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Europe > Latvia, Republic of

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Cover IMF Working Papers
Competitiveness and Productivity in the Baltics: Common Shocks, Different Implications
Saioa Armendariz
,
Carlos de Resende
,
Alice Fan
,
Gianluigi Ferrucci
,
Bingjie Hu
,
Sadhna Naik
, and
Can Ugur
This paper examines competitiveness and productivity in the Baltics. Focusing on recent developments, it asks why Russia’s war in Ukraine led to a prolonged recession and strong decline in competitiveness in Estonia, while Latvia and Lithuania shielded their economies more effectively. The paper starts by documenting a deterioration in export performance across the region. Using a constant share decomposition, it finds that, unlike in Latvia and Lithuania, Estonia’s declining export share has been mainly linked to a reduction in the ‘intensive margin’—a sign of weakening external competitiveness and declining relative productivity. Multivariate filtering techniques and estimates of the real effective exchange rates based on historical productivity trends, consistent with Balassa-Samuelson, confirm that differences in long-term total factor productivity growth have affected external competitiveness. While Estonia’s post-GFC slowdown in productivity growth and real exchange rate appreciation have eroded its competitive edge, Latvia and Lithuania have shown greater resilience, aided by more balanced real effective exchange rates and, for Lithuania, stronger corporate balance sheets. A micro-econometric analysis further reveals that resource misallocation, particularly in the services sector, has been a key driver of declining productivity in the region. These findings underscore the need for targeted reforms to improve allocative efficiency, boost productivity, and restore competitiveness in the Baltic region.
Keywords:
Export shares; Competitiveness; Productivity; Baltics; export share; productivity in the Baltic; resource misallocation; productivity trend; TFP dynamics; TFP deceleration; Total factor productivity; Real effective exchange rates; Real exchange rates; Global
Cover IMF Staff Country Reports
Republic of Latvia: 2024 Article IV Consultation-Press Release; and Staff Report
International Monetary Fund. European Dept.
The 2024 Article IV Consultation highlights that the Latvian economy contracted with significant disinflation. Amid high uncertainty, growth is projected to rebound, but risks are tilted to the downside. Considering the improving outlook, the IMF Staff recommends a less expansionary, neutral fiscal stance for 2024 and a tighter fiscal stance in 2025. Although Latvia has some fiscal space, structural fiscal measures are needed to provide buffers for medium to long term spending pressures. Although the financial sector has so far been resilient, continued monitoring of macrofinancial vulnerabilities and spillovers is warranted. While the current macroprudential policy stance is broadly appropriate, the recent adjustment to the borrower-based measures for energy-efficient housing loans should be reconsidered. The overall policy stance strikes the right balance between maintaining financial stability and the need to extend credit to the economy. However, borrower-based macroprudential measures should be relaxed only when their presence is overly stringent from the financial stability perspective.
Keywords:
World Bank-International Monetary Fund mission; IMF-World Bank mission; audit committee charter; executive board assessment; anti-corruption plan; Labor markets; Productivity; Fiscal stance; Inflation; Baltics
Cover IMF Staff Country Reports
Republic of Latvia: Selected Issues
International Monetary Fund. European Dept.
This paper assesses recent developments in Latvia’s competitiveness and productivity in the context of Baltic economies. Latvia’s export market share has declined in recent years reflecting weakening external demand and the effects of EU trade sanctions, but only limited loss of competitiveness. Latvia faces weakening competitiveness. Latvia’s real effective exchange rate appreciation in recent years has been greater than that implied by its productivity trend, so the economy faces a narrowing competitiveness buffer. Latvia’s total factor productivity growth boost post-global financial crisis is unlikely to be sustained without structural reforms and efforts to increase capital investment. A decade-long weak investment, large infrastructure gaps, aging and emigration, and insufficient accumulation in skills weigh on Latvia’s productivity growth and competitiveness. These also pose risks that Lavia could be caught in a middle-income trap with low growth and slow convergence to euro area income level. Therefore, Latvia requires significantly higher investment for sustained convergence. In order to preserve Latvia’s competitiveness and build more resilience against future shocks, it is key to promote productivity growth via structural reforms and capital investment. Boosting productivity is also needed to meet challenges presented from Russia’s war in Ukraine and the ongoing transitions to sustain income convergence.
Keywords:
labor productivity growth; D. allocative efficiency; export share decline; D. Latvia's productivity growth; B. CSA Decomposition; Total factor productivity; Productivity; Labor productivity; Real effective exchange rates; Baltics; Europe
Cover IMF Staff Country Reports
Kingdom of the Netherlands–The Netherlands: 2024 Article IV Consultation-Press Release; and Staff Report
International Monetary Fund. European Dept.
