This presentation summarises recent macroeconomic developments in Latvia and outlines a medium-term outlook for real GDP and inflation. Presentation reviews ongoing economic recovery, labour market issues and includes analyses on core factors behind the path of inflation. The main focus of the presentation is on the issue of competitiveness of the Latvian economy pointing to the costs adjustment process and productivity gains, as well as presenting export performance, market shares and current account developments. Presentation also features slides on monetary and financial market developments.

1. Recent Economic Developments
in Latvia and Outlook
March,
March 2012

2. So far economy has recovered swiftly
y y
Real GDP growth (%)
11.2
10.1 9.6
10 8.9
89
5.5
5
0
-0.3
-5 -3.3
33
-10
-15
-20 -17.7
17 7
2004 2005 2006 2007 2008 2009 2010 2011
Source: Central Statistical Bureau of Latvia

3. GDP growth, initially was led by exports;
broadened to investment
Real GDP growth (y-o-y %) and contribution to the growth (percentage points)
(y-o-y,
25
20
15
10
5
0
-5
-10
-15
-20
Q1 2010 Q2 Q3 Q4 Q1 2011 Q2 Q3 Q4
Private consumption Public consumption GFCF Changes in inventories
Exports Imports GDP, % yoy
Source: Central Statistical Bureau of Latvia

4. Wage-productivity gap has been closed
g p yg p
Real wage and productivity index
(whole economy, seasonally adjusted, per hour worked, 2005 Q1 = 100)
150
130
110
90
70
2005 Q1
Q2
Q3
Q4
2006 Q1
Q2
Q3
Q4
2007 Q1
Q2
Q3
Q4
2008 Q1
Q2
Q3
Q4
2009 Q1
Q2
Q3
Q4
2010 Q1
Q2
Q3
Q4
Q2
Q3
Q4
2011 Q1
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Labour productivity per hour Real hourly wage
4
Source: Central Statistical Bureau of Latvia data; Bank of Latvia staff calculations

5. Latvia’s export market shares are up in most of
our key markets reflecting gains in
y gg
competitiveness
Share of Latvian exports in particular country’s imports, % (4q-moving average),
country s (4q-
2009
2009 Q4–2011 Q4
2011
12
0.45
9
0.30
6
0.15
3
0.00 0
share of EU27 Germany UK Sweden Denmark Finland Poland Russia Estonia
E i Lithuania
Li h i
exports 72.4% 8.4% 3.1% 6.1% 3.4% 3.1% 5.9% 10.6% 13.6% 18.0%
Source: Eurostat, CSP, BoL calculations

6. Merchandise export growth remains robust
both in nominal and real terms
Merchandise export (Q1 2007 = 100)
180
Real export
170
Nominal export
160
150
140
130
120
110
100
90
80
II
III
II
III
II
III
II
III
II
III
IV
IV
IV
IV
IV
200 I
200 I
200 I
201 I
201 I
07
08
09
10
11
Source: Central Statistical Bureau of Latvia; Bank of Latvias calculations

7. Latvia’s export profile: a significant
diversification
di ifi ti
Structure of merchandise exports (%)
100% Others
90%
Textiles
80%
70% Transport vehicles
60%
Mineral products
50%
Chemical
40%
30% Machinery and electrical
equipment
20%
Metals
10%
0% Food products
000
005
010
011
20
20
20
20
Wood
, Source: Central Statistical Bureau of Latvia, Bank of Latvia

8. Intermediate goods dominate in the import
structure and drive import growth
t t dd i i t th
Import by BEC product group (million EUR)
1100
1000
900
800
Other items
700
600 Motor spirit and
passenger motor cars
500
400 Consumption g
p goods
300
Intermediate goods
200
100 Capital goods
0
V
IX
V
IX
V
IX
V
IX
2008 I
III
VII
XI
2009 I
III
VII
XI
2010 I
III
VII
XI
2011 I
III
VII
XI
Source: Eurostat

9. Investment in productive sectors like industry
and transport accounted for a half of non-
p
financial investment
Non-financial investment growth (y-o-y; %) and sector contribution to the growth
g (y y; ) g
(percentage points)
45
40 36.5
35 30.4
30 27.2 25.3
25
20
15
10
5
0
-5
-10
10
Q1 2011 Q2 Q3 Q4
Agriculture (A) Industry (BCDE) Construction (F)
Trade (G) Transportation and storage (H) Private services (IJKLMNRS)
Public services (OPQ) Non-financial investments, y/y, %
Source: Central Statistical Bureau of Latvia

