Ms. Françoise Le Gall, Ms. L. Effie Psalida, Mr. Pietro Garibaldi, Mr. Julian Berengaut, Mr. Jerald A Schiff, Ms. Kerstin Westin, Mr. Augusto López-Claros, Mr. Richard E Stern, and Mr. Dennis Jones
Are the three Baltic countries, Latvia, Estonia, and Lithuania, ready for accession to the European Union? Have their economies overcome the problems of transition? The answers to these questions and their implications for policy are provided in this collection of analyses. Rather than a country-by-country description, the volume provides a cross-country perspective of developments from 1994 through mid-1997. The seven sections of this paper discuss recent macroeconomic and structural policies, exchange rate regimes, fiscal issues, financial systems, private sector development, and accession to the European Union.
The process of adjustment and reforms in the Baltics deserves attention for three overarching reasons: (1) the extent and speed of transformation from the central plan and political repression to the market and democracy; from plummeting output and living standards and high inflation to high growth, low inflation, and rapidly rising real incomes; and from reliance on the central bank and bilateral and multilateral sources for financing to accessing domestic and international financial markets; (2) the policy challenges the countries have faced in choosing and maintaining exchange rate regimes; confronting weaknesses in the banking system; protecting public revenues while adjusting the pattern of expenditures; and resolving problems of interenterprise and energy arrears; and (3) an opportunity for a cross-country prospective based on similarities in size, starting positions, external shocks, and policy objectives, and differences in the choice of policies and their timing.
The Baltic countries were generally considered to be among the more developed of the economies of the Baltics, Russia, and other former Soviet Union countries (BRO), with a standard of living at the outset of the transition well above the average for the former Soviet republics. On regaining independence in 1991, the governments of the Baltic countries embarked upon comprehensive programs of economic and political reform involving a move away from central planning to reliance on the market and the establishment of a market-based legal framework and institutions for economic activity. In the early stages, the authorities gave priority to eliminating central plan distortions in the economy: the bulk of domestic prices were freed; external trade and the exchange system were liberalized; and the privatization of small and mediumsized enterprises was begun.
The conduct of macroeconomic policy in Estonia and Lithuania in recent years has taken place in the context of currency board arrangements (CBAs). Under the arrangements (introduced in Estonia in June 1992 and in Lithuania in April 1994), the monetary authorities have virtually no discretion in conducting monetary policy since, under a CBA, the monetary base rises or falls in response to the central banks’ sales and purchases of foreign exchange at the fixed exchange rate. Indeed, a currency board can be defined as an “arrangement that legislates a particular monelary rule,” under which a country gives up all monetary sovereignty and allows changes in the monetary base to be determined entirely by the international balance of payments.1 In Latvia, the currency has been pegged to the SDR since February 1994 and the conduct of monetary policy has since been overwhelmingly geared toward maintaining the exchange rate peg. Although the Bank of Latvia does have a range of monetary policy instruments at its disposal (e.g., reserve requirements, open market operations, a refinance facility for overnight loans to commercial banks, repurchase auctions, and auctions of central bank deposits), in practice, limited use has been made of such instruments and developments in the monetary aggregates have reflected, as in Estonia and Lithuania, mainly movements in the balance of payments and, to a much smaller extent, the extension of central bank credit to government. Thus, except for some institutional differences, all three countries have operated for the last several years in the context of a fixed exchange rate regime.
With the resumption in growth, the economic recession triggered by the Russian crisis has ended. Additional efforts will be needed to reduce the current account deficit and increase its financing. The IMF staff commend the intention to streamline tax benefits granted to enterprises and to eliminate the benefits that are inconsistent with EU regulations. Financial sector development is imperative for continued external sustainability and economic growth. The government’s ability to implement the privatization program and address the remaining impediments to an enabling business climate is crucial.
Developments and prospects of nonbank financial institutions of Latvia have been presented in this paper. Foreign direct investment (FDI) inflows to Latvia have declined compared with their earlier levels. This poses an important policy challenge owing to benefits of FDI in terms of financing the current account deficit, contributing to capital formation, productivity, and exports. This paper also discusses the role of the Latvian Privatization Agency (LPA) in the privatization of Latvia's public enterprises and property, along with statistical data on economic indices of Latvia.
Lithuania achieved significant progress in macroeconomic stabilization and structural reforms, under the previous Stand-By Arrangement. Executive Directors welcomed the new program, which aimed at maintaining macroeconomic stability, promoting private sector activity, and strengthening external viability in order to attain sustainable growth and create employment opportunities. They stressed the need to implement fiscal and structural reforms. They agreed that the authorities are following an appropriate approach of preparing a medium-term fiscal framework, determining priorities, and seeking ways to achieve the medium-term goal of a balanced budget.
The fiscal issues that are of particular interest to transition economies broadly center on the role that government should play in the transition from a planned to a market economy. A key question in this regard is, “Where do the Baltic countries appear to be heading?” Resolute rejection of Soviet practices and a commitment to join the European Union imply that the Baltics are moving toward western European models of economic and financial development and that they will tend to develop institutional arrangements and policies similar to those among their Scandinavian and continental European neighbors. This may especially be true in fiscal management, given the Baltic countries’ wish to comply fully with the Maastricht guidelines and, more generally, their desire to adapt their policies and institutions to the requirements of EU membership. Notwithstanding the progress that they have made in carrying out market-oriented reforms, they are not as far along the road as the more successful early transition economies (e.g., the Czech Republic, Poland, and Hungary).1 Their underlying institutional base is still much weaker than in the EU and considerable change is required to meet its standards.
This paper reviews economic developments in Latvia during 1994–96. The paper highlights that developments during this period have been dominated by the after-effects of the fiscal slippage in 1994 and the banking crisis in 1995, although there are signs of a recovery from these adverse episodes. The paper provides an in-depth analysis of selected economic issues facing Latvia. It analyzes the environment for the private-sector development, and reviews interest rate developments, focusing in particular on the treasury-bill market.
Latvia's economy has emerged from the recession triggered by the Russian crisis. Executive Directors commended the strong economic growth and low inflation. They appreciated the open and liberal trade system and the soundness of the banking system. They emphasized the need to maintain fiscal and monetary policies, and accelerate structural reforms. They urged the authorities to implement reforms to improve private sector development, increase foreign direct investment, enhance governance, and also to privatize state-owned enterprises, and approved a Stand-By Arrangement for the country.