The aim of this paper is to examine selected issues related to Latvia’s economic development. Latvia experienced a large macroeconomic adjustment in the aftermath of the crisis in 2007. The adjustment was characterized by internal devaluation via a combination of wage restraint and productivity gains. Latvia’s creditless recovery has taken unusually long to turn compared to international experience. Although lack of credit has not undermined recovery so far, support from the financial sector will be crucial for its continuation going forward. Emphasis on resuscitating credit growth is key to maintaining recovery. Focus should be on facilitating access to credit for small- and medium-sized enterprises and first-time borrowers, where market failures are the largest.
This Selected Issues paper seeks to determine the macroeconomic effects of credit growth in Latvia. To do so, the paper relies on two approaches. First, a vector autoregressive system consisting of domestic credit, real activity, inflation, and the current account is used to determine responses to a positive shock to credit growth. It also calibrates the IMF’s Global Fiscal Model to simulate the macroeconomic effects of Latvia’s financial integration with the European Union and developing financial system. The paper also discusses the balance sheet approach to macroprudential vulnerabilities in Latvia.
– particularly state authorities and insolvency administrators – are of paramount importance. As in other policy areas, grey economy remains an important factor holding back credit recovery.
The authorities acknowledge the importance of vigilant supervision and mitigating of risks in the NRD sector . The FCMC has taken important steps to mitigate anti-money laundering and terrorism financing (AML/CFT) risks. In this context, independent reviews of AML/CFT compliance in NRDbanks have been carried out by competent US consultancy firms in April and May.
As a minor point, the
context of the strong presence of the European, especially Scandinavian, capital in the Latvian banking system.
Our authorities note staff’s traditional concern about the high share of non-resident deposits in the Latvian banking system. In its latest published Financial Stability Report, The Bank of Latvia analyzed net assets and liabilities of resident deposit intensive (RD) and non-resident deposit intensive (NRD) banks. The analysis revealed significant differences between the two groups. RD banks attract funds available on the interbank market abroad, most
subordinated positions and encouraging the development of credit bureaus. Reforms to insolvency procedures and the court system are needed to encourage writedowns and accelerate the reduction in private sector debt. This would provide a spur to new lending from both the demand and supply side.
So far there have been no significant disruptions to NRD flows arising from geopolitical tensions. But the Russia-Ukraine conflict highlights the need for maintaining vigilant supervision of NRDbanks, which account for almost half of all deposits in the banking system. In this
of non-resident deposits in Latvia’s banking system represents a key vulnerability to the economy”. The authorities closely monitor banks focused on NRDs. Those banks are subject to additional, much stricter, prudential capital and liquidity requirements (within Pillar II)—based on pre-defined quantitative criteria, taking into account both the share of non-resident deposits and loans to non-residents in bank’s balance sheet, as well as their growth rate. Currently, NRDbanks’ capital adequacy ratio exceeds the minimum regulatory requirement on average about two
This 2015 Article IV Consultation highlights that Latvia’s strong recovery has recently slowed in the face of sluggish growth in the euro area and deteriorating economic conditions in Russia amid rising geopolitical tensions. GDP growth decelerated to 2.4 percent in 2014 reflecting weak demand and the prolonged closure of a steel manufacturer. In 2015, the weak external environment, particularly the sharp slowdown in Russia, will continue to weigh on exports and investment. This is expected to be mitigated, but not fully offset, by higher disposable income owing to lower oil prices and robust real wages, the reopening of the steel manufacturer, and the accommodative monetary stance of the European Central Bank.
’s total deposits, and could therefore be vulnerable to a sudden stop or flow reversal. Moreover, since NRDs are covered by the country’s deposit guarantee scheme, they represent a significant contingent fiscal liability. 6 That said, to date there are few signs of NRD inflows being impeded due to geopolitical events ( Box 1 ). Risks to the domestic economy are mitigated by various factors. NRDbanks hold the major share of their assets abroad in liquid instruments such as European and US government securities, and bank deposits. 7 They are already subject to higher
authorities’ recent actions to combat financial fraud and mitigate AML/CFT risks are commendable, yet safeguarding financial stability requires ongoing vigilance and action .
➢ The risks associated with non-resident deposits (NRDs) warrant continued vigilance . NRDbanks account for about 50 percent of total deposits, of which over 80 percent are estimated to originate from Russia and CIS countries. The NRDbanks 12 enjoy high liquidity ratios and stress tests suggest they can withstand outflows of close to 60 percent. Nevertheless, NRDs could be vulnerable to sudden
Latvia entered the euro area in January 2014 with the fastest rate of growth in Europe. The 2014 Article IV Consultation highlights that a slowdown in investment and exports was partly compensated by robust consumption demand, supported by rising real wages, bringing GDP growth in 2013 to 4.1 percent. Strong job creation reduced the unemployment rate to 11.3 percent by end-2013, close to its structural level. Consumer price inflation fell to an average of about zero in 2013, mainly owing to weakening energy prices. The 2013 general government deficit outturn of 1.0 percent of GDP was below the target of 1.4 percent.