Recent Economic Developments in Latvia and Medium-term

Outlook

January, 2012

Macroeconomic Overview

2

After a robust economic growth in 2011, GDP is expected to slow down due to weakening external demand and global uncertainty

Real GDP growth (%)

5.6% 6.6%

3.4%

2.5%

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

2010 Q1 Q2 Q3 Q4 2011 Q1 Q2 Q3 2011F 2012F

Source: Central Statistical Bureau of Latvia, F - Bank of Latvia forecast 3

In 2011, export performance has supported recovery of domestic demand

Real GDP growth (y-o-y, %) and contribution to the growth (percentage points)

Source: Central Statistical Bureau of Latvia

-20

-15

-10

-5

0

5

10

15

20

2010

Q1

Q2

Q3

Q4

2011

Q1

Q2

Q3

Private consumption Public consumption GFCF Changes in inventories Exports Imports GDP, % yoy

4

Rebound in manufacturing has been underpinned by strong export expansion

70

80

90

100

110

120

130

140

150

Q1

2006

Q2

Q3

Q4

Q1

2007

Q2

Q3

Q4

Q1

2008

Q2

Q3

Q4

Q1

2009

Q2

Q3

Q4

Q1

2010

Q2

Q3

Q4

Q1

2011

Q2

Q3

Manufacturing (seasonally adjusted data) Manufacturing (non-adjusted data) Real exports (nsa) Real exports (sa)

Manufacturing output volume index and real export (2005 = 100)

Source: Central Statistical Bureau of Latvia

Global prices as well as indirect taxes contributed most to the increase in inflation

4.4

0.6 -0.5

-8

-6

-4

-2

0

2

4

6

8

10

12

I 2009

III V VII IX XI I 2010

III V VII IX XI I 2011

III V VII IX

Energy Food 12 month inflation (%) Inflation excluding food and energy (%) Inflation excluding food, energy at constant tax rate

Annual average inflation forecast: 2011 – 4.4% 2012 – 2.4%

Y-o-y inflation excluding food, energy prices and tax changes (%), contributions (percentage points)

Source: Central Statistical Bureau of Latvia; Bank of Latvia’s calculations and forecast

Unemployment rate continued to decline

17.3

11.5

6.5 6.3 7.2

9.9

13.9

16.7 18.4

19.7 20.5 19.4 17.9

16.9 16.6 16.2

18.7

15

.9

15.1

0

5

10

15

20

2008

I II

III

IV

V

VI

VII

V

III

IX

X

XI

XII

20

09 I II

II

I IV

V

V

I V

II

VII

I IX

X

X

I X

II

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 20

10

2011

F

2012

F

Registered unemployment rate Unemployment rate (Labour Force survey)

Unemployment rate (% of economically active population)

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

Competitiveness issues

8

Wage-productivity gap has been closed

90

100

110

120

130

140

150

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

2011

Q1

Q2

Q3

Labour productivity Real wage

Labour productivity and real wages (2005 Q1 = 100; seasonally adjusted)

Source: Central Statistical Bureau of Latvia; Bank of Latvia’ s calculations 9

The price and cost competitiveness has improved markedly as compared to the pre-crisis levels

75 80 85 90 95

100 105 110 115 120 125 130

2000

I IV

VII

X

20

01 I IV

V

II

X

2002

I IV

VII

X

20

03 I IV

V

II

X

2004

I IV

VII

X

20

05 I IV

V

II

X

2006

I IV

VII

X

20

07 I IV

V

II

X

2008

I IV

VII

X

20

09 I IV

V

II

X

2010

I IV

VII

X

20

11 I IV

V

II

X

REEER_CPI REEER_PPI REEER_ULC_manuf

Source: Bank of Latvia

The REER of the lats (Jan 2000 / Q1 2000) = 100)

10

0.00

0.15

0.30

0.45

EU27 72.8%

Germany 8.3%

UK 3.1%

Sweden 6.2%

Denmark 3.3%

Finland 3.2%

Poland 5.8%

Russia 10.2%

Latvia’s export market shares are growing in most of our key markets reflecting gains in competitiveness

Share of Latvian exports in particular country’s imports, % (4q-moving average), 2008 Q4–2011 Q3

0

3

6

9

12

Estonia 14.5%

Lithuania 17.5%

Source: Eurostat, Central Statistical Bureau of Latvia; Bank of Latvia’s calculations 11

External imbalances have seen a significant improvement resulting in a sustainable level of CA and its components

-22.6 -22.4

-13.1

8.6

3.0 1.1 0.9

-3.7

0.6 -0.6

-25

-20

-15

-10

-5

0

5

10

2006 2007 2008 2009 2010 Q1 2011 Q2 2011 Q3 2011 2011F 2012F

Current transfers Income Goods and services Current account

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

Current account main positions (% of GDP)

The pickup in FDI inflows reflects growing investor interest

Net FDI inflows(% of GDP)

8.4 8.1

3.8

0.4

1.6

6.1

0

5

10

2006

2007

2008

2009

2010

9 m

onth

s 20

11

13 Source: Bank of Latvia

Monetary and Financial Market Developments

14

Both tight lending standards and low demand for loans determined credit decline

-20

0

20

40

60

80

100

I 200

4 IV

VII

X

I 2

005 IV

VII

X

I 2

006 IV

VII

X

I 2

007 IV

VII

X

I 2

008 IV

VII

X

I 2

009 IV

VII

X

I 2

010 IV

VII

X

I 2

011 IV

VII

X

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

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

15 Source: Bank of Latvia

0

500

1000

1500

2000

2500

3000

3500

4000

4500

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

Net foreign assets Monetary base

The backing of the monetary base with foreign reserves exceeds 150%

16 Source: Bank of Latvia

Net foreign assets and Monetary base (mln lats)

Capital adequacy ratios continued to be significantly higher than the required minimum of 8%

0

2

4

6

8

10

12

14

16

18

Q1 2006

Q2 Q3 Q4 Q1 2007

Q2 Q3 Q4 Q1 2008

Q2 Q3 Q4 Q1 2009

Q2 Q3 Q4 Q1 2010

Q2 Q3 Q4 Q1 2011

Q2 Q3

CAR Tier 1 ratio

Capital adequacy ratios (%)

Source: Financial and Capital Market Commission 17

Liquidity level remains very high

30

40

50

60

70

Q1

2006

Q2

Q3

Q4

Q1

2007

Q2

Q3

Q4

Q1

2008

Q2

Q3

Q4

Q1

2009

Q2

Q3

Q4

Q1

2010

Q2

Q3

Q4

Q1

2011

Q2

Q3

Source: Financial and Capital Market Commission

Liquidity ratio (defined by FCMC, %)

18

Non-performing loans have peaked in Q3 2010; signs of improvement are evident

0

500

1000

1500

2000

2500

3000

0 2 4 6 8

10 12 14 16 18 20

1Q 2008 3Q 1Q 2009 3Q 1Q 2010 3Q 1Q 2011 3Q

Mln. of lats %

Share of provisions in outstanding loans Share of loans over 90 days past due in outstanding loans Provisions (right-hand scale) Loans over 90 days past due (right-hand scale)

Amount of loans over 90 days past due, provisions and their share in outstanding loans

Source: Bank of Latvia, Financial and Capital Market Commission

RIGIBOR rates still remaine at low levels

0%

5%

10%

15%

20%

25%

30%

RIGIBOR 3M RIGIBOR 6M RIGIBOR 12M

Money market rates (%)

Source: Bank of Latvia 20

21