latvia: an overview of the imf program david moore, imf resident representative in latvia amcham,...

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

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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

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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

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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

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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

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Some of the output loss is permanent

Selected Countries: Output loss during Capital Account Crises(percentage change in real GDP)

-30

-25

-20

-15

-10

-5

0

5

10

Thailand Argentina Indonesia Latvia 1/

1/ Based on IMF Staff forecasts for seasonally adjusted quarterly GDP from 2007 Q4 to 2010 Q3.Sources: Central Statistial Bureau, Haver, IMF Staff Forecasts.

Latvia: Real GDP(seasonally adjusted, 2006 = 100)

80

90

100

110

120

2006 2007 2008 2009 2010 2011 2012 2013 2014

Actual

Forecast

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Program implementation

Financial SectorDeposit outflows diminished, Parex

stabilized Improved supervision and monitoringStrengthened intervention capacity

Debt Restructuring Insolvency Law reformedProgress in out-of-court restructuring

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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)

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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

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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

Figure 13. Latvia: Program and Rapid Adjustment scenarios, July 2009

Source: Latvian authorties, Fund Staff Estimates.

General Government's basic f iscal balance(in percent of GDP), 2005-2015

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

2005 2007 2009 2011 2013 2015

Program scenario

Rapid Adjustment scenario

Maastricht criteria (ESA)

General Government Gross Debt(in percent of GDP), 2005-2015

0

10

20

30

40

50

60

70

80

90

100

2005 2007 2009 2011 2013 2015

Program scenario

Rapid Adjustment scenario

General Government's primary structural basic f iscal balance (in percent of GDP), 2005-2015

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

2005 2007 2009 2011 2013 2015

Program scenario

Rapid Adjustment scenario

General Government's structural basic f iscal balance (in percent of GDP),2005-2015

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

2005 2007 2009 2011 2013 2015

Program scenario

Rapid Adjustment scenario

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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

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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

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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

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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

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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

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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, 2009

http://www.imf.org/external/country/LVA/index.htm