The Wind of Change: Economic and Financial Outlook

Mārtiņš Kazāks, PhD

Governor of Latvijas Banka

Global growth set to remain moderate

Real GDP growth and forecasts (%)

Source: International Monetary Fund. 2

-4

-2

0

2

4

6

8

10

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020F

2021F

World

Advanced economies

Emerging market anddeveloping economies

Avg. since 2010

The business cycle is quite mature

Unemployment rate (%; s.a.)

Source: Bloomberg LP. 3

Economic expansion*:

► US – since 2009Q3 (42 quarters)

► Japan – since 2016Q1 (16 quarters)

► Germany – since 2013Q2 (27 quarters)

0

2

4

6

8

10

12

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

US

Japan

Germany

* Period without a technical recession (two consecutive quarters in which GDP contracts).

Source: Bloomberg LP, Reuters Datastream, St. Louis FED, CEPR, Conference Board Leading economic index, Latvijas Banka's calculations. Last observation CB Leading economic index December.

Conference Board Leading economic index (%; annual growth rate of index)

4

What do markets think about recession?

0-40

-30

-20

-10

0

10

20

30

40

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Euro area recessions US recessions Euro area US China

Source: Eurostat, US Department of Labor, Statistics Bureau of Japan.

Major stock index profit margins (%)

5

Stock markets have been rather optimistic

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0

2

4

6

8

10

12

14

2005 2007 2009 2011 2013 2015 2017 2019

Euro area recessions US recessions S&P 500 MSCI EM STOXX 600

Profit margins calculated from trailing 12m net income divided by trailing 12m net sales

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0

50

100

150

200

250

300

2005 2007 2009 2011 2013 2015 2017 2019

Major stock prices (2005=100)

Source: Bloomberg LP, Markit Economics.

Global PMI

6

Manufacturing is the weak link…

Euro area PMI

40

45

50

55

60

65

2017 2018 2019 02/2020

Composite

Manufacturing

Services

46

47

48

49

50

51

52

53

54

55

56

2017 2018 2019 02/2020

Composite

Manufacturing

Services

Source: CPB Netherlands Bureau of Economic Policy Analysis, Bloomberg LP, Latvijas Banka's calculations.

World Trade and Industrial Production (3M moving avg. y-o-y % change); manufacturing PMI

7

… reflecting anaemic global trade

Will world trade

follow business

expectations?

-2

-1

0

1

2

3

4

5

6

2015 2016 2017 2018 2019 2020

World trade volumes

Industrial production

Manufacturing PMI(diff. from 50)

Source: Eurostat, European Central Bank, International Monetary Fund, European Commission.

Euro area real GDP growth and projections (%)

8

Euro area is expected to stay in a low gear

Euro area inflation un ECB projections (%)

-1

0

1

2

3

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

20

22

- 1

0

1

2

3

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

20

22

Actual ECB forecast EC forecast IMF forecast

Global financial crisis Start of the European sovereign debt crisis

Brexit vote and US 2016 Presidential elections

Shift in US trade policy; withdrawal from Iran deal;

instability in EM economies

0

50

100

150

200

250

300

350

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Source: http://www.policyuncertainty.com/global_monthly.html; Bloomberg LP.

Global Economic Policy Uncertainty Index

9

Geopolitical tensions add to uncertainty andundermine investments

Photo: Shutterstock, SipaPress/Scanpix, Pexels. 10

Future outlook overshadowed by…

Trade war: tariffs are much higher than before 2018

Source: PIIE.

Since 2018 tariff war led to

extra import taxes being

levied on more than $450bn

worth of traded goods

15

Trade war: leads to trade diversion effects for other countries

Source: PIIE. 16

U.S. – China trade deal

EU must be united to establish close

partnership withthe United Kingdom

Source:Shutterstock.

Coronavirus is a new source of uncertainty

Source: Institute of Medicine (US) Forum on Microbial Threats; National Academies Press (US), 2004. Photo: Pixabay. 20

► COVID-19 has disrupted economic activity in China.

► Global economic growth is at risk.

► IMF assumptions: relatively minor global impact (-0.1 pp from global growth in 2020), but situation can change.

