Latvia: an Overview of the IMF Program

1. Latvia: an Overview ofthe 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 2008. 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

18. Thank you AmCham, October 20, 2009 http://www.imf.org/external/country/LVA/index.htm