At the height of 2008’s global financial crisis, there were many economies that suffered sharp downturns. While much has been written about the economic mess left in the US and UK, other countries endured especially harsh financial collapses. In the post-Soviet state of Latvia – freshly absorbed into the EU just four years prior – the crisis struck particularly hard.
Fuelled by the bursting of a previously booming economy, creating soaring unemployment and the collapse of many companies, Latvia’s economy contracted by a staggering 10.5 percent during the final quarter of 2008. A few months later, the government called for a €7.5bn ($9.36bn) bailout from the EU and the IMF, and nationalised the country’s second largest financial institution, Parex Bank.
Nevertheless, the aftermath of this economic mess has been met with the sort of stable and sustained growth that has been the envy of all the other countries that suffered so badly during this period. By 2010, Latvia’s economy had experienced a recovery and now its GDP growth rate is among the strongest in the EU (see Fig. 1), leading to enthusiastic praise from IMF Managing Director Christine Lagarde.
A large structural deficit accumulated throughout the boom years in Latvia largely defined the severity of the crisis
Could Latvia teach the rest of Europe about how to recover from an economic catastrophe? On a recent trip to Latvia’s capital, World Finance discovered a dynamic economy after years of economic turmoil. However, while there was a sense of cautious optimism, there was also an atmosphere of worry regarding events nearby. The looming presence of Russia to the east, and the scars from Latvia’s time as part of the Soviet Union, means that the country is looking at the conflict in Ukraine with great concern.
Amid the turmoil of the eurozone crisis, it went largely unnoticed that one of the EU’s newest members had chosen to join the embattled currency. When Latvia officially installed the euro as its currency on January 1, 2014, it did so just as the rest of the eurozone was struggling to get back on its feet.
A hugely unpopular decision domestically, the joining of the euro represented yet another important step towards Latvia’s ascension into the EU. Initially joining in 2004, Latvia has sought to bind itself to the EU over the last decade as a means of turning its back on the influence of Russia.
Cash flow
Latvia’s economy, in the immediate aftermath of joining the EU, saw a dramatic upswing in activity. Money flowed into the country as investors sought to harness a region that had previously been closed off (see Fig. 2). Speaking in October at the annual conference of the Bank of Latvia (BoL) – the country’s central bank – the governor Ilmars Rimsevics said that the boom years had led to a structural deficit forming, which in turn caused the crisis of 2008. “A large structural deficit accumulated throughout the boom years in Latvia largely defined the severity of the crisis,” he said. “Experiencing the fastest economic expansion and extremely strong cyclical upturn in tax revenue, Latvia still continued to spend more than it earned. Needless to say, this added extra fuel to the already severely overheated economy. Between 2004 and 2008, expenditure grew two and a half times, and most of that was of a structural nature. While deficits remained moderate in nominal terms, they were extremely large when cyclically adjusted: they amounted to seven to eight percent of GDP. It became widely obvious only with the burst of the bubble. Guess where the extra revenues went? Of course, to a large extent they were used for increasing wages.”
These wage increases, said Rimsevics, severely damaged the country’s competitiveness.
The governor believes that Latvia’s response to the crisis is down to its quick reactions to reform its public finances. “We returned to growth in a few short years because of the policy mix activated at the very outset of the crisis. When cornered, Latvia carried out reforms of public finance management and structural reforms, quickly shifting the economy back into motion and onto the path of growth.”
One of the key milestones in Latvia’s return to economic prosperity was marked with its adoption of the euro at the beginning of 2014 as its currency. Initially, adopting the euro was a deeply unpopular move by Latvia’s government, with many in the country wondering why it needed to stop using the lats that had been in circulation for the previous two decades, in favour of a currency beset with problems. And although adoption has not been without its problems, the euro provided Latvia with a number of advantages in how it deals with the rest of the world, according to the BoL.
A representative of Deputy Governor Zoja Razmusa told World Finance that international SEPA (single euro payments area) credit transfers had been greatly reduced from €7 to just €0.36, while annual savings of €70m ($87.36m) had been made on removing fees for converting lats to euros. The euro had also provided Latvia with the benefits of using the global reserves’ currency in daily settlements, while also removing the risk of devaluation. Latvia’s sovereign debt has also become easier to manage, with the removal of servicing fees, and both Standard & Poor’s and Moody’s have subsequently upgraded its credit rating. The BoL believes that with the right use, the euro can help to boost Latvia’s investments and growth over the long term.
The bank says that the changeover has been largely successful, with people enthusiastically backing the new cashless payment systems that have come about as a result of the euro adoption. Indeed, the amount of cash in circulation in Latvia has halved over the last year.