10. Unemployment rate continue to decline
p y
Unemployment rate (% of economically active population)
20.5
20
15.4
15 14.3 14.4
13.7
10
5
0
II
III
II
III
II
III
II
III
2011
IV
IV
IV
IV
2012 F
2013 F
2008 I
2009 I
2010 I
2011 I
2
2
2
2
Source: Central Statistical Bureau of Latvia

11. Employment increased in the private
sector (manufacturing)
Hours worked by institutional sectors (y o y %)
(y-o-y,
10
6.7
5
3.5
0
-1.4
-5
10
-10
-15
-20
-25
-30
-35
Q2
2
Q3
3
Q4
4
Q2
2
Q3
3
Q4
4
Q2
2
Q3
3
Q4
4
Q2
2
Q3
3
Q4
4
2008 Q1
1
2009 Q1
1
2010 Q1
1
2011 Q1
1
Total Private sector Public sector
Source: Central Statistical Bureau of Latvia (firms’ survey data)

12. Number of job vacancies low; no evidence
of country wide labour shortage
country-wide
Beveridge curve: unemployed and job vacancies registered in the SEA
25 2007 VIII
20
Job vacancies, ths.
15
10
b
2012 II
5
2004 I
2010 III
2009 I
0
50 80 110 140 170 200
Unemployed, ths.
Source: Central Statistical Bureau of Latvia (firms’ survey data); State Employment Agency

13. While wage growth resumed in all sectors, it
remains stable and no major risks for wage
j g
acceleration so far
Average gross nominal wage (
g g g (for full-time work) by institutional breakdown
) y
(y-o-y changes, %)
30
20
10 5.4
4.5
0 4.0
40
-10
-20
-30
Q3
Q3
Q3
201 Q1
Q3
200 Q1
200 Q1
201 Q1
11
08
09
10
Total Private sector Public sector
Source: Central Statistical Bureau of Latvia

14. In 2012, slowdown in economic activity is
expected d e
e pected due to weakening in external demand
eakening e ternal
Real GDP growth (%)
8
6 5.7% 5.5%
4
2.7%
2 1.3%
0
-2
-4
-6
2010 I II III IV 2011 I II III IV 2011 2012 F 2013 F
Source: Central Statistical Bureau of Latvia data; F – Bank of Latvia forecast

15. Despite unfavorable external conditions,
manufacturing g
g growth doesn't show signs of
g
weakening
Manufacturing volume index
g
(2005 = 100)
120
110
100
90
80
70
60
IX
IX
IX
IX
IX
III
XI
III
XI
III
XI
III
XI
III
XI
V
V
V
V
V
2007 I
VII
2008 I
VII
2009 I
VII
2010 I
VII
2011 I
VII
2012 I
Seasonally adjusted data
15
Source: Central Statistical Bureau of Latvia,

16. The global commodity prices tend to contribute
less to the y-o-y inflation than in 2011 on
y y
average
Inmact of food and energ prices on total inflation (pp) and the y-o-y inflation rate (%)
energy o
7.0
Bank of Latvia forecast:
2012: 2.4%
2 4%
5.0 2013: 2.0%
3.0
1.0
-1.0
-3.0
3.0
-5.0
I 2010 III V VII IX XI I 2011 III V VII IX XI I 2012
Food Energy Y-o-y inflation Y-o-y inflation excluding food and energy prices
16
Source: Central Statistical Bureau of Latvia, Bank of Latvia calculations

17. Indirect tax changes contributed notably to
inflation in the recent years; no indirect tax
y ;
increases this year
The impact of changes in tax rates on HICP (I 2008=100)
115
Constant-tax-rate HICP
113 HICP
111
109
107
105
103
101
99
I IV VII X I IV VII X I IV VII X I IV VII X 2012
2008 2009 2010 2011 I
17
Source: Central Statistical Bureau of Latvia

18. External imbalances have seen a significant
improvement resulting in a sustainable level of
p g
CA and its components
Current account main positions (% of GDP)
10
5 8.6
3.0
-1.2 -0.6 -1.3
0
-5
5
-10 -13.1
-15
15
-20 -22.4
25
-25
2007 2008 2009 2010 2011 2012 F 2013 F
Current Transfers Income Goods and Services Current Account
Source: Bank of Latvia ;F- forecast