► Most likely COVID-19 will have wider impact than SARS coronavirus:

Fatality rate

China's

economy

9.6% 1-3%, but more infectious

16% of global GDP4% of global GDP

Close to $US 40 billion (in 2003)Largest impact: China (1.05 % of GDP),

Hong Kong (2.63 % of GDP)

Global

economic

loss?

11/2002-07/2003 (SARS) NOW (COVID-19)

MONETARY POLICY

0

20

40

60

80

100

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

202

0

ECB Federal Reserve SystemBank of England Bank of Japan

24

ECB, FRS, BoE, BoJ balance sheet (% of GDP)Central bank base rates and deposit rate (%)

-1

0

1

2

3

4

5

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

202

0ECB MRO Federal Reserve SystemBank of England Bank of JapanECB deposit rate

Monetary policy will remain supportive

Source: European Central Bank, Reuters, Bloomberg.

-0.8

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

3 m

on

ths

6 m

on

ths

9 m

on

ths

12

mo

nth

s

15

mo

nth

s

18

mo

nth

s

21

mo

nth

s

24

mo

nth

s

27

mo

nth

s

30

mo

nth

s

33

mo

nth

s

36

mo

nth

s

39

mo

nth

s

42

mo

nth

s

45

mo

nth

s

48

mo

nth

s

51

mo

nth

s

54

mo

nth

s

57 m

onth

s

60

mo

nth

s

End of 2014 28.02.2020

-1

0

1

2

3

3 m

on

ths

9 m

on

ths

2 y

ears

4 y

ears

6 y

ears

8 y

ears

10

yea

rs

12

yea

rs

14 y

ears

16

yea

rs

18

yea

rs

20

yea

rs

22

yea

rs

24

yea

rs

26

yea

rs

28

yea

rs

30

yea

rs

End of 2014 28.02.2020

Source: Bloomberg.

EONIA forward curve (%)

27

With ample monetary accommodation …

Euro area government bond yield curve (synthetic yields; %)

Source: Eurostat, European Central Bank.

Option-implied distribution of average inflation over thenext five years (%)

28

… inflation stays low for a prolonged period

Euro area inflation rate and ECB projections (%)

-1

0

1

2

3

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

202

0

202

1

202

2

► Expected to be concluded by the end of 2020

► Goal: making monetary policy strategy as effective as possible to achieve our price stability mandate

► Will take stock of historical experience and recenteconomic developments

► Based on thorough analysis and open minds, engaging all stakeholders

► Despite the strategic review, the ECB will continue to conduct monetary policy as usual and react to economic developments where it deems appropriate

ECB has launched strategic review of monetary policy

29

Monetary policy should not be the only game in town

30

Sustainable

economic growth

Structural reforms

Fiscal policy

Monetary policy

Source: International Monetary Fund. 31

Inertia of the current fiscal policy

Euro area government primary balance and debt (% of GDP; 2015–2019 vs 2019)

Cyprus

Estonia

Germany

Ireland

LatviaLithuania

Luxembourg

MaltaNetherlands

Slovak Republic

Slovenia

0

20

40

60

80

100

120

140

160

180

200

-4 -2 0 2 4 6 8 10

Gro

ss d

eb

t

General government primary balance

2019

2015-2019 avg.

High debt

Expansionary fiscal policy

High debt

Contractionary fiscal policy

Low debt

Contractionary fiscal policy

Low debt

Expansionary fiscal policy

Long-term trends affecting Europe

Photo: Shutterstock, Pixabay. 34

Source: World Inequality Database; Blanchet et al. (2019).

European growth incidence curve (1980 to 2017)

35

Income inequality: a source of rising anxiety

Bottom 50% captured

15% of total growth

Top 1% captured

17% of total growth

0

50

100

150

200

250

10

15

20

25

30

35

40

45

50

55

60

65

70

75

80

85

90

95

99

99.1

99.5

99.9

1

99

.95

99

.99

1

99

.99

5

99

.99

9

To

tal in

co

me

gro

wth

(%

)

Income group (percentile)

Digitalisation: to compete globally, the EU needs to reduce divergence

International Digital Economy and Society Index (I-DESI)*

*I-DESI measures performance in 5 areas: connectivity, digital skills, use of Internet by citizens, integration of

technology and digital public services.

36Source: European Commission, I-DESI 2018.

