Speech

Latvia and the Baltics—a Story of Recovery By Christine Lagarde, Managing Director, International Monetary Fund

June 5, 2012

As prepared for delivery

Thank you President Bērziņš for your warm welcome and to other dignitaries, distinguished guests, and the audience for taking the time to participate in this important conference.

It is a great pleasure to be here today in this beautiful city of Riga to celebrate the remarkable achievements of Latvia and the Baltic countries over the past few years.

It is fitting that we are meeting in this fantastic building—the Great Guild—which was founded in 1353 by members of the Hanseatic League. The Hanseatic merchants turned Riga and Tallinn into vibrant centers for trade in the 14^th century, and their reach and dynamism reached all corners of Europe. It is a fitting symbol for the open, vibrant, and—above all—integrated approach that the Baltics, and indeed the whole of Europe, need to embrace today to overcome their challenges and succeed in their ambitions.

To get the ball rolling with this conference, I would like to talk briefly about three things:

• First, on the context: a look at how far Latvia and the Baltics have come.



• Second, on the lessons: just how did Latvia and the Baltics do it? And what lessons should policymakers elsewhere learn from their experience?



• Third, on the road ahead: how can Latvia and the Baltics integrate further with Europe while avoiding the pitfalls that have caused problems for other countries?

Crisis and recovery

Let me begin with the context. As you all know too well, the Baltic nations have been tested severely over the past number of years. Latvia alone lost a fifth of its output in just two years, 2008 and 2009. Unemployment rose above 20 percent, and double this among young people. Poverty increased and people from all walks of life endured great suffering. The other Baltics also went through incredibly tough times.

And yet while challenges remain today, you have pulled through. You have returned to strong growth and reduced unemployment, even if it remains far too high at around 16 percent. You have lowered budget deficits and kept government debt ratios to some of the lowest in the European Union. You have become more competitive in world markets through wage and price cuts. You have restored confidence and brought down interest rates through good macroeconomic policies.

We are here today to celebrate your achievements, but also to make sure that you can build on this success as you look to the future.

How did they do it?

How did Latvia and the Baltics do it? It certainly was not luck. With the turmoil affecting their neighbors and trading partners, nobody can argue that the Baltics were dealt a good hand. They were not just pushing a huge boulder—they were pushing it up a steep hill.

That said, there was no simple recipe for success. Rather, it was the right combination of policies, the right degree of support, and the right level of determination all coming together.

If we want to single out one factor for Latvia, it would be the impressive determination. This had a number of dimensions:

• After a difficult start to the program, we soon saw strong political will and ownership. Especially during the difficult decisions made in 2009, politicians took the long view over the short view.



• At a very basic level, everybody knew what needed to be done. They understood that the huge spike in spending in the years leading up to the crisis could not be sustained. It was almost a feeling of “easy come, easy go”—mistakes were made, and mistakes had to be fixed.



• Latvia decided to bite the bullet. Instead of spreading the pain over many years, the country stood together and did what needed to be done up front. And the achievement was incredibly impressive—in the first year of its program, Latvia implemented fiscal adjustment of more than 8 percent of GDP. Total adjustment for the whole program is even higher, at around 15 percent of GDP.



• Latvia also had a clear end goal—euro adoption. This meant that everybody knew where they were going, and Latvia has stayed the course.



• To cushion the hardship, the government agreed to protect the poorest and most vulnerable people by strengthening the social safety net. So even in an atmosphere of major budget cuts, Latvia expanded and improved unemployment assistance. I am pleased to note that the IMF, working with the World Bank and the European Commission, helped spearhead these efforts. And even though this was intended initially only as an emergency measure, it will be important to keep social safety net protection in place as long as the unemployment rate remains so high and poverty remains a problem.

The case of Latvia also shows how strong internal commitment can go hand-in-hand with strong external support, as the international community rallied to help the country get back on its feet. Latvia’s partners put together an impressive financing package of €7.5 billion.

I should also single out the strong cooperation among Latvia’s external partners—the European Commission, the IMF, the Nordic countries, a few other countries including Poland, as well as the ECB. And let us also not forget the assistance from the World Bank and the EBRD. This was critical to the program’s success.

But what really made it work was the high level of ownership—this was your program, your objectives, your future on the line. Our role was simply to help.

The road ahead

Let me now turn to my third and final point: the road ahead, and the key challenges facing the Baltic countries as they return to growth and—for Latvia and Lithuania—prepare to join the euro. I see three priorities.

First, Latvia still needs to deliver on the program’s exit strategy of euro adoption. This should remove exchange rate uncertainty, reduce interest rates, and promote integration with the rest of Europe.

Second, regardless of whether or not they join the euro, all three Baltic countries need to continue to implement the reforms necessary to make sure they can thrive under a fixed exchange rate. These reforms include raising labor productivity and boosting competitiveness to put them on a permanent path of higher growth and more inclusive growth.

What kind of reforms do I mean? Product market reforms are central to higher productivity and growth. And labor markets also need to work for all, making sure that everybody who wants a job can find one, and that the economy can readily adapt to the realities of the future, within an environment of inclusive growth. To survive under a fixed exchange rate or common currency, fiscal policy also will need to remain disciplined—Latvia’s proposed Fiscal Discipline Law is a good step in the right direction.

Third, all three Baltic countries could do more to support social cohesion. Income inequality in the Baltics is among the highest in Europe—in Latvia, the top 20 percent earns seven times more than the bottom 20 percent. There is an urgent need to create jobs—for young people, for the long-term unemployed, for those nearing retirement age who will find it difficult to re-train. A greater push to reduce inequality would also help a lot—IMF research shows that a more equal distribution of income is good for both macroeconomic stability and sustained growth, so it’s win-win.

This means smarter investment in education, a move towards more progressive taxation, and a stronger—but well-targeted—social safety net. Right now, Latvia spends only about half the EU average on social programs, so there is room to do more.

Conclusion

Let me conclude briefly. I believe the future of Latvia is bright. In a spirit of sustained solidarity and sheer determination, it has passed through a great ordeal, and is now well on the road to a better future.

Speaking for the IMF, I am proud to have been part of Latvia’s success story, alongside our European Commission and Nordic partners.

Going forward, we will stick with you. We will continue helping the Latvian people walk the road you have chosen, which includes entering the door of the eurozone.

As Rainis, the great Latvian poet, once said: “The one who will endure is the one who is willing to change” (“Pastāvēs, kas pārvērtīsies”) I think this embodies the spirit of the Latvian people. Latvia will endure, it will succeed, it will thrive—of this I am certain.

With that I will yield the floor to the many distinguished speakers here today for what I am sure will prove a fascinating discussion. Thank you.