Saturday, 5 June 2010

EU: Convergence programme Latvia

Stability programmes for eurozone countries on the one hand, convergence programmes for member states still without the euro; you can start by reading the background remarks on economic policy coordination in the European Union, in the blog post EU: Useful stability and convergence programmes? (3 June 2010).

You can then move on to the EU Council opinion on the convergence programme of Latvia, published in the Official Journal of the European Union (OJEU):

COUNCIL OPINION on the updated convergence programme of Latvia, 2009-2012; OJEU 1.6.2010 C 142/19

Economic background

The updated convergence programme of Latvia covers the period 2009 to 2012. The EU Council began its 26 April 2010 assessment with the following remarks on the economic situation:

The global financial crisis amplified the shock of the reversal of Latvia's domestic lending and house price boom by tightening credit availability and conditions. The concomitant downturn in external markets hit the tradeables sector. Furthermore, the depreciation of the currencies of certain principal trading partners added to the competitiveness losses of previous years.

Latvia's financial markets and banking sector came under significant pressure from October 2008 onwards. This prompted the Latvian authorities to seek international financial assistance, which was provided at the end of 2008 and made conditional on major fiscal consolidation as well as financial system and structural reforms. Subsequently, in view of a much larger than expected deterioration in economic and budgetary conditions in the first half of 2009, the government implemented additional fiscal consolidation measures, partly underpinned by structural reforms. The above mentioned developments led the Council to decide on the existence of an excessive deficit in Latvia on 7 July 2009 and to recommend its correction in accordance with Article 104(7) TEC by 2012. In the second half of 2009, the export-oriented sector of the economy stabilised and started to show some early signs of a recovery. However, the fall of domestic demand remained very severe, due mainly to a sharp deterioration on the labour market and negative credit growth. Nevertheless, the disbursements of international financial assistance, the rigorous implementation of the 2009 budget and the successful adoption of the 2010 budget with further fiscal consolidation measures helped to stabilise confidence and improved market sentiment towards Latvia. The main challenge for economic policy remains economic stabilisation and a return to a well-founded catching-up process. Economic stabilisation depends to a great extent on anchoring long-term expectations for which the implementation of the planned fiscal consolidation path is crucial. Economic stabilisation also hinges directly on taking structurally sound and socially equitable fiscal measures and also on the progress with restructuring the economy towards the tradeable sector. In view of the significant deterioration in external competitiveness during the boom years, there appears to be some further need for domestic price adjustment and productivity improvement. The use of EU structural funds should contribute to the strengthening of the tradeable sector and cushion the recession.

The sharp decline in domestic demand and the opening up of spare capacity helped unwind existing imbalances, reducing inflation and eliminating the external deficit, largely through a collapse in imports. The external account balance, substantially negative in the boom years and financed by capital imports associated with the banking sector, leading to a rapid increase in net external liabilities, reached in 2009 an estimated surplus of over 8 % of GDP, and is set to remain in significant surplus over the programme period.

The financial rescue package was described in the following terms:

The up to EUR 7.5 bilion financing package is jointly funded by the EU, IMF, World Bank, EBRD, Nordic countries, Czech Republic, Estonia and Poland and is provided to Latvia in several instalments up to end-2011, in a front-loaded manner.

Council recommendation

Despite the measures undertaken and endured, arduous times still lie ahead for the government and people of Latvia.

After a detailed discussion, and in the light of the recommendation under Article 104(7) TEC, as well as given the need to ensure sustainable convergence and a smooth participation in ERM II, the EU Council invited Latvia to:

(i) fully implement the 2010 budget as adopted on 1 December 2009; prepare a menu of budgetary options producing savings or additional revenues allowing the adoption of a 2011 budget in accordance with the consolidation needs; adopt a 2012 budget also consistent with the targeted fiscal path, in line with the Council Recommendation under Article 104(7);

(ii) carry out the thorough and forward-looking analysis needed for a wide-ranging social benefits reform, with a view to implement such a reform in the course of 2011 together with further measures on the revenue side;

(iii) improve fiscal governance and transparency, inter alia by adopting the draft fiscal discipline law, by strengthening the binding nature of the medium-term budgetary framework, and by putting in place effective sanction procedures for individuals’ misuses of public funds; strengthen control, coordination and sanction mechanisms aiming at tackling the grey economy;

(iv) foster economic growth by promoting the shift towards the tradeable sector and productivity improvements, including by ensuring that the available EU structural funds reach the real economy, and restructuring state-owned banks in a timely manner, within a medium-term strategy.

Convergence reports

For a wider view and comparison between nine EU member states still outside the euro area, you can study the convergence reports published by the European Central Bank and the European Commission:

European Central Bank: Convergence Report May 2010 (273 pages)

European Commission: Convergence Report 2010 (Prepared in accordance with Article 140(1) of the Treaty); Brussels, 12.5.2010 COM(2010) 238 final (30 pages)

Commission staff working document accompanying the Convergence Report 2010; Brussels, 12.5.2010 SEC(2010) 598 final (197 pages)

Ralf Grahn