Digitalisation: transforming financial sector services

37

POSSIBLE GAPS: speed, cost,

transparency, access, security,…

USER NEEDS: pay, save, borrow,

manage risks, get advice

FINTECH SOLUTIONS

Big Data

distributed ledger

technology

artificial intelligence

cloud computing

Internet of

Things

TECHNOLOGICAL

INNOVATIONS

ROBO-

ADVISING

CROWDFUNDING

PAYMENTS

BLOCKCHAIN

BONDS

DIGITAL CURRENCIES

REGTECH

SMART

CONTRACTS

MONEY

TRANSFERS

IMPORTANT TOPICS: level playing field and competition, financial stability, financial integrity, consumer

protection, cybersecurity, impact on monetary systems, money laundering and terrorism financing risks

Climate change: delivering goals will be a challenge

Greenhouse gas emission trends, projections and targets in the EU

Source: EEA Report, 10/2019. 40

5 4 3 2 1 0 1 2 3 4 5

<5

5-9

10-14

15-19

20-24

25-29

30-34

35-39

40-44

45-49

50-54

55-59

60-64

65-69

70-74

75-79

80-84

≥85

Women 2050

Women 2018

Men 2050

Men 2018

Source: Eurostat.

Population pyramids, EU-28, 2018 and 2050 (% share of total population)

45

Ageing: a concern for future growth

Economic outlook for Latvia

100

110

120

130

140

150

160

170

180

190

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019*

Romania (65.6%)

Poland (70.3%)

Bulgaria (50.8%)

Slovakia (73.0%)

Czechia (90.4%)

Hungary (70.7%)

Slovenia (86.9%)

Croatia (62.9%)

Lithuania (80.2%)

Estonia (81.6%)

Latvia (68.9%)

47

Latvia ranks among top growth performers in Europe

Source: Eurostat, Latvijas Banka’s staff calculations.

Gross domestic product per capita (2004 = 100; volume index) (% of EU28 PPS, current prices,in 2018)

* according to

data availablity

0

10

20

30

40

50

60

70

2004 2009 2015 2019

Exports (% of GDP)

49

Economy: more open and balanced

Current account and net foreign debt (% of GDP)

-0.3

0

10

20

30

40

50

60

70

-25

-20

-15

-10

-5

0

5

10

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

2019*

Current Account

Net Foreign Debt (rhs)

Source: Eurostat, Latvijas Banka. * preliminary data for CA

9

32

0%

25%

50%

75%

100%

2000 2019

Other services

Financial services

Transit relatedtransport (rail, sea)

Travel

Other transport (air,road)

ICT, other bussinessservices

6

16

0%

25%

50%

75%

100%

2000 2019

Other goods

Textiles

Mineral products

Base metals

Food & Beverages

Chemical & Plastics

Agricultural

Machinery, electrical

Wood & Paper

Source: Latvijas Banka.

Services export (% of total)

50

Economy: more diversified and sophisticated

Goods export (% of total)

15% 10% 9% 8% 7% 6% 4% 3% 3%3% 33%

Lithuania Estonia Russia Sweden Germany United Kingdom Denmark Poland Norway Netherlands Other

Source: Central Statistical Bureau, European Comission Autumn forecast 2019 and Winter forecast 2020.

Latvia’s goods and services export partners (% of total exports)

51

Modest growth outlook for main export markets

2020 growth forecast (%)

green – better than 2019

red – worse than 2019

2.6 2.2 1.4 1.2 1.1 1.2 1.5 3.3 1.9 1.3

LT EE RU SE DE UK DK PL NO NL

6.0

4.4

2.42.0

3.1

1.6

3.8

4.5

2.22.6

0

1

2

3

4

5

6

7

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020F

Source: Eurostat, F – Latvijas Banka's December 2019 forecasts.

Real GDP (y-o-y; %; s.a.)

52

Growth rate has passed its cyclical peak …

Source: Central Statistical Bureau.

Value added growth by sector (%; y-o-y; s.a.)

