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Republic of Latvia Presentation November/December 2015 A Performing Eurozone Economy Disclaimer This presentation and its contents are confidential and may not be reproduced, redistributed, published or passed on to any other person, directly or indirectly, in whole or in part, for any purpose and should not be treated as offering material of any sort. If this presentation has been received in error it must be returned immediately to the Ministry of Finance of the Republic of Latvia (“Latvia”). This presentation is not directed at, or intended for distribution to or use by, any person or entity that is a citizen or resident of, or located in, any locality, state, country or other jurisdiction where such distribution or use would be contrary to law or regulation or which would require any registration, licensing or other action to be taken within such jurisdiction. THIS PRESENTATION IS NOT FOR PUBLICATION, RELEASE OR DISTRIBUTION, DIRECTLY OR INDIRECTLY, INTO THE UNITED STATES, AUSTRALIA, CANADA OR JAPAN OR ANY OTHER JURISDICTION IN WHICH SUCH PUBLICATION, RELEASE OR DISTRIBUTION WOULD BE UNLAWFUL. This presentation and the information contained herein are not an offer of securities for sale in the United States or any other jurisdiction. No action has been or will be taken by Latvia in any country or jurisdiction that would, or is intended to, permit a public offering of securities in any country or jurisdiction where action for that purpose is required. In particular, no securities have been or will be registered under the U.S. Securities Act of 1933, as amended (the “Securities Act”) or with any securities regulatory authority of any state or other jurisdiction of the United States and securities may not be offered, sold or delivered within the United States except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws and may only be sold outside of the United States in reliance on Regulation S under the Securities Act and otherwise in compliance with all applicable laws and regulations in each country or jurisdiction in which any such offer, sale or delivery of securities is made. Latvia does not intend to register or to conduct a public offering of any securities in the United States or any other jurisdiction. This presentation and its contents may not be viewed by persons within the United States (within the meaning of Regulation S under the Securities Act). This presentation is directed solely at (i) persons who are outside the United Kingdom, (ii) persons in the United Kingdom who have professional experience in matters relating to investments falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 as amended (the “Order”) and (iii) those persons in the United Kingdom to whom it may otherwise lawfully be communicated (all such persons together being referred to as “relevant persons”). In the United Kingdom, this presentation is directed only at relevant persons and persons who are not relevant persons should not in any way act or rely on this presentation. Any investment activity to which this presentation relates will only be available to and will only be engaged with relevant persons. This presentation does not constitute or form part of, and should not be construed as, an offer or invitation to sell securities of Latvia, or the solicitation of an offer to subscribe for or purchase securities of Latvia, and nothing contained herein shall form the basis of or be relied on in connection with any contract or commitment whatsoever. Any decision to purchase any securities of Latvia should be made solely on the basis of the conditions of the securities and the information contained in the offering circular, information statement or equivalent disclosure document prepared in connection with the offering of such securities. Prospective investors are required to make their own independent investigations and appraisals of the business and financial condition of Latvia and the nature of any securities before taking any investment decision