BANK OF LATVIA: ANNUAL REPORT 2010 ISSN 1407–1800 BANK OF LATVIA: ANNUAL REPORT 2010 In Charts, the dots indicate the actual data, and the lines reflect the smoothing approximation of the data. The smoothing approximation of the daily data is more distinguished than the curve of the actual data. Details may not add because of rounding-off. – no transactions or no outstanding amounts in the period. x no data available or no computation of indicators possible. 2 0 the indicator is below 0.5 but over 0, or the result of the computation of the indicator is 0. 2 0 1 0 T REPOR L A N N U A : A VI T A B A N K O F L © Latvijas Banka, 2011 The source is to be indicated when reproduced. Photos by Aivars Liepiņš and Andris Tenass. The cut-off date is 26 April 2011. CONTENTS Foreword of the Governor 5 3 The Bank of Latvia Vision and Mission 9 Economic Environment 11 2 0 1 0 Global Economic Environment 12 T Latvia's Economic Environment 14 Inflation and Prices 14 REPOR Gross Domestic Product 16 Labour Market 18 L Foreign Trade, Balance of Payments and External Debt 19 Fiscal Developments 22 A N N U A : Banking Developments 23 A Money Supply 25 VI T Monetary Base 30 A Lending and Deposit Rates 31 Interbank Market 32 Foreign Exchange Market 33 Securities Market 35 B A N K O F L Bank of Latvia Operations and Activities 39 Legal Framework and Functions. The Bank of Latvia in the European System of Central Banks and Institutions of the European Union 40 Development, Adoption and Implementation of Monetary Policy 41 Provision of Currency in Circulation 45 Payment and Settlement System Operation 48 Financial Stability 51 Operation of the Credit Register 52 Statistics 53 Providing Financial Services to the Government 54 Advisory Activities and Information to the Public 55 Cooperation with International Organisations and Foreign Central Banks 59 Bank of Latvia Management and Organisation 61 Bank of Latvia Organisational Structure 62 Management Principles and Development 65 Resource Management 66 Risk Management 70 Internal and External Audit 71 Financial Statements of the Bank of Latvia for the Year Ended 31 December 2010 73 Independent Auditors' Report 118 Appendices 119 1. Monetary Indicators in 2010 120 2. The Bank of Latvia Month-End Balance Sheets for 2010 121 3. The Bank of Latvia Year-End Balance Sheets for the Years 2006–2010 122 4. The Bank of Latvia Profit and ossL Statements for the Years 2006–2010 123 5. The Bank of Latvia Exchange Rates for the British Pound Sterling, the Japanese Yen and the US Dollar 123 6. The Bank of Latvia Organisational Units at the End of 2010 124 7. Representation of the Bank of Latvia in International Organisations 127 8. The Bank of Latvia Publications and Major Publications by the Bank of Latvia Experts in 2010 129 9. 2010 Highlights of Regulatory Documents Adopted in Pursuit of the Bank of Latvia Main Tasks 130 10. Glossary 132 4 Abbreviations BIS Bank for International Settlements CIS Commonwealth of Independent States 2 0 1 0 CSB Central Statistical Bureau of Latvia T EBA European Banking Authority EC European Commission ECB European Central Bank REPOR EEA European Economic Area L EFC Economic and Financial Committee EKS Bank of Latvia's Electronic Clearing System EMU Economic and Monetary Union A N N U A : ERM II Exchange Rate Mechanism II A ESA 95 European System of Accounts 1995 VI T ESCB European System of Central Banks A EU European Union EU12 countries which joined the EU on 1 May 2004 and 1 January 2007 ESRB European Systemic Risk Board Eurostat Statistical Bureau of the European Union B A N K O F L FCMC Financial and Capital Market Commission FRS US Federal Reserve System GDP gross domestic product IMF International Monetary Fund JSC joint stock company LCD Latvian Central Depository Ltd. limited liability company M0 monetary base M1 narrow monetary aggregate M2 intermediate monetary aggregate M2X broad money M3 broad monetary aggregate MFI monetary financial institution Ministry of Finance Ministry of Finance of the Republic of Latvia OECD Organisation for Economic Co-operation and Development OFIs other financial intermediaries, excluding insurance corporations and pension funds OPEC Organization of the Petroleum Exporting Countries RIGIBID Riga Interbank Bid Rate RIGIBOR Riga Interbank Offered Rate SAMS Bank of Latvia's Interbank Automated Payment System SDR Special Drawing Rights SEPA Single Euro Payments Area SJSC state joint stock company Treasury Treasury of the Republic of Latvia UK United Kingdom US United States of America FOREWORD OF THE GOVERNOR FOREWORD OF 5 B A N K O F L A T VI A : A N N U A L REPOR T 2 0 1 0 6 2 0 1 0 T REPOR L A N N U A : A VI T A