19. With the economic environment stabilizing,
Latvia has been able to attract considerably more
y
net FDI in 2011 than in previous year
Net FDI inflows (% of GDP)
10
8.4
8.1
5.5
5
3.8
1.6
0.4
0
2006
2007
2008
2009
2010
2011
Source: Bank of Latvia

20. Monetary and Financial Market
Developments

21. Both tight lending standards and low demand
for loans determined credit decline
Credit to private sector (y o y %)
(y-o-y,
100
80
60
40
20
0
-20
I 2004
IV
X
I 2005
IV
X
I 2006
I 2007
IV
X
I 2008
IV
X
IV
X
I 2009
IV
X
I 2010
IV
X
I 2012
IV
X
VII
VII
VII
VII
VII
VII
VII
VII
I 2011
Annual growth of h
A l th f household credit stock
h ld dit t k
Annual growth of nonfinancial corporation credit stock
Annual growth of resident credit stock (without government)
Source: Bank of Latvia

22. The backing of the monetary base with
foreign reserves is high
Net foreign assets and Monetary base (mln lats)
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
08
09
I 2010
I 2012
II
II
II
II
II
II
II
II
II
11
IVV
V
VI
II
II
IXX
X
XI
II
IVV
V
VI
II
II
IXX
X
XI
II
IVV
V
VI
II
II
IXX
X
XI
II
IVV
V
VI
II
II
IXX
X
XI
II
I
II
I
II
I
II
I
II
I
V
VI
VII
X
XI
V
VI
VII
X
XI
V
VI
VII
X
XI
V
VI
VII
X
XI
I 201
I 200
I 200
Net foreign assets Monetary base
Source: Bank of Latvia

23. Foreign exchange resources are adequate
to meet 5 4 months of import
5.4
Ratio f the t foreign
R ti of th net f i assets of th B k of L t i i the months of i
t f the Bank f Latvia in th th f imports of goods
t f d
12.00
10.00
8.00
6.00
4.00
2.00
0.00
I 2004
IV
X
I 2005
IV
X
I 2006
IV
X
I 2007
IV
X
I 2008
IV
X
I 2009
IV
X
I 2010
IV
X
I 2011
IV
X
VII
VII
VII
VII
VII
VII
VII
VII
Source: Bank of Latvia

24. Sector capital adequacy ratios at
historically highest levels
Capital adequacy ratios (%)
20
18
16
14
12
10
8
6
4
2
0
Q1 2006 Q3 Q1 2007 Q3 Q1 2008 Q3 Q1 2009 Q3 Q1 2010 Q3 Q1 2011 Q3
CAR Tier 1 ratio
Source: Financial and Capital Market Commission

25. Liquidity level remains very high
q y y g
Liquidity ratio (defined by FCMC %)
FCMC,
70
60
50
40
30
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
Q1 2011
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q
Q
Q
Q
Q
Source: Financial and Capital Market Commission Q

26. Non-performing loans have peaked in Q3
2010; signs of improvement are evident
Amount of loans over 90 days past due, provisions and their share in outstanding
%
loans mln lats
20
Share of provisions in outstanding
2,800
,
18 loans
Share of loans over 90 days past
16 2,400
due in outstanding loans
14 Provisions (right-hand scale)
2,000
2 000
12
Loans over 90 days past due (right-
1,600
10 hand scale)
8 1,200
1 200
6
800
4
400
2
0 0
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q2
Q3
Q4
Q1 2005
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
011
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q
Q1 20
Source: Bank of Latvia, Financial and Capital Market Commission

27. Fiscal consolidation and implemented reforms
helped to stabilize economy and financial
p y
markets: interest rates below pre-crisis level
Money market rates (%)
30%
25%
20%
15%
10%
5%
0%
jan mar mai jūl sep nov jan mar mai jūl sep nov jan mar mai jūl sep nov jan mar mai jūl sep nov jan mar
08 08 08 08 08 08 09 09 09 09 09 09 10 10 10 10 10 10 11 11 11 11 11 11 12 12
RIGIBOR 3M RIGIBOR 6M RIGIBOR 12M
Source: Bank of Latvia

28. 28