with respect to securities of Latvia. By accessing this presentation the recipient will be deemed to represent that they possess, either individually or through their advisers, sufficient investment expertise to understand the information contained herein. The information in this presentation has not been independently verified. No representation or warranty, express or implied, is made as to the accuracy, completeness or fairness of the presentation and the information contained herein and no reliance should be placed on such information. None of Latvia, its advisers, connected persons or any other person accepts any liability for any loss howsoever arising, directly or indirectly, from this presentation or its contents. This presentation should not be construed as legal, tax, investment or other advice and any recipient is strongly advised to seek their own independent advice in respect of any related investment, financial, legal, tax, accounting or regulatory considerations. There is no obligation to update, modify or amend this presentation or to otherwise notify any recipient if any information, opinion, projection, forecast or estimate set forth herein changes or subsequently becomes inaccurate or in light of any new information or future events. This presentation contains forward-looking statements, which include all statements other than statements of historical facts, including, without limitation, any statements preceded by, followed by or including the words “anticipates,” “estimates,” “expects,” “believes,” “intends,” “plans,” “aims,” “seeks,” “may,” “will,” “should” or similar expressions or the negative thereof. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors beyond Latvia's control that could cause Latvia’s actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements speak only as at the date of this presentation. Latvia expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statements contained herein to reflect any change in its expectations with regard thereto or any new information or change in events, conditions or circumstances on which any of such statements are based. 2 For convenience, an exchange rate of EUR/LVL: 0.702804 was used throughout this presentation and it is the exchange rate Latvia used to adopt euro as lawful currency on 1 January 2014. Presentation Overview 1. Overview 4 2. Latvia’s Economy Continues to Perform Strongly 9 3. Stable and Well Capitalised Banking Sector Prepared to Restore Credit Growth 19 4. Outstanding Track-record of Fiscal Consolidation and Structural Reforms 24 5. Government Debt and Funding Strategy 31 6. Credit Positioning of Latvia 36 7. Conclusion 38 8. Tender Offer 40 9. New EUR Issuance 43 Overview Latvia Overview - High income(1), advanced economy(2) Key Facts on Latvia • • • • • • • • • Territory: 64,569(3) sq. km Capital: Riga (population 0.64 million(3)) Population (1/1/2015): 2.0 million(3) GDP per capita (2014): EUR 11,824(3) Nominal GDP (2014): EUR 23.6 billion(3) Currency: Euro €(4) Credit ratings: A- (S&P), A3(Moody’s), A- (Fitch), BBB+ (R&I) Borders: Estonia, Russia, Belarus, Lithuania Main economic sectors: — Services (74.5%(3) GDP in 2014): logistics, IT, financial, trade — Manufacturing (12.2%(3) of GDP in 2014): wood, metal, chemicals, pharma, food Source: (1) - World Bank classification; (2) - IMF classification; (3) - Central Statistical Bureau of Latvia, (4) - formerly the Lat (LVL), Euro adopted as lawful currency on 1 January 2014 Latvia’s historic strides to become a robust global economy Becomes a Member of the UN 1991 1991 Sep Sep 1991 1991 Latvia Regains Independence 5 Mar Mar 2004 2004 Entry into EU International Loan Programme with IMF/EC Closed Successfully Initial Memorandum delivered to OECD MayMay Dec DecDec 2011/ May MayMay May Jan Dec 2011/ 2004 2008 Jan 2012 2012 2013 2014 2008 2004 Jan 2012 2012 2013 Admitted to NATO Approval of Loan Programme with IMF, EC and Bilateral Lenders All rating agencies rate Latvia investment grade S&P and Fitch upgrades rating to A- May-Jun May-June Jan-Jun