The 2024 Article IV Consultation discusses that the economy has cooled, but signs of overheating remain in The Netherlands. After two years of strong recovery, growth decelerated in 2023, reflecting the energy shock, tighter financial conditions, and a slowdown in key trading partners, particularly Germany. Core inflation remains elevated, reflecting a tight labor market, robust wage growth, and healthy profit margins. Growth is expected to gradually regain momentum in 2024, driven by higher private consumption and external demand. High interest rates will weigh on business and residential investment. For 2024, given the high cost of underestimating inflation persistence, a non-expansionary stance is warranted; adjustment measures should be identified. Medium-term fiscal challenges call for structural reforms to stabilize debt. Climate mitigation strategies need to tackle implicit fuel subsidies, striking the right balance among regulation, pricing/feebates, and subsidies, while addressing distributional concerns and ensuring policy predictability.
Keywords:
government Finance statistics yearbook; IMF staff calculation; core inflation persistence; EMU aggregate; consultation cycle; Labor markets; Inflation; Labor shortages; Fiscal stance; Europe
Cover IMF Working Papers
High Inflation in the Baltics: Disentangling Inflation Dynamics and Its Impact on Competitiveness
Alice Fan
,
Bingjie Hu
,
Sadhna Naik
,
Neree C.G.M. Noumon
, and
Keyra Primus
This paper identifies and quantifies the drivers of inflation dynamics in the three Baltic economies and assesses the effectiveness of fiscal policy in fighting inflation. It also analyzes the macroeconomic impact of inflation on competitiveness by focusing on the relationship between wages and productivity in the tradeable sector. The results reveal that inflation in the Baltics is largely driven by global factors, but domestic demand matters as well, suggesting that fiscal policy can play a role in containing inflation. Also, there is robust evidence of a long-run (cointegration) relationship between (real) wages in the tradeable (manufacturing) sector and productivity in the Baltics with short-term deviations self-correcting in Estonia and Lithuania only.
Keywords:
Inflation Dynamics; Competitiveness; Baltics; labor productivity Wage-Productivity nexus; food inflation; inflation in the Baltic; energy inflation; Wage-Productivity growth nexus; Inflation; Wages; Productivity; Labor markets; Fiscal stance; Global
Cover IMF Working Papers
Is Inflation Good for Business? The Firm-Level Impact of Inflation Shocks in the Baltics, 1997-2021
Serhan Cevik
,
Alice Fan
, and
Sadhna Naik
Using a large panel of firm-level data, this paper provides an analysis of how inflation shocks in the Baltics between 1997 and 2021 affected total factor productivity (TFP), gross profitability, and net fixed investment in nonfinancial sectors. First, we find that inflation and inflation volatility had mixed effects on TFP growth, profitability and net fixed investment in the first year as well as over the medium term, albeit at a dissipating rate. Second, focusing on subsamples, we find that inflation shocks had differential effects on large versus small firms. Third, we explore sectoral heterogeneity in how firms responded to inflation shocks and observe significant variation across tradable and non-tradable sectors. Finally, estimates from a state-dependent model suggest that firms’ response to inflation shocks varied with the state of the economy. The results suggest that nonfinancial firms in the Baltics have been agile in adjusting to inflation shocks, possibly by either transferring higher production costs to consumers or substituting inputs. Given the differences in the level and nature of the recent inflation shock and the sample period on which our analysis is based, empirical findings presented in this paper might not necessarily apply to the latest bout of inflation in the Baltics.
Keywords:
Inflation; firm performance; productivity; profitability; fixed investment; Baltics; Estonia; Latvia; Lithuania; inflation shock; inflation volatility; IMF working paper No. 24/43; nonfinancial firm; impact of inflation; affected total factor productivity; Total factor productivity; Economic recession
Cover The IMF and the European Debt Crisis
The IMF and the European Debt Crisis
Harold James

Abstract

The book explores the Fund’s engagement in Europe in the aftermath of the 2008 global financial crisis, and especially after 2010. It explains how, why, and with what consequences the International Monetary Fund—along with the European Central Bank and the European Commission (together known as “the troika”)—supported adjustment programs in Greece, Ireland, Portugal, and Cyprus as well as helping to monitor Spain’s adjustment program and exploring modalities for supporting Italy. Additionally, it analyzes how the euro area developments interacted with and affected the rest of Europe, including not only eastern and southeastern Europe but also the United Kingdom, where the political fallout from post-financial crisis populism—in the form of “Brexit” from the European Union—was, in the end, the most extreme. The IMF’s European programs embroiled the Fund in numerous controversies over the exceptionally large lending, over whether or not to impose losses on private creditors, and over the mix between external financing and internal adjustment undertaken by program countries. They also required the IMF to confront longstanding questions about its governance and evenhandedness in the treatment of different segments of its membership. The crisis programs, with Greece, Ireland, Portugal and Cyprus, all revolved around debt sustainability. In the Greek case, after an intense internal debate, the IMF initially chose a program without debt reduction because it feared that such a program–even if ultimately in the interests of Greece, the client country–would trigger a panic of banks and other creditors and thus generate contagion for the rest of Europe. Learning from the Greek case, in Ireland and Portugal, the IMF pushed for debt reduction, to which the government in Ireland but not in Portugal was sympathetic. There was thus no private sector debt reduction in Ireland and Portugal. The European programs were caught up in big geopolitical debates about the appropriate role of the Fund in the aftermath of the global financial crisis. The book examines the intellectual and policy shifts that took place in the IMF as a result of the controversies about its European programs. It concludes with some reflections on how all the programs also produced genuine policy reform and held out the possibility of a return to growth and prosperity.

