Latvia: an Overview of the IMF Program David Moore, IMF Resident Representative in Latvia AmCham, October 20, 2009

2 Background Rapid international response to crisis €7.5 billion package; €3bn already disbursed IMF one of several contributors: EC: €3.1 billion IMF: €1.7 billion (Stand-By Arrangement: at 1,200 percent of quota, one of largest ever IMF programs) Nordic governments: €1.8bn World Bank: €0.4 billion Others: €0.5 billion IMF Board approved SBA in December SBA runs until March 2011

3 Goal and structure of IMF programs To rebuild international reserves, stabilize currencies, and pay for imports, while borrowing countries correct underlying balance of payment problems Programs supported by IMF lending specify the policies and measures agreed by countries to resolve balance of payments problems IMF loans are usually released in phased instalments as the program is implemented  The IMF Board approved the First Review of Latvia’s SBA on August 27, releasing €195m

4 This time, with partners EU Balance of Payments facility, for non-euro area member states, has similar goals to the IMF Stand-By Arrangement Besides financial and fiscal issues, EC covers structural policies, including use of EU funds Joint programs active in Hungary and Romania, as well as Latvia Joint missions, though EC and IMF representation offices have different roles

5 Latvia program: goals at launch Counter balance-of-payments strains Correct current account deficit Address liquidity crisis Stabilize financial sector Restore depositor confidence Structural reforms in anticipation of deteriorating credit quality Fiscal adjustment Reduce external financing needs Wage cuts to help correct a competitiveness problem, while maintaining the long-standing peg to the euro Program exit strategy: euro adoption

6 Macroeconomic developments Much deeper downturn Real GDP projected to contract 18 percent in 2009; initial program envisaged only 5 percent contraction Weaker than expected international environment Credit crunch exacerbated domestic demand collapse Unemployment approaching 20 percent Big swing in current account 2007 deficit of 23 percent of GDP 2009 surplus projected around 5 percent of GDP Deflation setting in Wages and prices falling  Helps correct competitiveness, but erodes tax revenues

7 Some of the output loss is permanent

8 Program implementation Financial Sector Deposit outflows diminished, Parex stabilized Improved supervision and monitoring Strengthened intervention capacity Debt Restructuring Insolvency Law reformed Progress in out-of-court restructuring

9 Program implementation (2) Fiscal Large general government deficit overshoot in 2009 Downturn eroding tax revenues Some spending cuts not implemented  Program lenders have shown flexibility in adjusting fiscal targets Budget institutions and processes need to be upgraded Other SBA targets were met (quantitative targets for international reserves, monetary developments)

10 SBA First Review: Letter of Intent Balancing act Wider fiscal deficit target needed for 2009, given revenue slump and basic social assistance needs Medium-term fiscal adjustment also needed: policies consistent with peg, euro adoption Not just how much to tighten, but how Across-the-board cuts risky Structural reforms needed to underpin permanent deficit reduction

11 First Review: fiscal deficit path “ECOFIN” path 2009 – 10% 2010 – 8.5% 2011 – 6% 2012 – 3% Meeting these targets could resolve fiscal and external vulnerabilities—but will be difficult to achieve IMF program adds buffer to this path: flexibility for higher deficit levels, but deficit reduction from next year and path towards meeting Maastricht

12 First Review LoI: fiscal strategy 2009: improve implementation 1 percent of GDP for social safety net: GMI, healthcare copayments for most vulnerable Ringfenced resources to implement EU-funded projects: only feasible source of stimulus 2010: identify savings, but not preempt budget Adjustment of at least Ls 500 million (4 percent of GDP), more if needed Revenue measures 1½ percent of GDP Expenditure measures 2½ percent of GDP

13 LoI: 2010 revenue commitments Revenue of 1½ percent of GDP from: Broaden base of personal income tax, including capital income Reduce or remove most exemptions, including for farmers End of special self-employed tax regime, treat like other personal income taxpayers Expand real estate tax to include all residential properties

14 LoI: 2010 spending commitments Savings of 2½ percent of GDP from: Reform of public sector pay scale (½ percent of GDP) Structural reforms based on functional audits, to generate sustainable savings of 2 percent of GDP Consolidation of agencies Lower state support to agriculture Review of spending on culture, defense, foreign affairs Better targeting social benefits and public transport subsidies

15 LoI: other measures for 2010 LoI commitments targeted areas that would avoid unduly deep cuts to essential public services Contingency measures if Ls 500 million not enough to achieve fiscal deficit goal VAT, more progressive personal income tax (VAT increase also in supplementary MoU for the EC program), plus further spending cuts

16 Next steps EC and IMF staff in close contact with the authorities as they prepare 2010 budget Program back to quarterly reviews Joint mission—EC, IMF, other program partners—could take place in November

17 Summary Painful adjustment, but mitigated by large, coordinated international support Progress in stabilizing the financial sector, as initial program intended Program has responded to severe downturn: room for a wide fiscal deficit this year, but sustainable deficit- reducing measures needed from 2010

Thank you AmCham, October 20,