January 2014 2015 2014 2014 Latvia joins Eurozone/ EMU Moody`s upgrades Latvia’s rating to A3 Feb February 2016 2015 2015 Latvia’s Presidency of EU Council Target for OECD membership Key Features of Latvia’s Sovereign Credit Profile Sustained growth reached through a successful economic adjustment ● Average 3.9% GDP growth rate since 2011(1), when the post-crisis recovery started ● GDP growth was led by rising exports (driven by regained competitiveness), rebound of investments, and is supplemented by rising domestic demand in recent years ● Increased resilience to external risks, as net external debt is rapidly declining, and current account balance improved to a sustainable level ● Latvia joined the Eurozone on 1 January 2014, adopting the Euro as its lawful currency Eurozone member since January 2014 ● Latvia was already well integrated in the Eurozone's economy and the Eurozone membership reduced foreign exchange risks, eliminated currency conversion costs, improved financial stability and will facilitate trade and investments in the long term ● Participation in the Eurozone’s European Stability Mechanism brings additional financial security Strong fiscal position & rigorous fiscal discipline ● Over the last three years Latvia has consistently achieved one of the lowest fiscal deficits in the EU. General government budget deficit was 1.5% of GDP in 2014, while in the 2015 deficit is forecasted to be 1.4% of GDP ● Recent reform of social security system notably enhanced sustainability of government finance in the long term ● Fiscal prudence is ensured by the implementation of the Fiscal Discipline Law, including fiscal rules with an automatic correction mechanism (based on Swiss model), multi-year targets and independent oversight ● At the end of 2014, general government debt amounted to 41% of GDP and was one of the lowest in the EU Low government indebtedness & sound public debt management Stable and well capitalised banking sector — With a repayment of EUR 1.2bn to the European Commission in January 2015, Latvia’s general government debt is set to decline further relative to GDP in 2015 ● Latvia has successfully extended its EUR yield curve with a 7 and 10 year benchmark issues in 2014 ● Government debt has smooth redemption profile, while investor base is diversified across Europe and the US ● Well capitalised (21.6% CAR) and highly liquid (67,05% liquidity ratio) banking sector (2), predominantly owned by strong international owners ● The banking sector returned to profitability in 2012 and reached an 12,6% ROE in the-end-September 2014, as the quality of loan portfolio has been gradually improving since the mid of 2010(2) ● The three largest banks successfully passed the European Central Bank’s (ECB) comprehensive assessment in 2014, and are subject to the ECB’s Single Supervisory Mechanism since November 2014 Source : The Treasury (unless noted otherwise) Note: (1) - Central Statistical Bureau of Latvia; (2) – Financial and Capital Market Commission, capitalisation and liquidity ratios at the end of September 2015 6 Latvia is Benefiting from Eurozone Membership Since January 2014 Strong economic rationale ● For Latvia as a small, open economy with most of the trading partners in the euro area and EU, EMU membership brought greater exchange rate stability, reduced foreign exchange risks, and eliminated currency conversion costs ● In the long term Euro will give further boost to the economy and living standards by providing stimulus to trade and investments Solid political foundation ● Fully integrated in the EU political, economic and financial system Competitive economy with capacity to adjust ● Latvia has demonstrated that it has the structural flexibility needed to adjust to external imbalances and remained competitive in the context of a fixed currency regime Euro brings significant economic gains, reduces risk and enhances stability ● Eurozone membership has contributed to credit rating upgrades and further eased access to international capital markets, as Latvia re-opened