Recent Developments

The massive macroeconomic turbulence in 2008-2009 made Latvia better known abroad than it has ever been. Initially the country’s name became a byword for excesses and a fall from grace – not the kind of popularity to strive for. In 2009, however, the cast of good and bad macro heroes in Europe started to rotate, following revelations about the true state of euro zone sovereign finances and, in contrast, decisive steps taken in Riga. At the time of this writing, Latvia – along with the other Baltic states – is known as resolute, decisive, and capable of overcoming difficulties.

Joining the European Union, the Boom Years

The difficulties of 2008-2010 in Latvia were indeed mostly self-inflicted, unlike in the historical accidents mentioned earlier. In 2004 the country entered the European Union in a good economic shape, enjoying strong (GDP rose by 8% in that year) and broad-based growth, driven by productivity and exports. Latvia was still quite poor by European standards, but the future looked bright. The following three years indeed exceeded the wildest dreams of many people. Real estate prices roughly tripled, supercharging double-digit GDP growth, which also brought a 20% real-wage increase in 2007.

To sober-minded outsiders and also some insiders this seemed worrying, and for a good (or rather bad) reason. Net external debt in the period starting from 2004 increased from 2.5 to over 9 billion lats by late 2008, when the boom was well and truly over. Nominal GDP more than doubled, from 7.5 to over 16 billion in the period despite the currency being pegged to the low-inflation area called the euro zone. Unsurprisingly, exports, the main pillar of any sustainable growth strategy for such a small country, soon started to stagnate, after an initial spurt.

The real estate market, and also the booming sales of consumer durables, was the main magnet for the easy global credit of the era, somewhat optimistically supplied by foreign, mostly Nordic banks. As global financial crisis deepened in September 2008, lending froze in Latvia, too. In a matter of weeks, consumption crashed, pulling state budget revenues along with it. Last but not least, difficulties in the biggest locally owned commercial bank forced the government to apply for international assistance.

The Economic Crisis

The period since has been a time of austerity and restructuring of the public sector. Also, entrepreneurs have learned to operate in a new environment without the rising tide that lifted (almost) all boats during the boom. While the recession was not that long, less than two years, GDP fell by an extraordinary 25% from peak to trough. To a large extent this reflected the disappearance of unsustainable consumption and construction, but it was more than that; export also shrank due to the global crisis, and consumption actually went well below sustainable levels. As it happens in economic matters, excesses were followed by opposite excesses.

While Latvia’s economic performance in 2008-2009 was significantly below expectations, since 2010 the opposite was true. In 2009 it was forecast that by the end of 2011 the economy will have made no progress, a rather feeble expansion of 2-3% will only match corresponding decline.

In 2012, it is already clear that growth in 2011 has been ~ 5.5%, far outweighing 0.3% decline in 2010. There was in fact a steady quarterly growth in 2010, the annual total was slightly smaller than a year ago due to basis effect – the year started from a lower point than the previous one. If situation abroad were calm, we would be looking towards a growth rate in 2012 that would be at least as good as in 2011. Latvia will most probably do better than the rest of Europe, but as the laws of gravity clearly apply here, growth is likely to slow down to about 3%.

The Government and politicians hold that Latvia’s return to growth has happened largely due to a fast and considerable reduction of expenses, or inner devaluation, thus adapting salary levels to the revenues’ side of the budget. Apart from that, achieving a more sustainable balance between the country’s imports and exports has mattered significantly Not less so an improved structure of economy with competitive production being promoted vs real estate deals. However, several international analysts have been critical of the method applied, and have insisted on devaluation proper.

What has been the reason behind this above-consensus performance during the last two years if we look beyond the political rhetoric? Several thoughts:

The economy is stronger at the “micro” level than is often given credit for. Companies are flexible, people are innovative and hard working. While it is easy to see problems at macroeconomic level, it is not easy to see solution at the micro level until they emerge in the marketplace. There have been substantive qualitative improvements in the economy, the country’s export portfolio is becoming more diverse and sophisticated. Inevitably it is a gradual process, but it is taking place.
Better exports performance has helped revival in consumption, and in 2011, also investment, that improved the fiscal situation, alleviating fiscal consolidation needs that in turn helped consumption and investment again and so on.
Some of the worst scenarios for financial sector remained on paper, foreign banks remained very supportive towards their local branches and subsidiaries.
Last, but not least, in 2010 and 2011 global economic performance was slightly above previous expectations and that helped too.

The Situation Today

At the turn of the years 2011/2012 Latvia has seen eight successive quarters of growth, driven by exports that have exceeded pre-crisis peaks. While investment is positively booming too (up 25% in the first half of 2011), and consumption is picking up (4% growth in the same period), they have regained less than half of their lost ground.

Not that all of it was really necessary, but it felt nice while it lasted.

© The Latvian Institute

This fact sheet can be freely printed from homepage of the Latvian Institute, distributed and cited, on condition that the Latvian Institute is acknowledged as the source. The Latvian Institute promotes knowledge about Latvia abroad. It produces publications, in several languages, on many aspects of Latvia.