Burgeoning industry
Alongside this new economic stability has come a swathe of successful domestic companies that are exporting to the rest of the world, contributing impressive figures (see Fig. 3). Joining the EU has helped too, allowing additional funding and concessions to start-ups and businesses looking to expand their operations. The country has developed a burgeoning range of industries in recent years. Widely known for its woodworking sector, thanks to the proliferation of forests, and accounts for 13 percent of Latvia’s exports. It has also seen a large amount of logistics and transport flow in recent years.
Individual manufacturing companies have also grown in recent years. One such company is glass manufacturer Groglass, which has grown to become one of the leading makers of high quality anti-reflective glass in the world over the last decade. Speaking to the company’s Head of Marketing Arturs Rozkalns, it’s clear that Latvia is a good fit for ensuring there is a quality workforce, the legacy of which largely stems from the AS Siderabe research centre that provided much of the Soviet Union’s aerospace and nano technology.
Rozkalns also cites the efficient logistics network and favourable business environment as reasons for Latvia being the home of the company. Part of this is down to the support of the government, he says. “The government has been very supportive, as export-oriented high-value added production is Latvia’s priority for development.”
It is being part of the EU and eurozone that is helping the company get its products to a wider market. “Today, Groglass products are being delivered to more than 40 countries, and of course, being a part of EU, has helped to develop what we have achieved today, e.g., with a help of Latvian Development and Investment Agency, Groglass has received support from EU funds to develop new products and improve production efficiency. Having most of our customers within the eurozone makes it easy to trade without any currency risks or transactional costs”, says Rozkans.
There are even very niche industries in which Latvia is enjoying success, and in direct competition to an industry famously dominated by its former Soviet rulers – caviar making. While Russian caviar is widely regarded around the world, the methods of extracting the eggs from fish has seen bans placed on imports in many western countries.
One Latvian company based just outside of Riga has developed a sustainable form of farming for sturgeon eggs that kills no fish in the process. Mottra Caviar has been warmly embraced by some of the leading restaurant groups and retailers in the West, with well known British chef Mark Hix using their caviar in all his restaurants and high-end department store Selfridges stocking it too.
Russian sanctions
Despite this economic optimism, there are concerns about the future, most notably in relation to the situation with Russia. Latvia’s relationship with Russia has been fraught with conflict and distrust. Swallowed up by the Russian Empire in the 18th century, it briefly enjoyed independence after the First World War, before being subsumed once again by the Soviet Union in 1940. Following 50 years of oppression, civil resistance came to an end alongside the collapse of the Soviet Union in 1991.
Ever since, relationship has continued to be troubled, with accusations of Russian meddling in elections in the Ukraine over the last two decades coming alongside its strong opposition to the Baltic States joining the EU and NATO, which they did in 2004. In 2005, when Vladimir Putin agreed to develop the Nord Stream gas pipeline that passed through the Baltic Sea to Germany, it was seen as an effort to bypass traditional transit countries that include Ukraine, as well as the Baltic States. They see it as an effort to make Europe increasingly dependent on Russian gas, while exerting greater influence on the politics within the east of the EU.
As a result of the conflict in Ukraine, the EU has imposed sanctions against Russia, including on various powerful individuals and state-owned energy companies. However, while it is damaging Russia’s economy, these sanctions will also have an impact on Europe’s too, and the impact of sanctions against Russia on Latvia could be considerable. Moscow is likely to impose retaliatory sanctions on the west, which will likely hurt Latvia harder because of its proximity and the trade between the two countries.
Karlis Eihenbaums, Press Secretary to the Ambassador of Latvia’s Ministry of Foreign Affairs, told World Finance, “According to the information of the Ministry of Economy, the direct impact of Russia’s retaliation sanctions could reach 0.25 percent of Latvia’s GDP. Primary negative impact is on the Latvian farmers and food manufacturing companies, as well as transportation companies related to food supply. At the same time it should be noted that more danger for regional economy occurs from Russia’s own recession. The domestic economic situation in Russia has done more to pull down GDP than any application of sanctions.”
Specific industries might be harmed even more. Back in 2007 the influence of Russia on its neighbours’ economies was shown through the petty way in which it reacted to the removal of a Soviet-era war memorial. In the Estonia’s capital Tallinn, the bronze statue of a Soviet soldier was taken down as it represented to many in the country an example of communist oppression by Russia.
While there were vocal and violent protests by some young ethnic Russian protestors, the move was widely supported by the majority of the country. Putin’s response was to divert Russian merchant ships from Tallinn’s docks, while at the same time heavily investing in domestic Russian ports that would take business away from Tallinn. According to some, Tallinn’s port lost around 60 percent of its business as a result.