EUR market in 2014 with a 7 and 10 year benchmark bond offerings achieving high oversubscription and record low borrowing costs ● Currently, Latvia benefits from ECB’s quantitative easing policy with the government bonds yields and spreads tightening on the back of ECB’s Public Sector Purchase Program ● Eurozone membership enhances financial stability through the Single Supervisory Mechanism and European Stability Mechanism ● Euro introduction has also helped to improve tax compliance since cash usage in the economy has fallen substantially, as evidenced by cash rate to monetary base dropping from an average of 38.6% in 2013 to an estimated 12.6% in 2014(1) Source: (1) Bank of Latvia; Since joining of the Eurozone, the cash ratio is approximated by the ratio, which is based on Latvia’s share to the ECB capital. 7 Rating Upgrades Reflect Latvia’s Successful Adjustment Efforts Rating agencies have recognised Latvia’s recovery from the crises, it’s continuing institutional strength, bold reforms, flexible labour markets and falling indebtedness Moody’s S&P Fitch Germany Aaa AAA AAA A/A2 Belgium Aa3 AA AA A-/A3 Czech Republic A1 AA- A+ Sovereign Long-term Foreign Currency Rating development BBB+/Baa1 BBB/Baa2 BBB-/Baa3 BB+/Ba1 A1 AA- A+ Slovakia A2 A+ A+ Fitch Poland A2 A- A- Moodys Latvia A3 (stable) A- (stable) A- (stable) A3 A- A- Lithuania Ba1 BB+ BB+ Jan-15 Hungary Jan-14 BBB+ Jan-13 BBB+ Jan-12 Baa2 Jan-11 Spain Jan-10 BBB+ Jan-09 A- Jan-08 Baa3 Jan-07 Slovenia Jan-06 BBB+ Jan-05 BBB- Jan-04 Baa2 Jan-03 Italy Jan-02 BB-/Ba3 Jan-01 A- Jan-00 A+ Jan-99 Baa1 Jan-98 Ireland Jan-97 BB/Ba2 Source: S&P, Fitch, Moody’s • 8 Estonia S&P Source: S&P, Fitch, Moody’s Over the last 2 years, Latvia benefitted from the rating upgrades to the upper medium grade category from all three major agencies Credit highlights (Standard & Poor’s) (1) Credit highlights (Fitch) (1) • “Latvia benefits from generally strong institutional and governance effectiveness.” “In our view, the government will maintain its focus on sustainable public finances, and energy supply diversification, as well as the efficient absorption of EU funds.” • “Latvia's fiscal position remains a ratings' strength.” • “Latvia has one of the lowest net general government debt levels in the eurozone.” • “With eurozone membership, Latvia now benefits from the highly developed capital market of the monetary union as well as the credibility of ECB monetary policy.“ • “Eurozone membership enhances the sovereign’s creditworthiness with the reduction of foreign exchange rate risks, greater fiscal financing flexibility via the euro’s reserve currency status, and allows Latvian banks access to European Central Bank liquidity facilities.“ Source: Standard and Poor’s (29 May 2015, 28 November 2014), Fitch (20 June 2014, 5 December 2014, 15 May 2015) Note: (1) Selected quotes. Full report can be obtained from respective rating agency • “Latvia is one of the fastest growing eurozone countries, with growth in line with 'A' rated peers.“ • “Latvia’s ratings are currently supported by the sovereign’s stronger fiscal position relative to its ‘A’ range peers, its stable banking sector, as well as Fitch’s baseline assumption that economic growth will stay resilient against geopolitical risks.” Latvia’s Economy Continues to Perform Strongly The Latvian Economy Remains Resilient Economic growth softened to 2.4% in 2014 and 2.7% in the first nine months of 2015, while the outlook is robust with strengthening of domestic demand projected to be the main growth driver in 2015-2016 Gross Domestic Product (current prices, EUR billion) and Growth (n.s.a., %) Average GDP growth 2011-2014 (YoY, %) GDP growth, YoY (%) Contribution to real GDP growth (%) 20 In 2014 and first half of 2015 GDP growth was balanced between household consumption and exports Public administration, defence, compulsory social securit; Education; Human health and social work activities 15.3% 10 5 0 -5 2010 2011 Private consumption 2012 Public consumption Source: Central Statistical Bureau of Latvia 10 