Gold Magazine February - March 2013, Issue 23 | Page 82

AUSTERITY

FEELTHE
PAIN
LATVIA’S
TURNAROUND
SINCE THE 2008
FINANCIAL CRISIS
MAY BE A MODEL
FOR THE FALTERING
COUNTRIES OF
SOUTHERN EUROPE.
BUT THEY MAY NOT
LIKE IT...

F

By Kyproula Papachristodoulou

or countries with flexibility in the
labour market and a willingness
to suffer serious pain for some
time, the solution to bankruptcy
is quite simple and, as shown in
the case of Latvia, highly effective: austerity, austerity, austerity.
That, and strict implementation of the structural reform
programme. Latvia is the case
which proves the theory which,
of course, is not necessarily
good news for all problematic

European countries: austerity works. Latvia was booming
during the decade preceding
the recent financial crisis. From
the start of the new millennium, its annual GDP growth
exceeded 5% and in 2006 it
reached its peak, above 10%.
The then country went through
a huge bubble: public wages
grew threefold over the three
pre-crisis years (2004-2007) and
inflation reached double-digit
figures in 2008 (reaching an
all time high of 17.7% in May
2008) while a huge construction and real estate bubble
was evident. This all came to a
sudden end in 2008 and, over
the next two years, the country
lost a cumulative 25% of GDP
while unemployment soared
from 6.7% in 2006 to over 20%
in 2010. All of the above have
since been quite effectively dealt
with and, as a result, the country
is again enjoying growth – as the
best performer in the European
Union – as well as falling unemployment and international
admiration for its accomplishments and most importantly
for its ability to adopt and
implement the IMF-EU fiscal
consolidation programme. The
country today provides a boost
to champions of the proposition
that “pain pays”.
“We are here to celebrate
your achievements,” IMF Head
Christine Lagarde, told a confer-

ence in the Latvian capital Riga,
last summer. The Fund was
“proud to have been part of Latvia’s success story,” she said.

Pre-crisis problem
November 2008 was the starting point of Latvia’s severe economic and financial adventures.
The downfall of the country’s
second largest bank, Parex Banka, as a result of the Lehman
Brothers collapse, was the event
that triggered the crisis. Parex
Banka had to be nationalized
with a total state contribution
of €1.4 billion. CDS spreads
grew eight times (from over
100 basis points spread to over
1,000 bp spread) while the
country lost market access and
its credit rating was reduced to
junk status.
Latvia had to ask for financial
assistance from the IMF and its
European partners. The total
amount received, after agreeing
to a tough Memorandum of
Understanding which included
extensive public sector firings
and huge salary cuts, totalled
€7.5 billion.
The crisis hit hard indeed
but, as the IMF and EU appraisal later concluded, the
action taken by the government
was rapid, deep and extensive.
As a result, Latvia is now the
fastest-growing EU Member
State with an estimated GDP
growth in 2012 of 5.5%. It has

set itself the target of adopting
the euro on 1 January 2014.

Solving the problem
The country’s approach towards
solving the crisis puzzle was clear
and simple in theory but hard
when it came to implementation.
The main objective was to stabilize state finances and the financial system as soon as possible,
while maintaining the currency’s
euro peg by taking the internal
devaluation route. At the same
time, it set about improving administrative efficiency, pursued a
tax system, health and education
reform and tried to stimulate the
economy with the help of EU
funds.
The fiscal consolidation undertaken from 2009-2012 amounted to 17% of the country’s GDP.
One third of fiscal consolidation
came in tax increases, and two
thirds came in expenditure cuts.
Almost all possible taxes were
raised (and tax exemptions minimized for personal income tax).
As to the expenditure cuts, the
public wage bill was reduced by
40% and the size of the public
sector was significantly reduced
(about one third of staff was
dismissed).
More specifically, within four
years the budget expenditure for
state remuneration had decreased
by 46% and the number of persons employed in state budget
institutions fallen from 78,900

80 Gold THE INTERNATIONAL INVESTMENT, FINANCE & PROFESSIONAL SERVICES MAGAZINE OF CYPRUS

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