Recent economic developments in Latvia

July, 2013

Real GDP growth in 2012 and Q1 2013 (% y-o-y)

2 Source: Eurostat.; *data is not available for Q1 2013 yet

-8

-6

-4

-2

0

2

4

6

Lat

via

Lith

uani

a E

ston

ia

Slov

akia

Po

land

M

alta

Ir

elan

d B

ulga

ria

Aus

tria

G

erm

any

Rom

ania

Sw

eden

L

uxem

bour

g U

nite

d K

ingd

om

Fran

ce

Bel

gium

D

enm

ark

Finl

and

Net

herl

ands

C

zech

Rep

ublic

Sp

ain

Hun

gary

Sl

oven

ia

Ital

y C

ypru

s Po

rtug

al

Gre

ece

2012 Q1 2013

Latvia is the fastest growing EU country

Economic momentum is well sustained despite slow-down in Europe, growth is expected to remain robust

3

Real GDP growth (%)

Source: Central Statistical Bureau of Latvia; F – Bank of Latvia forecast

-6.2

-4.0

3.1 2.8 3.6

5.7 6.6

5.7 6.9

5.0 5.2 5.1

3.6

5.6 4.1

-8

-6

-4

-2

0

2

4

6

8

Q1 2010

Q2 Q3 Q4 Q1 2011

Q2 Q3 Q4 Q1 2012

Q2 Q3 Q4 Q1 2013

2012 2013 F

Favorable competitive position shapes export trends: Latvia ranges among the export leaders in Europe

98 95 93 82

78

57 55 51 50 50 46 43 43 43 43 40 36 36 33 33 32 31 27 26 22

9

-2

-20

0

20

40

60

80

100

120

Lat

via

Lith

uani

a E

ston

ia

Gre

ece

Bul

gari

a Sl

ovak

ia

Rom

ania

C

ypru

s C

zech

Rep

ublic

M

alta

Po

land

U

nite

d K

ingd

om

Swed

en

Port

ugal

N

ethe

rlan

ds

Spai

n G

erm

any

Hun

gary

It

aly

Slov

enia

A

ustr

ia

Bel

gium

Fr

ance

Fi

nlan

d D

enm

ark

Irel

and

Lux

embo

urg

Merchandise export revenue growth (2012 over 2009, %)

Source: Eurostat 4

Growth has been supported by regained competitiveness: wage-productivity gap remains closed

70

90

110

130

150

2000

Q1

Q3

2001

Q1

Q3

2002

Q1

Q3

2003

Q1

Q3

2004

Q1

Q3

2005

Q1

Q3

2006

Q1

Q3

2007

Q1

Q3

2008

Q1

Q3

2009

Q1

Q3

2010

Q1

Q3

2011

Q1

Q3

2012

Q1

Q3

2013

Q1

Labour productivity Real wage 5

Wage and productivity (2005 Q1 = 100, seasonally adjusted)

Source: Central Statistical Bureau, Bank of Latvia staff calculations

Latvia’s market share in world exports continues to grow

80

100

120

140

160

180

200

220

240

260

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Czech Republic

Estonia

Hungary

Latvia

Lithuania

Poland

Slovak Republic

Merchandise export shares in world import (2002=100)

Source: WTO 6

7

Domestic demand has also recovered: regained competitiveness and corporate profitability have pushed up productive investment

Gross fixed capital formation (1Q 2010 = 100)

Source: Central Statistical Bureau of Latvia

+64%

100

110

120

130

140

150

160

170

2010 Q1

Q2 Q3 Q4 2011 Q1

Q2 Q3 Q4 2012 Q1

Q2 Q3 Q4 2013 Q1

Structure of investments has been shifting towards tradable sector

28.2 31.2

10.1 16.9

0

10

20

30

40

50

60

70

80

90

100

2008 2012

Industry Transport and storage Public administration Trade Others

Source: Central Statistical Bureau of Latvia 8

Non-financial investments by branches (% of total)

Unemployment rate has been going down alongside with growing employment opportunities

9.9

12.8

8

10

12

14

16

18

20

22

2010

I II

III

IV

V

VI

VII

V

III

IX

X

XI

XII

20

11 I II

II

I IV

V

V

I V

II

VII

I IX

X

X

I X

II

2012

I II

III

IV

V

VI

VII

V

III

IX

X

XI

XII

20

13 I II

II

I IV

V

Registered unemployment rate Job seekers rate

Unemployment rate (% of economically active population)

Source: Central Statistical Bureau; State Employment Agency, Bank of Latvia staff calculations 9

Strong competitive position and a shift from non-tradable to tradable sector is expected to keep current account in equilibrium

Source: Bank of Latvia; F – Bank of Latvia forecast

Current account balance (% of GDP)