2013 GFCF 2014 Exports 1H 2015 Imports (-) Other sectors 21.3% Agriculture, Forestry and Fishing 3.3% Manufacturing 12.2% Real estate activities 12.4% Construction 6.8% Information and Transportation communication and storage 4.6% 10.1% Source: Central Statistical Bureau of Latvia Wholesale and retail trade, repair of motor vehicles and motorcycles 14.0% Estonia Latvia Lithuania Malta Poland Ireland Luxembourg Source: Eurostat Composition of Gross Value Added by sectors in 2014 (%) 15 -10 Slovakia 2016F 2015F 2014 2013 2012 2011 GDP (EUR billion) Source: Central Statistical Bureau of Latvia, European Economic Forecast, Autumn 2015, European Commission No assurances can be given that forecasted information will prove to be correct and actual results may differ materially United Kingdom -5 Romania -4.0 Sweden -3 -6.0 2010 0 -2.0 Germany -3.8 -1 Hungary 5 0.0 EU-28 0.7% Austria 10 1 Bulgaria 3.0 France 2.4 Belgium 2.4 Denmark 3.0 15 3 2.0 3.9 Czech Republic 4.0 5 4.0 Slovenia 20.2 7 6.0 Netherlands 17.9 24.9 Croatia 21.8 24.1 Finland 20 23.6 22.8 Italy 25 Spain 6.2 Latvia has been one of the fastest growing EU economies over the last 4 years Cyprus 8.0 Greece 30 Portugal Economy is in the fifth year of stable growth Leading Indicators Point to Strengthening Domestic Demand and Sustained Economic Growth Amid rising consumer confidence retail sales growth has increased to 3.7% in 2014 and further accelerated to 6.3% in the first half of 2015 Consumer confidence indicator (Balance, %) Consumer confidence rises Retail trade turnover, S.A. data (2010=100) Source: Central Statistical Bureau of Latvia Note: Data on October 2015 Sep-15 May-15 Jan-15 Sep-14 May-14 Jan-14 Sep-13 Jan-13 May-13 Sep-12 Jan-12 May-12 90 Sep-11 -60 May-11 100 Jan-11 -50 Sep-10 110 May-10 -40 Jan-10 120 Sep-09 -30 Jan-09 130 May-09 -20 Sep-08 140 Jan-08 -10 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 150 May-08 Retail trade turnover is steadily increasing 0 Source: Central Statistical Bureau of Latvia Note: Data on September 2015 Economic sentiment indicators (Balance, %) Real manufacturing output, S.A. data (2010=100) Manufacturing output has surpassed pre-recession peak level Renewed confidence following recession 120 130 110 120 100 90 110 80 100 70 90 European Union (28 countries) Source: Eurostat; Note: Data on October 2015 11 Latvia Source: Central Statistical Bureau of Latvia Note: Data on September 2015 Sep-15 May-15 Jan-15 Sep-14 May-14 Jan-14 Sep-13 May-13 Jan-13 Sep-12 May-12 Jan-12 Sep-11 May-11 Jan-11 Sep-10 May-10 Jan-10 Sep-09 May-09 Jan-09 Sep-08 May-08 80 Jan-08 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 60 Resilient and Well Diversified Exports Continue to Support the Economy In 2014 Latvian exports of goods managed to grow by 2.3 percent, in spite of challenging external environment, including Russian sanctions, the falling rouble and slow recovery in Europe Merchandise exports revenue growth (2014 over 2009,%) Latvia remains among the leaders in terms of export growth in EU Exports of goods and services The economy has shifted towards tradable sector driven by regained competitiveness 54 20 49 42 15 8.4 54 53 52 12.0 12.3 45 40 9.7 8.5 9.6 10.8 11.8 120 60 100 50 80 40 60 30 40 20 98.1 20 0 5 10 Exports of goods and services (EUR billion) 2014 2013 2012 2011 2010 2009 2008 2007 0 2006 0 Exports of goods and services (% of GDP) Source: Central Statistical Bureau of Latvia Source: Eurostat Composition of merchandise exports by country (2014) CIS (ex. Russia) 4.2% Other 12,9% -20 Lithuania Latvia Bulgaria Estonia Romania Poland Slovakia Czech Republic Greece Portugal Cyprus United Kingdom Spain Slovenia Netherlands Germany Hungary Croatia Italy Austria Belgium Sweden France Denmark Finland Ireland Malta Luxembourg 10 9.5 53 Lithuania 18.7% Composition of merchandise exports by sector (2014) Textiles and textile articles 4.0% Other 14.2% Live animals and animal products 4.3% Other EU 14,1% Estonia 11.9% Transport vehicles 5.1% Vegetable products 5.4% Denmark 3.8% UK 5.0% Sweden 5.4% Poland 