In nearby Riga, many fear that similar sanctions against Russia as a result of the Ukrainian crisis will lead to Moscow doing similar economic damage to its growing port. Visiting the growing port of Riga, it is clear that the huge transformation that it being undertaken to modernise and expand could be severely jeopardised by a reduction in the amount of trade with Russian ships.
EU Presidency
With this backdrop of geopolitical tension, Latvia will take centre stage. From the beginning of this year it will hold the position of President of the Council of the EU. Lasting six months, the presidency will see Latvia’s President Andris Berzins shape EU policy at a time when conflict with Russia seems its closest for a generation. While it won’t be the only issue facing the EU during Latvia’s tenure, it will certainly loom large over all the decisions made.
Latvia’s ambassador to the EU told reporters in late November of the country’s priorities going into its presidency. Ilze Juhansone said that the three priorities will be boosting competitiveness, enhancing Europe’s digital services, and fostering greater engagement between members states.
She also talked at length about the current system of sanctions being imposed on Russia by the EU as a result of the conflict in Ukraine. “From our national perspective and also from the EU perspective sanctions are not a policy, sanctions are an instrument, a foreign policy instrument, not a goal. So we have supported sanctions when the EU immediately reacted, but have always also said that if the situation de-escalates, which unfortunately is not the case, we are also ready to look at reducing sanctions.”
Russia hasn’t reacted well to the prospect of Latvia heading up the EU, and in particular statements made by Juhansone regarding propaganda emanating from Moscow. Juhansone had said in November during a discussion with journalists that Russia was lurching back towards the propaganda-driven tactics of the Soviet era. “With the latest developments in Ukraine, we felt a massive increase of propaganda on Russian-speaking channels.”
The government has banned Russian state-television broadcasts in Latvia as a result of the propaganda. “Unfortunately, when I’m looking at those channels, my feeling is that I’m back to the 1980s”, said Juhansone.
Stepping away from Russia, Latvia intends to promote itself as a forward-thinking, modern country, but with a rich cultural heritage. Events planned during Latvia’s six months in charge of the EU include a number of cultural, historical and diplomatic showcases throughout the country. Nearly 200 events will promote the idea of a united Europe, as well as the end of the Second World War, contemporary arts, and social developments as art. Tours and concerts will run throughout the six months, largely based in Riga, and will include contributions by the Latvian National Symphony Orchestra, Latvian Radio Choir, Sinfonietta Riga, and Kremerata Baltica.
Energy surge
With such a heavy reliance on Russian oil and gas, Latvia is in need of diversifying its energy mix. It is looking at boosting various forms of renewable energy, and is Europe’s second largest consumer of renewable energy. Latvia is also enthusiastically supporting calls for a EU Energy Union.
In November, Foreign Minister Edgars Rinkēvičs gave a speech at the Copenhagen Energy Security Dialogues event, where he said that energy was not merely an economic issue for countries, but also a geopolitical one. Citing the problems in Ukraine, he said that a European Energy Union would be a priority of Latvia’s presidency in the first half of 2015. This would mean the building and upgrading of infrastructure between EU member states, and in particular the grid network with the Baltic States. Some of this might come from the huge €350bn ($437bn) fund of investments set out for the EU in the coming years.
Jean-Claude Juncker, the newly installed President of the European Commission, has talked at length about the need for greater cooperation between member states over energy issues, and Latvia’s support for an energy union will have been warmly received.
Juncker said that the recent Transatlantic Trade and Investment Partnership (TTIP) between the US and the EU would be a good starting point for collaboration over energy needs. It’s unsurprising that Latvia would like to see the US relax its restrictions on energy exports, and it is hoped that such a move might eventually allow the US to fill the gap left by continued sanctions against Russia.
Uncertain future
Latvia represents one of the few former Soviet states to successfully embrace the EU and the euro, while at the same time skillfully navigating what was a disastrous financial crisis. As a member of the EU it can teach a lot of its partners about how to deal with massive economic problems and get back to growth. However, the optimism that abounded in Latvia at the start of 2014 was quickly turned to concern over the actions of its domineering neighbour to its east.
While Russia can no longer lay claim to Latvia now that it is part of the EU, its attitude towards Ukraine is quite different. In the coming months, if Russia continues to destabilise the region, Latvia’s economic optimism will take an even greater hit. Its leadership of the EU council should present Latvia with the perfect opportunity to shape EU policy towards ensuring that its interests are taken care of. While a harder line against Moscow could severely harm Latvia’s economy, allowing Russia to further meddle in the region will have much more serious long-term consequences for a country with so much economic potential.