B A N K O F L After a globally unprecedented deep yet brief recession, the Latvian economy in 2010 saw macroeconomic stabilisation supported by recovered export competitiveness. That is one of the structural changes indispensable for sustainable development, which indicates that the path of overcoming the crisis taken by the Latvian government and supported by the monetary policy of the central bank has been chosen correctly. The difficult and complicated work of balancing the budget is going on. Without it, no new investments, job vacancies or tax revenues would be possible, yet the process was protracted and precluded reaping the benefits of a faster fiscal consolidation. The opportunity to cut expenditure more rapidly, which would have helped to resume economic activity sooner and more tangibly for enterprises, has been left unused for several years. Therefore overall, we must consider last year as a year of lost opportunity. It was common knowledge at the beginning of the year that to cut the budget deficit to 6% of gross domestic product in 2011 a fiscal consolidation in the approximate amount of 300–400 million lats would be necessary, and the more decisive our actions, the easier we will have it fiscally in 2012. The economic policy makers were well aware also of the need for the work on the budget to proceed briskly, so that the necessary structural reforms could be conducted in a thoughtful and coordinated manner. It could be predicted that the drafters of the budget will run out of time after the parliament elections in autumn, and, in the absence of timely preparation, we will not face economically beneficial and well-thought cuts in expenditure aimed at expedience but raised taxes that hinder the economic growth. The nine months before the parliament elections were not used to clarify the situation, with economists and investors alike in the dark about the future link between fiscal consolidation and changes in taxation. Cutting the budget deficit took place, to a large extent, at the expense of higher tax revenues (of the approximately 300 million lats fiscal consolidation, expenditure cuts account for only 90 million lats in the 2011 budget). In order not to cut the budget deficit all at once by 2 billion lats during the crisis, Latvia used the opportunity to gain time to conduct structural reforms gradually, in the course of three years, stabilise the economy and, in time, become capable of paying off the loan. So far, however, the still high budget deficit has meant a growing public debt, which has inevitably raised the costs of debt servicing: in 2011 they will amount to about 270–300 million lats (50 million lats before the crisis). In the absence of better credit ratings in the future, Latvia can be expected to have difficulty in refinancing and paying off the 7 government debt that has grown substantially during the crisis (from 1 billion lats to about 5 billion lats in three years; in 2014 and 2015 combined, a debt of 2.3 billion lats will have to be refinanced). 2 0 1 0 Latvia spends large resources to service its public debt. Money from the international T lenders has given it respite and an opportunity to pay less in interest than currently offered REPOR by the world financial markets. Once the loan programme comes to an end at the close of 2011, it will be important for Latvia to appear to potential investors as an attractive L country with sustainable growth. This is important for Latvia to borrow cheaper resources. A N N U A A balanced budget would also open up the opportunity for Latvia's rating to gradually : return to the safe investment category in the assessment of not one but all international A VI credit rating agencies. Barring that, we must reckon with stagnating growth and tax T A revenue and the need to continue fiscal consolidation also in 2013 in the situation of hindered economic growth, lack of new job vacancies, and growing inflation expectations. In the period at hand, exports were and to this day still are the driver of the Latvian economy. That was determined both by the growth in foreign demand and increased B A N K O F L competitiveness of Latvian producers. In 2010, Latvia exported goods and services in the amount of 6.7 billion lats, a 1 billion year-on-year increase. This is the largest revenue from exports ever registered in the history of Latvian economy and the growth of Latvian goods exports in 2010 (by 30%) was the fourth fastest in the European Union, outpaced only by Estonia, Lithuania, and Bulgaria. In addition, all of these countries are implementing similar exchange rate policies, which have helped along the recovery from the crisis.