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Convergence Report 2013 on Latvia

Convergence Report 2013 on Latvia. Christian Weise EUROPEAN COMMISSION, DG ECONOMIC AND FINANCIAL AFFAIRS 05 June 2013, Riga. The Convergence Criteria - 1. “Maastricht” convergence criteria were assessed in line with the principle of equal treatment

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Convergence Report 2013 on Latvia

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  1. Convergence Report 2013 on Latvia Christian Weise EUROPEAN COMMISSION, DG ECONOMIC AND FINANCIAL AFFAIRS 05 June2013, Riga

  2. The Convergence Criteria - 1 • “Maastricht” convergence criteria were assessed in line with the principle of equal treatment • Quantitative and qualitative assessment – focus on sustainability of convergence • Integrating findings of broader European Semester surveillance (e.g. MIP) • Broad approaches and results are consistent with ECB (but the two reports are fully independent)

  3. The Convergence Criteria - 2 • Reference values and periods • Price stability: 2.7% in April 2013, based on the 12-month average inflation of Sweden (0.8%), Latvia (1.3%) and Ireland (1.6%) plus 1.5 percentage points; Greece (0,4% and widening gap to EA) excluded as an 'outlier'. • Exchange rate: from 17 May 2011 to 16 May 2013 • Long-term interest rate (LTIR): 5.5% in April 2013, which is the 1-year average of the LTIRs of the price stability best performers plus 2 p.p.; normalisation on Ireland's bond market has allowed to use its LTIR in the assessment (contrary to 2012)

  4. Conv. Criteria – 3 • The average inflation rate in Latvia during the 12 months to April 2013 was 1.3%, 1.4 p.p. below the reference value and it is forecast to remain below the reference value in the months ahead (with Latvia's HICP projected at 1.4% in 2013 and 2.1% in 2014). • The 1 p.p. VAT reduction in July 2012 contributed to low inflation, but in light of the analysis of underlying fundamentals and the fact that the reference value has been met by a wide margin, Latvia's price performance is assessed as sustainable. • Regarding public finances, the Commission considers that the excessive deficit has been corrected in a credible and sustainable way (the deficit was at 1.2% and debt at 40.7% of GDP in 2012) and has recommended that the Council closes the EDP for Latvia. If this is done, Latvia will fulfil the criterion on the government budgetary situation.

  5. Conv. Criteria - 4 • The Latvian lats has participated in ERM II since 2 May 2005, which is considerably more than the minimum two years. Upon ERM II entry, the Latvian authorities committed to keep the lats within a ±1% fluctuation margin and they have adhered to this. The lats has not experienced tensions during the assessment period. • Reflecting strengthening confidence, Latvia’s average long-term interest rate has declined significantly and was 3,8% over the year to April 2013, below the reference value (5.5%). Spread to the Bund was around 200 basis points in April 2013.

  6. Conv. Criteria - 5 • Compatibility of legislation: Following the 10 January 2013 parliamentary adoption of amendments to the 'Law on the Bank of Latvia', Latvia’s legislation in the monetary domain is fully compatible with the EU legislation. • Additional factors (Art 140 TFEU): • Latvia's external balance adjusted significantly during the crisis, supported also by improvements in its external competitiveness. • Latvia's economy is well integrated within the EU economy through trade and labour market linkages, and it attracts sizeable foreign direct investments. • The integration of the domestic financial sector into the EU financial system is substantial, mainly due to a high level of foreign ownership of the banking system. Financial supervision and regulation have been strengthened. In light of its assessment, the Commission considers that Latvia fulfils the conditions for the adoption of the euro.

  7. Sustainability of convergence • Convergence framework aims to ensure that MS follow policies that support the smooth functioning of EMU – sustainability is key • Accordingly, the sustainability dimension is inherent in the convergence criteria themselves, in particular the ones on price stability and public finances (EDP) • Additional factors broaden the view on sustainability (required by the Treaty) • Findings of enhanced policy coordination and surveillance also inform the convergence assessment (e.g. no IDR in the MIP for Latvia) • Overall, the conditions are in place for Latvia to maintain a sustainable and robust medium-term convergence path, • But this needs to be validated by sound policies following euro adoption

  8. Selected policy issues -1 Financial stability – Non-resident banks • The banking sector went through sizable deleveraging since 2008 (credit decreased by around 40% of GDP) • Bank assets to GDP are relatively small in Latvia (147% versus 367% in EU) • Locally- and CIS-owned banks have a long tradition in servicing non-resident clients (up to 50% of total deposits) • These banks are required to keep a high share of liquid assets and are subject to additional capital requirements • Latvia's legislation complies with international anti-money laundering standards, but further efforts are needed to improve implementation

  9. Selected policy issues -2 Public support • Public support for euro is rising, but from a very low basis • 36% of residents are in favour of euro adoption (TNS, April 2013) • Opinion-makers have expressed their support (Employers’ Confederation, the Chamber of Commerce, the Traders’, the Banking, and the Farmers’ Associations, the President) • Latvia is somewhat reassured by experience of Estonia, where public opinion became more favourable mainly after euro adoption • Commission helps Latvia in the information and communication campaign on the introduction of the euro in the framework of a Partnership Agreement

  10. Key challenges To ensure that euro adoption is a success, it is key that: • Latvia conducts a prudent fiscal policy, including resolute implementation of the newly adopted Fiscal Discipline Law. • Latvia keeps up momentum with structural reforms (social inequality, education, public administration) and further strengthens quality of institutions. • Latvia avoids the re-emergence of a demand/wage boom and loss of competitiveness by ensuring that wages grow in line with productivity • Latvia closely monitors financial stability and is ready to implement further regulatory measures if needed, in particular as regards non-resident deposits and preventing asset bubbles. • Thechangeover to the euro is carefully prepared.

  11. Latvia – Convergence report 2013 – timeline Latvia requested an ad-hoc convergence assessment on 5 March 5 June: Commission (and ECB) evaluate the fulfilment of Maastricht criteria in the Convergence Report 2013; COM adopts legal proposal for a Council Decision on the adoption of the euro by Latvia on 1 January 2014 (plus set of other legal documents) June/July: Eurogroup recommendation, discussion in European Council, opinion from European Parliament July: Final decision: ECOFIN Council of 9 July 2013 to decide on the abrogation of Latvia's derogation from the participation in the EMU and to fix irrevocably the conversion rate between lats and the euro (COM proposal to be adopted in late June)

  12. Thank you for your attention

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