Architect of Latvia’s Economic Miracle

Prime Minister Dombrovskis
Prime Minister Dombrovskis

Prime Minister Valdis Dombrovskis has been called the ‘Architect of Latvia’s Economic Miracle’. He explains how his government managed to turn the economy around.

European Times: You formed your first cabinet in 2009 when Latvia was on the verge of bankruptcy. Now, after four years and three cabinets, Latvia is the EU’s fastest-growing economy. How did you do it?

Valdis Dombrovskis: The problems started after Latvia joined the EU and NATO in 2004. There was probably too much optimism after that. This positive outlook coincided with a general optimism in global financial markets. Latvia began to register huge capital inflows, but unfortunately this capital was not put to productive use. Inflation neared double digits, the current-accounts deficit was more than 20% of GDP, and there was a property-market bubble. And, to make matters worse, the Latvian government at that time did not balance the budget in spite of double-digit growth. Then, the real-estate bubble burst, the economy started to shrink, currency devaluation seemed inevitable, and Parex Bank, Latvia’s largest independent commercial bank, could not refinance its syndicated loans and had to be nationalised. In late 2008, Latvia turned to the IMF for help. A couple of months later, the government collapsed. That is when my government took office with the mission of sorting out this situation.

European Times: How did you turn the economy around?

Valdis Dombrovskis: The key factors were fiscal consolidation, economic stimulus measures and a reinforced social safety net. Between 2008 and 2012 we implemented severe and unpopular fiscal-adjustment measures adding up to 17% of Latvia’s GDP. These included reducing public-sector salaries by around 25%, reducing the size of ministries by around one third, cutting in half the number of government agencies, and making comprehensive reforms in education and healthcare. Roughly two-thirds of the fiscal adjustments came from expenditure cuts, while the remaining third was in tax increases. We raised all kinds of taxes and introduced new taxes, for example a capital-revenue tax and capital-gains tax. There is a lot of discussion in Europe today about austerity versus growth. In Latvia’s case, we had to restore financial stability before the economy could grow again, so we made adjustments quickly, mainly in 2009. By 2010 Latvia’s financial sector was stabilising and, by the second half of 2010, the economy began to grow again. When there is no financial stability, banks do not lend, businesses do not invest, citizens do not spend, and the country falls deeper into recession. Once financial stability is restored, the opposite happens.

European Times: What did you do to stimulate the economy?

Valdis Dombrovskis: We needed to counteract the fiscal adjustments we were making, so we stepped up our absorption of EU funds and used these funds to boost growth, especially of export-oriented industries, and to support social programmes. Between 2008 and 2009, we increased our absorption of EU funds by three-fold. We created additional social safety net provisions by prolonging unemployment benefits and increasing guaranteed minimum income benefits, improving accessibility to healthcare and medicines for the poor, co-financing benefits with local governments, and, probably most important of all, introducing major temporary work programmes. This helped us avoid the kind of social instability that Greece is currently experiencing. For the past two years, Latvia has increased its exports by an average 30% and achieved a more than 10% increase in industrial production. One could say that industrial production and exports got the country out of the crisis.

European Times: Is the current growth stable?

Valdis Dombrovskis: Yes. We anticipate GDP growth of close to 5% for 2012 compared to 5.5% in 2011. One factor helping Latvia is that most of our foreign trade is with the Baltic and Nordic countries as well as Poland, Germany and Russia, and all these economies are doing relatively well. The Baltic region, in fact, is registering the most dynamic development in the EU.

European Times: What specific measures have you adopted to keep the economy healthy and how much of Latvia’s current success depends on you personally?

Valdis Dombrovskis: Prime Ministers and governments can change, but if the right structures are in place, economic stability can be maintained. We have built the right foundations. We have boosted Latvia’s World Economic Forum competitiveness ranking by nine positions through increasing wages and productivity, reducing personal income tax from 25% to 20% over the next three years, and reducing the ‘shadow’ economy. We now offer reductions in corporate income tax for certain large projects and we want to use EU funds to add value to our traditional sectors, including wood processing, food production, metal processing and machinery, chemicals and pharmaceuticals, transport and logistics, and ICT. Our budget deficit dropped to below 1.9% of GDP in 2012 and we aim for 1.4% in 2013. Interest rates are low, our credit ratings are rising, and the economy is growing. We aim to sustain this momentum.

European Times: What is your message to potential foreign investors?

Valdis Dombrovskis: Latvia is certainly one of the best places to invest today. Riga ranks number one among EU capitals in value for money as a business location, and Latvia has a competitive and highly skilled workforce, one of the EU’s lowest tax burdens, excellent communications and transport infrastructure, and many opportunities, including the privatisations of Citadele Bank, Air Baltic, and part of Mortgage and Land Bank. We have also established the Large Investment Projects Coordination Council to support investors. As a result of all this, we are seeing quite a substantial increase in FDI in Latvia.