-22.6 -22.4

-13.1

8.6

2.9

-2.2 -1.7 -1.8

-25

-20

-15

-10

-5

0

5

10

15

2006 2007 2008 2009 2010 2011 2012 2013F

Goods and services Income Current transfers Current account 10

Inflation on a declining trend; past increase has been driven by the commodity prices

Source: Central Statistical Bureau of Latvia, Bank of Latvia staff calculations

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

I 2010

III V VII IX XI I 2011

III V VII IX XI I 2012

III V VII IX XI I 2013

III V

Food Energy Inflation (yoy) Inflation excluding food and energy (yoy)

2012: 2.3% Forecast: 2013: 0.7%

Impact of food and energy prices on total inflation (%-points) and the annual inflation rate (%)

Banking sector has returned to profitability, capital adequacy has strengthened to record-high levels

Profitability indicators

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

-800

-600

-400

-200

0

200

400

Q1

2008

Q

2 Q

3 Q

4 Q

1 20

09

Q2

Q3

Q4

Q1

2010

Q

2 Q

3 Q

4 Q

1 20

11

Q2

Q3

Q4

Q1

2012

Q

2 Q

3 Q

4 Q

1 20

13

% Mln. of lats

Accrued profit ROE (right-hand scale)

0

2

4

6

8

10

12

14

16

18

20

Q1

2008

Q

2 Q

3 Q

4 Q

1 20

09

Q2

Q3

Q4

Q1

2010

Q

2 Q

3 Q

4 Q

1 20

11

Q2

Q3

Q4

Q1

2012

Q

2 Q

3 Q

4 Q

1 20

13

CAR Tier 1 ratio Minimum capital adequacy requirement

Capital adequacy ratio (%)

Source: FCMC and Bank of Latvia 12

Decline in credit stock reflects ongoing deleveraging; reappearance of a credit boom is unlikely for many years to come

Credit to private sector (y-o-y, %)

Source: Bank of Latvia 13

-20

0

20

40

60

80

100

2004

Q1

Q3

2005

Q1

Q3

2006

Q1

Q3

2007

Q1

Q3

2008

Q1

Q3

2009

Q1

Q3

2010

Q1

Q3

2011

Q1

Q3

2012

Q1

Q3

2013

Q1

Q3

2014

Q1

Q3

2015

Q1

Q3

Annual growth of household credit stock Annual growth of nonfinancial corporation credit stock Annual growth of resident credit stock (without government)

Forecast

Money market rates have remained stable at low levels for a lengthy period of time

0%

5%

10%

15%

20%

25%

30%

jan

08

apr 0

8

jūl 0

8

okt 0

8

jan

09

apr 0

9

jūl 0

9

okt 0

9

jan

10

apr 1

0

jūl 1

0

okt 1

0

jan

11

apr 1

1

jūl 1

1

okt 1

1

jan

12

apr 1

2

jūl 1

2

okt 1

2

jan

13

apr 1

3

jūl 1

3

RIGIBOR 3M RIGIBOR 6M RIGIBOR 12M 14

Money market rates (%)

Source: Bank of Latvia

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

I 200

8 II

III

IV

V

VI

VII

V

III

IX

X

XI

XII

I 2

009 II

II

I IV

V

V

I V

II

VII

I IX

X

X

I X

II

I 201

0 II

III

IV

V

VI

VII

V

III

IX

X

XI

XII

I 2

011 II

II

I IV

V

V

I V

II

VII

I IX

X

X

I X

II

I 201

2 II

III

IV

V

VI

VII

V

III

IX

X

XI

XII

I 2

013 II

II

I IV

V

V

I

Net foreign assets Monetary base 15

The backing of the monetary base with foreign reserves is over 150%

Source: Bank of Latvia

Net foreign assets and Monetary base (mln lats)

16

Maastricht criterion* Reference value Latvia’s respective indicator

Inflation (April 2013) 2.7% 1.3%

Budget deficit (% of GDP, 2012) -3% -1.2%

Public debt (% of GDP, 2012) 60% 40.7%

Long-term interest rate (April 2013) 5.5% 3.8%

ERM II membership At least 2 years Since 2005

* Convergence Report 2013 on Latvia; EC, 5 June 2013

After fulfilling criteria, Latvia is set to become the 18. euro area country in 2014

Latvia’s credit ratings have been upgraded and have positive outlooks

Standard&Poor's Fitch Investment grade Moody's (rhs)

Latvia’s sovereign rating on long-term foreign currency debt

17

A1

A2

A3

Baa1

Baa2

Baa3

Ba1

Ba2

Ba3

A+

A

A-

BBB+

BBB

BBB-

BB+

BB

BB-

Source: Bloomberg

18