EPC (ekonomiskās prognozēšanas centrs)

The impact of the global financial crisis on the industrial sectors of Eastern European countries and

industrial change in Croatia

The European Economic and Social Committee's Consultative Commission on Industrial Change (CCMI)

Public Hearing

The impact of the global financial crisis on the industrial sectors of Eastern European

countries and the case of the Baltic States (Latvia)

Acad. Raita Karnīte, EPC, Ltd

Zagreb, April 27, 2009

• Main aggravating factors of the crisis

• Possible solutions

• CEE countries, Baltic countries, Latvia

GDP per capita, current prices in PPS, 2007

Total external debt/GDP, %

General government debt/GDP, %

Budget balance/GDP, % FDI/GDP,%

Latvia 14,4 134,2 9,7 -0,04 8,0

Estonia 17,9 110,3 2,9 2,8 11,7

Lithuania 15,0 ? 17,3 -1,2 5,0

Hungary 15,7 97,7 66,0 -5,5 4,0

Bulgaria 9,5 97,3 19,8 3,5 21,1

Slovenia 22,0 96,5 24,1 -0,1 3,0

Croatia 13,9 89,1 38,9 -2,3 9,6

Slovakia 17,0 54,7 29,4 -2,2 3,8

Poland 13,3 48,3 45,0 -1,8 4,4

Czech Republic 20,3 38,0 28,7 -1,6 5,2

Rumania 10,1 31,7 18,6 -2,3 8,9

CEE countries - selected indicators, 2007 Source: CEE Quarterly, UniCredit Group

Main aggravating factors of the crisis – input

Massive money (loans) inflow since end 2003

Growing consumption (real estate, long-term household goods, cars)

Main activity - real estate market (speculative demand)

Consumption driven growth – 5 sectors (real estate, trade, banks, construction, building materials industry) provide 75% of GDP growth, 80% of growth on the basis of external money

Growing prices in resource sector (labour, energy, row materials)

Main aggravating factors of the crisis – outcome

Active markets (real estate and financial) saturate

Loan activity of banks slows down (loan/deposits ratio more >2 in foreign owned banks, <1 in local banks)

Declining financing – declining consumption

Scale and contribution of main industries to GDP decline – negative GDP growth

External market

Main aggravating factors of the crisis – industry

SME dominate, subcontracting (SME promoting policies)

Main exporters – wood processing, textiles, food industry - traditional products

Finances – loans less available, rare proposals for EU structural funds

Wage competition

Productivity

Internal consumption decline

External markets

Labour costs -one hour, LVL %

0

5

10

15

20

25

30

35

40

1/2004 2/2004 3/2004 4/2004 1/2005 2/2005 3/2005 4/2005 1/2006 2/2006 3/2006 4/2006 1/2007 2/2007 3/2007 4/2007 1/2008 2/2008 3/2008 4/2008

Series1

Production costs in construction, in % to relevant period of previous year

0

10

20

30

40

50

60

70

2006 I 2006 II 2006 III 2006 IV 2007 I 2007 II 2007 III 2007 IV 2008 I 2008 II

%

Construction, total Prices of building materials Wages and salaries Equipment

Number of market sector economicaly active companies

0

2

4

6

8

10

12

14

16

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Thsd

.

0

10

20

30

40

50

60

70

Construction (F) Real estate (K) Manufacture (D) Agriculture, forestry, fishing(A+B) Trade (G) Hotels and restaurants (H) Total (number on righ axe )

Turnover of retail trade in % of average monthly turnover in 2005

                                                                                                                                                                                                

                                                                                                                                                               

Manufacturing output (quarters 2000-2009, 2005 = 100)

                                                                                                                                                                                               

                                                                                                                                                                   

Exports and imports, miln. LVL

Dynamics of GDP, prices and wages, in % to previous period

-15

-10

-5

0

5

10

15

20

25

30

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Economic Growth Inflation Real wages Producers' prices

GDP, thsd LVL

0

2 000 000

4 000 000

6 000 000

8 000 000

10 000 000

12 000 000

14 000 000

16 000 000

18 000 000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 20080

1 000

2 000

3 000

4 000

5 000

6 000

7 000

8 000

Total, real prices Total - 2000 prices Per capita - real prices Per capita - 2000 prices

GDP in Baltic Countries

-15

-10

-5

0

5

10

15

I/2007 II/2007 IIII2007 IV/2007 I/2008 II/2008 III/2008 IV/2008

Latvija Lietuva Igaunija

Theoretical solutions

Markets are the main factors – internal consumption, exports (state procurement)

Production capacity - confidence, availability of resources (labour - education, health care)

Competitiveness – inovations, equal competition

Specialisation, mobilisation of resourses to selected, most profitable directions (post-war renovation experience)

Good social and security services• Confidence of tax payers• More money for state

The role of the state increases in post-crisis period

Business is not pessimistic

Arguments:

Lower resource prices

Less and better competition

Business environment more predictable

Time to mobilise for growth

Time to start business

Some worry about uncertain state policy, others do nat care

Real action

National level objectives :

To fulfill requirements of international organisations

State budget deficit less than 5% (7% is not allowed)

Wage cut on 15%, 20% ... in four steps (recently 40% cut is under discussion)

Economy in social expenditures (education and science 30-40% less, health care less, schools and hospitals closed)

Reforms in public sector – what and why - capacity of public institutions in difficult period

Implementation of memorandum is strongly controlled

Is Latvia unique????

Priorities:

Cut of costs, not devaluation of lats (CB reserves in foreign currency will not be published in future)

In economics:

Strenghtening of financial system (international aid (loan) to banks (36% of total) and state budget (35% of total plus 21% for refinancing of state debt plus 8% for loans from the state budget)

Heating of economy through state procurements in infrastructure projects (housing) – budget??

Capacity rising of SMS companies – market ????

EU Structural funds – credit guaranty system

Exports – export guaranty system (90% of export value, not more than 1 million EUR per deal, high

requirements)

No proposals in market development

Conclusion

Market forces will be the main politician in the field of economic policy

Industry development is not clear

High level of free economic capacity but this need to be employed

Social crisis may cause human crisis

Better is slow recovery on the basis of industry than on the basis of “new” money – impact of local government elections

The role of government is important

International organisations

Thank You for attention !