Latvia and the Euro

Ilmārs Rimšēvičs

Governor. Latvijas Banka

October, 2013

Despite loud ex ante warnings of protractedrecession risks under internal adjustment scenario,a strong “V” shaped recovery followed

Real GDP growth, %

Source: CSB

Latvia has implemented sizable fiscal consolidation underpinned by structural reforms

Breakdown of budget consolidation measures, % of GDP

Source: Ministry of Finance; Bank of Latvia staff calculations

Currently Latvia’s economy is balanced and grows at the fastest pace in EU

Cyprus

Greece

Slovenia

Netherlands

Italy

Portugal

Spain

Finland

Belgium

Austria

France

Luxembourg

Germany

Ireland

Slovakia

Estonia

Malta

Latvia

-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5

Annual GDP growth in 2Q 2013, %

4

Euro brings a change of perspective

5

Why euro on 1 January 2014?

• Crucial decisions are made within the euro area, Latvia will participate in making decisions that affect our daily life

• Why not to take advantage of the benefits as soon as possible?• Euro area is not collapsing but getting stronger• Credible compliance with Maastricht criteria

Criterion Maastricht criteria

Latvia’s performance

Inflation (April 2013*) 2.7% 1.3%

Budget balance (% of GDP; in 2012) -3.0% -1.2%

Government debt (% of GDP; in 2012) 60% 40.7%*

Interest rate (April 2013*) 5.5% 3.8%

Source: Bank of Latvia, * - Convergence report of May 2013

Credit rating↑Long term interest rate

Investment↑

Consumption↑

Income account↑

Current account↑

Net foreign assets↑

Welfare↑

Government debt service↓

Budget balance↑

Direct taxes↓

Disposable income↑

GDP ↑

Exports↑

↓

Latvia will benefit from Euro introduction in many ways

Euro will help save government money by lowering debt servicing costs

Additional annual interest payments failing to introduce the euro and continuing to borrow and refinance the debt in the financial market (EUR million)

Savings of EUR 787 million in 10 years

Source: Bank of Latvia’s estimates

Ratings of countries that joined the euro area in the latest enlargement rounds have improved by up to 3 notches

Standard&Poor’s Fitch Moody’s

A year before

After a year Total A year

beforeAfter a

year Total A year before

After a year Total

Slovenia AA– AA +1 AA– AA +1 Aa3 (AA–)

Aa2(AA)

+1

Cyprus A A+ +1 A+ AA– +1 A2(A)

Aa3(AA–)

+2

Malta A A 0 A A+ +1 A3(A–)

A1(A+)

+2

Slovakia A A+ +1 A A+ +1 A1(A+)

A1(A+)

0

Estonia A– AA– +3 BBB+

A+ +3 A1(A+)

A1(A+)

0

Change in major credit rating agency ratings a year before and after the country joined the euro area

+/– no change + 2 notchesSource: Bloomberg

+ 1 notch + 3 notches

Other things being equal, euro will raise Latvia’s credit rating

01/2

000

01/2

001

01/2

002

01/2

003

01/2

004

01/2

005

01/2

006

01/2

007

01/2

008

01/2

009

01/2

010

01/2

011

01/2

012

01/2

013

Standard&Poor's - Latvia Fitch - Latvia Fitch - Estonia Standard&Poor's - Estonia

Lowest investment-grade

Long-term foreign currency credit ratings for Latvia and Estonia

AAAAA+AA+AA–

A+A+A–

BBB+BBB+BBB–

BB+BB+BB–

B+ B+

B–

AAAAA+AAAA–A+AA–BBB+BBBBBB–BB+BBBB–B+BB–

Source: Reuters

The "devaluation ghost" and the related costs will cease to exist

RIGIBOR indices

Avots: Bank of Latvia

RIGIBOR and EURIBOR indices

Euro will save transaction and conversion costs (EUR 650 million in the last 6 years)

Source: Bank of Latvia, costs have been calculated on the basis of turnover and exchange rate difference in cash and non-cash EUR/LVL transactions in banks and currency exchange offices

EUR/LVL foreign exchange conversion for customers of bank and currency exchange offices (EUR million)

Had the euro been introduced in 2008, the financial crisis in Latvia would have been less severe

Access to ECB funding Protection of the sound banks in case of a bank run The soundness of banks will be in their own hands

The ECB funding will not cure insolvency/lack of capital

Impact of introduction of euro on prices in previous cases was small relative to other factors (oil prices, tax increases etc.)

Impact of euro introduction on inflation Inflation in Estonia (%)

Impact on inflation (pp)

Estonia 0.30

Malta 0.20

Slovakia 0.25

Consumer protection activities launched already in Latvia

Source: Eurostat

Long-term benefits will outweigh short-term costs

Indicator Value

Savings in the government budget due to lower debt servicing costs (in 10 years from euro changeover)

~800 million EUR

Benefits from export growth and a decrease in the interest rate for the private sector (2014– 2020, in cumulative terms)

~8 000 million EUR

Benefits from the lack of currency conversion costs (in 10 years from euro changeover)

~700 million EUR

One-off euro introduction costs in the public sector (estimates of the Ministry of Finance)

12 million EUR

One-off euro introduction costs in the private sector ~110 - 219 million EUR

Payments in the ESM capital (in 5 years from euro changeover)

199 million EUR

Bank of Latvia costs (provision of cash) 21 million EUR

In fact euro is already widely used in Latvia

82%

Share of euro in loans to domestic

companies and households(June 2013)

44%

Share of euro in domestic companies’

and households’ deposits

(June 2013)

59%

Settlements in euro for imports or

exports of goods and services(2012)

Source: Bank of Latvia

78,7%

82,7%

86,1%

87,3%

91,2%

10,4%

8,7%

3,6%

5,4%

4,5%

10,8%

8,6%

10,3%

7,3%

4,3%

0% 25% 50% 75% 100%

Latvia must show solidarity to other European countries because in the long run it will be beneficial also for us

In the economic sphere, Latvia should activelly collaborate with the strongest partners

Low interest rates on loans are important for the development of the country and for individual borrowers

In the coming years, the national debt and debt service burden should be reduced

The Government should not spend more than it earns

To what extent do you agree with the following statements?

Fully + more agree Fully+ more disagree Don’t know/NA

Population in Latvia generally welcome the implicit benefits from the euro and share euro zone's main working principles

Source: Latvijas Fakti

Public support for euro is steadily increasing

18

2013 VIII

2013 VII

2013 VI

2013 V

2013 IV

2013 III

2013 II

2013 I

2012 XII

2012 X

2011 V

2010 V

2009 V

2008 V

-56.5

-59.4

-58.5

-61.1

-61.8

-63.5

-65.4

-62.8

-66.1

-70.6

-55.5

-45.7

-47.1

-53.5

38.9

36.8

38.0

35.5

35.5

28.5

31.5

32.8

30.9

25.3

32.0

38.6

35.9

29.8

4.6

3.8

3.5

3.5

2.6

8.0

3.1

4.4

3.0

4.0

12.5

15.7

17.1

16.7

Negative

Tukšs

Hard to tell

Source: TNS Latvia

Respondents attitude towards euro changeover in Latvia