53

… remaining rather broad across sectors

-10 -5 0 5 10 15 20

GDP

Agriculture (3.6%)

Manufacturing (10.4%)

Mining, energy (3.1%)

Construction (5.8%)

Trade (12.1%)

Transport (7.8%)

Tourism (1.7%)

ICT (5%)

Finance (3.2%)

Real estate (10.7%)

Professional serv. (6.8%)

Public serv. (14%)

Art (2.6%)

2018 2019

Source: Central Statistical Bureau.

GDP expenditure side (%; y-o-y; s.a.)

54

… remaining rather broad across sectors

0 2 4 6 8 10 12 14 16

GDP

Private consumption (59.7%)

Government consumption (18.2%)

Gross fixed capital formation (22.9%)

Exports of goods and services (59.9%)

Imports of goods and services (-59.8%)

2018 2019

80

85

90

95

100

105

110

115

2015 2016 2017 2018 2019

Risk:

6.4% ↓

?

-0.3

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

Em

plo

ym

en

t

Re

al w

ag

es

Re

al p

riva

te c

on

su

mp

tion

Re

al in

ve

stm

en

t

Re

al e

xpo

rts

GD

P

Source: Central Statistical Bureau, Latvijas Banka’s staff estimation (CGE model).

Unit value index of exports of wood and wood products (2015 = 100)

55

Slowdown affected also by one-off factors – timber prices

Estimated impact of lower wood prices on Latvia's economy (%)

7.8

6.3

0

2

4

6

8

10

12

14

16

18

2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020F

Average wage Unemployment

Source: Central Statistical Bureau, European Commission, E – estimate; F – December 2019 Latvijas Banka's forecast.

Average wage (y-o-y; %; gross nominal) andunemployment (% of econ. active)

56

Economic slowdown to ease labour shortage; inflation to stay moderate

Inflation (%; y-o-y)

2.4

2.1

-1

0

1

2

3

4

5

6

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020F

Headline inflation Inflation excluding food and energy

Source: Krasnopjorovs,O. Anatomy of labour reserves in the Baltic countries: a snapshot 15 years after the EU accession. Latvijas Banka's Discussion paper 2/2019.

Labour market mismatch indicator (2016–2018 average)

Challenges on the use of labour remain:high structural unemployment reflects skill mismatches…

Natural unemployment rate and labour market mismatches in the EU countries

EE

LV

LT

0

2

4

6

8

10

12

14

16

18

0 20 40 60

NA

IRU

(2

01

6–2018)

Labour market mismatch index (2016–2018)

57

0

10

20

30

40

50

60

Gre

ece

Spa

in

Cro

atia

Italy

Lithu

ania

Fra

nce

Latv

ia

Cyp

rus

Fin

land

Luxe

mb

ou

rg

Esto

nia

Port

ug

al

Belg

ium

Sw

ede

n

Bulg

aria

Pola

nd

Austr

ia

Slo

vakia

Hung

ary

Ire

land

Denm

ark

Czechia

UK

Germ

any

Rom

ania

Ma

lta

Slo

ven

ia

Source: Central Statistical Bureau, Latvijas Banka’s staff calculations. 58

and lack of geographic mobility

50

55

60

65

70

To

tal

Rīg

a r

egio

n

Pie

rīg

a

Vid

ze

me

Ze

mg

ale

Ku

rze

me

La

tga

le

60

65

70

75

To

tal

Rīg

a r

egio

n

Pie

rīg

a

Vid

ze

me

Ze

mg

ale

Ku

rze

me

La

tga

le

0

5

10

15

To

tal

Rīg

a r

egio

n

Pie

rīg

a

Ku

rze

me

Ze

mg

ale

Vid

ze

me

La

tga

le

Unemployment rate(% of economically active population; 2018)

Participation level(% from working-age population; 2018)

Employment rate(% from working-age population; 2018)

400

420

440

460

480

500

520

540

Esto

nia

Fin

land

Pola

nd

Ire

land

UK

Slo

ven

ia

Ne

the

rla

nds

Denm

ark

Germ

any

Belg

ium

Sw

itze

rla

nd

Norw

ay

Cze

ch R

ep

Fra

nce

Port

ug

al

Austr

ia

Latv

ia

Lithu

ania

Hung

ary

Italy

Luxe

mb

ou

rg

Cro

atia

Slo

vak R

ep.

