercial banks go on with granting loans to both corporations and households, only in June the amount of loans outstanding has begun to lag behind the level of the same period in the previous year. Loans outstanding still exceed the levels of 2007 and the first half of 2008, while a decrease is anticipated on account of more prudent lending policies due to uncertainty and a sluggish demand for loans. When the current uncertainty surrounding the government's decisions dissipates, better availability of credit resources to ensure the revival of domestic economic activity can be expected due to improved bank lending in the financial markets and a steadier external environment.
Thus in conclusion I would like to return to the issue
regarding the central government budget. We could put an equals sign
between the confidence in the budget and in the economic growth of
Latvia. Confidence means future-oriented activities of businesses,
availability of credit funds and investors' sense of security.
Conversely, we would again experience a situation when uncertainty
results in nervousness, speculations about the lats and high interest
rates, as well as hinders returning to sustainable economic growth.
Thus currently the most important task
is to approve the budget for 2010 as soon as possible instead of doing
it at the last moment as usual when in Latvia and abroad a bet has
already been placed on the outcome, foreign currency reserves outflow
due to unsolved domestic budgetary problems, interest rates rise,
credit ratings are downgraded, foreign investment inflows are hindered
and speculations about the lats exchange rate unfortunately are going
on.
The lats exchange rate developments and the Bank of Latvia
interventions clearly reflect uncertainty at the end of 2008. When
budgetary amendments were adopted and the loan was approved, the lats
exchange rate stabilised at the lower limit of the intervention band
and stability was observed overall. As soon as the uncertainty about
the government and budget resumed, the currency speculation also
returned and the Bank of Latvia had to conduct interventions on the
foreign exchange market. This applies to both the developments in March
and June. Interest rates reflect the same picture - Rigibor decreased
and stabilised after sharp leaps as soon as the light was thrown on the
budget issues.
Why are we talking about this? The current course of the budget drafting causes concern about the potential recurrence of the previous scenario. To prevent this, the budget should be adopted as soon as possible, so that lenders and credit rating agencies do not start to worry about Latvia changing its determination to address public finances.
If the general government consolidated budget deficit in 2009 could reach 9.6% of GDP, it should be reduced to 8.5%, 6% and to 3% in 2012 respectively in the coming years according to the economic stabilisation programme. It should also be noted that, according to current estimates, Latvia's external debt approaches the limit set by the Maastricht criterion (below 60% of GDP in the medium term). Compliance with the Maastricht criteria in 2012 would enable Latvia to return to a definite date for the introduction of the euro - in 2014. It would suffice to say: had Latvia implemented the euro in 2008, we would have escaped the downslide with the Parex banka and other negative developments. Therefore even some talking that the introduction of the euro cannot be an end in itself, is not important and will give nothing is unacceptable. Even the Prime Minister of Sweden has expressed a clear view recently that the exsistence of the Swedish krona over a longer period could only be the source of instability. For such a small and open economy as Latvia, the introduction of the euro is a self-evident and strategic goal.
And in conclusion - the Bank of Latvia Council, at its meeting today, resolved to leave the interest rates and the minimum reserve ratio unchanged.
