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ViewpointJuly 1 2013

Finance minister brings Latvia in from the cold

The Banker’s Finance Minister of the Year for Europe 2013 won his award thanks to a successful and determined fiscal adjustment programme. He explains how moving early is now allowing Latvia to look beyond austerity.
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Finance minister brings Latvia in from the cold

If the EU and International Monetary Fund (IMF) want an example to show that post-crisis fiscal austerity can work, Latvia is likely to be high on their list. After the Baltic country recorded budget deficits in excess of 7% of gross domestic product (GDP) for three consecutive years from 2008 to 2010, finance minister Andris Vilks managed to run a balanced budget in 2012, having taken office in November 2010.

“The measures we have taken are paying off now. We are not just talking about austerity. The country had understood that adjustment was inevitable, that we needed to change the model for the national budget and national business. We have achieved more than our goals and faster than expected,” Mr Vilks tells The Banker.

Impressive growth

Latvia is by no means immune from the difficulties elsewhere in the EU, and GDP growth is expected to slow in 2013. But at 5.6% in 2012, the country enjoyed the highest growth rate in the EU and the forecast 3.5% in 2013 is likely to repeat this feat. There is admittedly a long way to recover from a savage 17.7% contraction in 2009. Unemployment is still high, at more than 13%, but this is down from more than 20% at the start of 2010, and the country had the highest job creation rate in the EU in 2012.

“The public sector is still fulfilling the same functions but with levels of expenditure and staff that are one-third lower, and the private sector has done the same. Productivity is rising faster than wages, and the growth is now more broad-based, not just focused on services, construction and real estate,” says Mr Vilks.

He cites agriculture, transport and logistics as important drivers to boosting the role of industry and exports in the economy. Manufacturing has risen from 9% to 15% of GDP in four years. The success of the private sector reflects Mr Vilks’ view that a strong social dialogue generating the support of entrepreneurs and trade unions alike is a crucial ingredient of Latvia’s success. Although he acknowledges that not every country has enjoyed such cohesion in the face of profound fiscal and economic challenges, he does not let his fellow finance ministers off the hook.

“Many countries are struggling where governments do not provide the leadership and ownership for what they have to do. It becomes more difficult to keep the support of the public and there have been many new finance ministers in recent years,” he says.

More integration please

While investors and politicians elsewhere contemplate the fate of the euro, Mr Vilks is still determined that Latvia should become the next country to adopt it, with the European Commission signalling in June 2013 that the country should be ready to join at the start of 2014. He describes Latvia as a “benchmark” in terms of compliance with the Maastricht Treaty criteria for the budget deficit and government debt – which at little over 40% of GDP is 20 percentage points lower than the Maastricht maximum. Latvia’s trade is predominantly with the eurozone or with euro-pegged countries such as Lithuania and Denmark.

“Our currency is already pegged to the euro but without the institutional support of eurozone membership. Joining the euro makes sense for a small, open economy like ours, and it has always been our strategic plan. The eurozone problems are not problems of the euro, but of fiscal discipline among certain members,” he says.

Coordination among EU financial regulators is also important for Latvia, where Scandinavian banks dominate the system. Many were hit hard by the real-estate crash and loan growth is still negative. But non-performing loans have almost halved from a peak of 21%. The banking sector has capital adequacy ratios of 16% to 20%, and liquidity ratios of about 60% to 70%, both of which are double the EU average, according to Mr Vilks. He welcomes eurozone proposals for a banking union as a natural step for a country with one of the highest rates of foreign bank ownership in the world.

“Regulation needs to be horizontal as markets are not country-specific, we need to take care of the system on a net basis. Further integration is easy for us to accept as we already have such close ties with Scandinavian supervisors, as well as double checking by the EU and IMF authorities,” he says.

His hope is that banking union will not only enhance cross-border co-operation, but also create better early-warning systems for any looming financial risks.

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