Press Release No. 14/203

Press Release: IMF Executive Board Discusses Baltic Cluster Report on the Republics of Estonia, Latvia, and Lithuania

May 8, 2014

On May 2, 2014, the Executive Board of the International Monetary Fund (IMF) discussed the Baltic Cluster Report on the Republic of Estonia, the Republic of Latvia, and the Republic of Lithuania, which complements the Article IV consultations for these countries. The report is part of an IMF pilot project on clustering Article IV consultations, which looks at logical groups of economies and considers policies in an integrated way. These consultations also aim to fill the gap between bilateral surveillance (on the ground appraisals of individual countries) and multilateral surveillance (oversight of the global economy). In this respect, it follows the recommendations of the 2011 Triennial Surveillance Review and is part of the IMF’s efforts to strengthen work on interconnectedness.

The Baltic countries share similarities in their economic structure and their trade and financial linkages to the Nordic countries are important. As they are charting the course of economic convergence, they also face some common challenges.

While significant progress has been made since the crisis in improving the resilience of the Baltics’ financial systems, the Baltic economies are not yet providing much credit to support the ongoing recovery. Hence, their recoveries have been so far largely creditless and credit is lagging that of other episodes of creditless recoveries. Reviving credit growth is essential to sustain economic growth, and, in the longer term, foster income convergence.

A key feature of the Baltic’s post-crisis recovery has been their success in increasing exports. However, some aspects of the Baltics’ exports performance—including a high concentration in labor-intensive goods—raises questions as to how well positioned they are to extend this good performance, but maintaining export competitiveness will remain important to extend the recovery.

The Baltic economies also still face high unemployment, with staff estimates suggesting that much of this unemployment is structural in nature. This is despite the presence of relatively flexible labor markets. At the same time, labor taxation is high and skill and education mismatches also appear present. Further progress on income convergence calls for the best use of available labor resources, especially in the context where the labor force is declining.

Executive Board Assessment¹

Executive Directors welcomed the Baltic Cluster Report, which usefully complements the Fund’s regular bilateral consultations with Estonia, Latvia, and Lithuania. Directors commended the authorities and staff for their successful collaboration in identifying common features and challenges, while highlighting scope for cooperative policy responses. They looked forward to further discussion of country-specific policies in the Article IV consultations of these countries respectively.

Directors noted that the Baltics share key economic features and linkages. While there is no articulated “Baltic Model,” all three countries have made impressive strides in advancing income convergence with Western Europe over the past two decades, based on generally prudent macroeconomic policies, small governments, and a relatively favorable investment climate. Directors highlighted the Baltics’ strong economic integration with Western Europe in general and the Nordic economies in particular, through banking, foreign direct investment, and trade.

Directors underscored that the “creditless recoveries” in the Baltics could become increasingly difficult to sustain. They commended the strong economic recovery from the 2008/09 crisis, but noted that it has been accompanied by contracting credit to the private sector. While not an unusual pattern in a boom-bust cycle, continued anemic credit could constrain investment and growth. In this context, they were encouraged by the recent real credit growth in Estonia. They recommended further improving the insolvency regimes to address remaining debt overhang and to improve banks’ risk perception. Over the medium term, Directors encouraged the authorities to explore additional promising initiatives to deepen non-bank sources of financing, including alternative exchanges with less stringent reporting requirements, regional ratings agencies, and securitization.

Directors highlighted the importance of securing a vibrant export sector for the future. Strong export growth has been instrumental for the post-crisis recovery in the Baltics, with improved price competitiveness being a key factor that should be preserved. Directors noted, however, that future export success cannot be taken for granted, especially considering the Baltics’ reliance on labor intensive exports in conjunction with adverse demographics. They stressed that structural reforms will be critical for longer-term competitiveness, including upgrading labor force skills and better labor force utilization, along with infrastructure improvements and efforts to further capitalize on the relatively favorable business environment.

Directors expressed concern about the still high unemployment in the Baltic economies. Despite considerable resilience and flexibility in labor markets in the wake of the crisis, Directors considered current unemployment largely structural in nature. They recommended two areas for improvement: a reduction of the Baltics’ relatively high tax wedge in a fiscally-neutral manner, and greater emphasis on education, training, and other active labor market policies to tackle skill mismatches.

Directors encouraged the authorities to supplement national policies with joint action as they address potential challenges in credit, export, and labor markets. In this context, Directors supported active regional cooperation, particularly for upgrading the energy sector and exploring alternative energy options, investing in transportation infrastructure, and developing the non-bank financial sector.

¹ At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://0-www-imf-org.library.svsu.edu/external/np/sec/misc/qualifiers.htm.