Keywords:
Debt; debt sustainability; bank crisis; deflation; IMF conditionality; policy reform; current account imbalances.; IMF mission; finance minister; IMF crisis lending; IMF official; stabilization plan; Debt restructuring; Sovereign bonds; Europe; Global; Eastern Europe; Baltics; East Asia
Cover IMF Working Papers
Micro-Assessment of Macroprudential Borrower-Based Measures in Lithuania
Mantas Dirma
and
Jaunius Karmelavičius
Despite having introduced borrower-based measures (BBM), Lithuania's housing and mortgage markets were booming during the low-interest-rate period, casting doubt on the macroprudential toolkit's ability to contain excessive mortgage growth. This paper assesses the adequacy of BBMs’ parametrization in Lithuania. We do so by building a novel lifetime expected credit loss framework that is founded on actual loan-level default and household income data. We show that the BBM package effectively contains mortgage credit risk and that housing loans are more resilient to stress than in the preregulatory era. Our BBM limit calibration exercise reveals that (1) in the low-rate environment, income-based measures could have been tighter; and (2) borrowers taking out secondary mortgages rightly are and should be required to pledge a higher down payment.
Keywords:
macroprudential policy; borrower-based measures; LTV; mortgage credit risk; lifetime expected loss; probability of default.; calibration exercise; BBM package; modeling mortgage risk; Lithuania's housing market; Mortgages; Loans; Credit risk; Housing prices; Macroprudential policy instruments; Europe; Baltics; Global
Cover IMF Staff Country Reports
Republic of Latvia: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Latvia
International Monetary Fund. European Dept.
The 2023 Article IV Consultation highlights that Latvia is facing an inflation shock, slow growth, and geopolitical challenges. The government will have to continue to deal with the spillovers in the Baltic region from the Russian invasion of Ukraine and the impact of sanctions imposed on Russia and Belarus, the cost-of-living crisis, and energy security. These short-term concerns are adding to the long-term policy challenge of sustaining the income convergence process. Latvia’s income convergence has already been lagging the other Baltic countries. Amid high uncertainty, the balance of risks is tilted to the downside. The main risks stem from an escalation of the war and associated sanctions, which could result in renewed increases in energy prices, energy supply disruptions in Europe, and weaker external demand. Global financial conditions could further tighten, with spillovers to Latvian banks and domestic credit growth. The paper recommends that structural policies should facilitate the green transition, reduce skill shortages, and boost productivity.
Keywords:
income convergence; shock support measure; inflation shock; government finance statistics yearbook; inflation momentum; bank credit risk indicator; Inflation; Energy prices; Fiscal stance; Baltics; Europe
Cover High-Level Summary Technical Assistance Reports
Project Summary: Nordic-Baltic Technical Assistance Project – Financial Flows Analysis, AML/CFT Supervision, and Financial Stability
Ms. Grace Jackson
,
Maksym Markevych
,
Antoine Bouveret
,
Pierre Bardin
,
Alexander S Malden
,
Santiago Texidor Mora
, and
Indulekha Thomas
This paper focuses on the summary of Nordic-Baltic Regional Technical Assistance Project Financial Flows Analysis, Anti-Money Laundering and combating the Financing of Terrorism (AML/CFT) Supervision, and Financial Stability. Various international banking scandals concerning AML/CFT breaches have taken place in the Nordic Baltic region, with far-reaching financial and reputational consequences. Financial integrity issues could potentially present risks to financial stability in the short and medium term. The depth of geographic ML/TF risk analysis and understanding differs among the Nordic-Baltic countries. There has been clear investment in ML/TF risk models across the region, but some gaps remain, notably, advanced data collection and analysis. Quantifying the financial stability impact of money laundering shocks is an understudied area. AML/CFT regimes in the region would benefit from better understanding of the ML threats associated with cross-border financial flows and nonresident activities. In order to address cross-border AML vulnerabilities, efforts to enhance the supervisory understanding of ML risks, strengthen the risk-based supervision of banks and crypto asset service providers, and deepen cooperation should continue.
Keywords:
Anti-Money Laundering; Combatting the Financing of Terrorism; Money Laundering Shocks; Financial Stability; Illicit Financial Flows; Machine Learning; and Risk-Based Supervision