Ma

lta

Gre

ece

Cypru

s

Rom

ania

Bulg

aria

Average Reading Math Science

0

5

10

15

20

25

30

35

Ma

lta

Italy

Sw

ede

n

Cypru

s

Spa

in

Fra

nce

Ire

land

Luxe

mb

ou

rg

Ne

the

rla

nds

UK

Austr

ia

Belg

ium

Gre

ece

Denm

ark

Fin

land

Germ

any

Port

ug

al

Slo

ven

ia

Czechia

Cro

atia

Pola

nd

Slo

vakia

Esto

nia

Rom

ania

Hung

ary

Bulg

aria

Lithu

ania

Latv

ia

healthy* unhealthy

Source: Eurostat and OECD, Latvijas Banka’s staff calculations.

PISA 2018 results (international test for 15-year-old students)

60

Accumulation of human capital gains importance in growth equation …

Life expectancy of 50-year-old men (years; in 2016)

*Healthy life expectancy without long-term activity limitation (self-assessment: EU-SILC survey data).

The impact of population age structure on the headline participation rate (pp; compared to the age structure in 2002)

… more so as we face demographic headwinds

Source: Krasnopjorovs, O. Anatomy of labour reserves in the Baltic countries: a snapshot 15 years after the EU accession. LB Discussion paper 2/2019.

-4

-3

-2

-1

0

1

2

3

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Estonia

Latvia

Lithuania

projection

61

0

5

10

15

20

25

30

2010 2011 2012 2013 2014 2015 2016 2017 2018

EU structural funds/investment_Latvia

Investment/GDP_EU average

Investment/GDP_Latvia

Source: Eurostat, Ministry of Finance, Latvijas Banka’s staff calculations.

Gross fixed capital formation (% of GDP) and EU structural funds (% of investment)

62

Challenge – investment to boost productivity

50

70

90

110

130

150

170

190

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Labour productivity Real remuneration

Labour productivity and real remuneration per hour worked (2005 Q1 = 100; s.a.)

Lending remains sluggish

Domestic enterprises and households’ loan-to-deposit ratio (%)

63

0.9%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

Loans to domestic enterprises andhouseholds* (%; y-o-y)

-20

0

20

40

60

80

100

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

Total

To non-financialenterprises

To households

-1.1%

Source: Latvijas Banka.

38.1%

0

20

40

60

80

100

120

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

Credit to GDP ratio (% of GDP)

* For the sake of comparability, the one-off effects related to the restructuring of Latvia's banking sector have been excluded.

Source: Latvijas Banka, The Financial and Capital Market Commission.

Foreign client transactions in Latvia'sbanking system (EUR billions)

64

Prompt action to strengthen AML/CFT framework leads to success

Foreign client deposits (EUR billions)

0

3

6

9

12

15

2014 2015 2016 2017 2018 2019

EU non-EU

0

5

10

15

20

25

30

35

2014 2015 2016 2017 2018 2019

EUR Other RUB USD

Territorial reform to unlock reform potential

Source: Ministry of Environmental Protection and Regional Development. 65

119 40

General government budget balance in Latvia(% of GDP)

66

Prudent fiscal policy allows for fiscal stimulus if needed

Source: Eurostat.

-10 -8 -6 -4 -2 0 2

199519961997199819992000200120022003200420052006200720082009201020112012201320142015201620172018

2019*2020*

General government debt in 2018; EU countries(% of GDP)

0 20 40 60 80 100 120 140 160 180 200

Greece

Italy

Portugal

Cyprus

Belgium

France

Spain

UK

EU avg.

Croatia

Austria

Slovenia

Hungary

Ireland

Germany

Finland

Netherlands

Slovakia

Poland

Malta

Sweden

Latvia

Romania

Denmark

Lithuania

Czechia

Bulgaria

Luxembourg

Estonia

*Budgetary Plan of the Republic of Latvia 2020

► Inequality – benefits-based solution rather than tax policy

►Education and health care reforms – to increase labour force

quality within prevailing demographic trends

►Administrative territorial reform – to improve cost-efficiency of

currently fragmented municipal governance model

►Targeted investment policy and wise use of available financing

(incl. EU funds) – to boost productivity and skills, including fostering

adaptation to challenges brought by climate change and digitalisation

Areas where strategic approach is needed to boostLatvia’s resilience towards long-term challenges

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