6.5% Source: Eurostat 12 Russia 10.7% Germany 6.9% Products of the chemical and allied industries 6.8% Mineral products 8.3% Source: Central Statistical Bureau of Latvia Wood and articles of wood 16.6% Machinery and mechanical appliances; electrical equipment 16.8% Prepared foodstuffs 9.4% Base metals and articles of base metals 9.1% Flexible and Diversified Exports Help Limiting the Impact of Russia’s Economic Downturn and Trade Sanctions Sanctions affect only small part of Latvian exports Merchandise exports to Russia and Ukraine (% of total exports) Past experience show high degree of export flexibility Drop in exports to Russia and other CIS countries has been compensated by growth in core export markets in 2014 35 30 Weight adjusted merchandise exports index (2007 = 100) 200 5.5 25 +2.3% 6.2 150 3.9 20 15 10 +4.6% 25.3 22.8 5 10.6 11.4 11.6 10.7 1997 2011 2012 2013 2014 0.9 1.4 2.9 6.6 2.4 4.2 7.9 1999 2000 2005 0 1996 0.9 2.9 21.0 12.1 1995 1.0 1998 Russia 100 0.7 0.6 Ukraine 7.7 2015 Jan Sep Source: Central Statistical Bureau of Latvia Exports to Russia are diversified Mechanic / Electr appliance Metals Textile Wood Plastics and articles thereof Chemical manufacture Source: Central Statistical Bureau of Latvia 13 Others Transport vehicles 1995 2000 2005 2011 2012 2013 2014 2015 JanSep -5.0% 0 2007 2008 2009 2010 Total 2011 EU-27 2012 2013 2014 CIS Source: Central Statistical Bureau of Latvia export data Merchandise exports to Russia by product category (%) 100 90 80 70 60 50 40 30 20 10 0 50 Agriculture and food Beverages Impact of Russia’s sanctions and weaker rouble contained ● Direct impact of Russian sanctions on Latvian economy is limited, and exports to Russia affected by sanctions do not exceed 0.2% of GDP ● In 2014, a direct impact of Russia’s sanctions and weaker rouble on Latvia’s economy was not significant. The drop in exports to the CIS, in particularly to Russia, was fully compensated by growth in exports to the EU countries and other markets. ● The provisional data for Jan-Sep 2015 suggest the same trend with the total merchandise export up by 2.0% y-o-y, in spite of 19.0% y-o-y decline in merchandise exports to CIS. ● However, increased uncertainty and cross border spill-overs from sanctions and economic downturn in Russia has an additional negative indirect impact on business and consumer confidence that has materialized in somewhat slower economic growth. Source: Central Statistical Bureau of Latvia Improved Competitiveness is a Major Export Growth Driver Adjustment in labour costs and increased productivity have restored competitiveness Export market shares (2002=100) The Global Competitiveness Index 2014-2015 Rankings Growing export market shares point to a favourable competitive position Latvia ranks as a top 4 CEE country, and consideration of sustainability indicators lifts Latvia to top 3 in CEE Bulgaria 240 200 Czech Republic Estonia 180 Hungary 160 Latvia 140 Lithuania 120 Poland 220 100 Romania 2014 2013 2012 2011 2010 2009 2008 2007 Slovak Republic Slovenia Source: World Trade Organization Unit Labour Cost (ULC) index (2005 = 100; seasonally and working day adjusted) Source: Eurostat 14 2005 2006 2007 2008 ULC nomin 2009 2010 2011 % change (3 years) 2012 2013 2014 2015Q2 2014Q4 2014Q2 2013Q4 2013Q2 2012Q4 2012Q2 2011Q4 2011Q2 2010Q4 2010Q2 2009Q4 2009Q2 2008Q4 2008Q2 2007Q4 2007Q2 Real Effective Exchange Rate remains in check after significant adjustment 2006Q4 170 160 150 140 130 120 110 100 90 2006Q2 ULC is increasing slightly in the context of improving non-cost competitiveness and broadly in line with developments in major trading partners 2004 ‒ Finland Germany Sweden Denmark Belgium Ireland Czech Republic Estonia Latvia Lithuania Spain Slovenia Portugal Poland Hungary Italy Bulgaria Slovak Republic Romania Croatia Real Effective Exchange Rate (REER) index (2005 = 100) 2005Q2 80 70 60 50 40 30 20 10 0 -10 -20 ‒ 4 3 Global Competitiveness Index Ranking 5 4 10 7 Sustainability-adjusted Global 13 10 Competitiveness Index Ranking 18 14 25 20 29 24 35 25 36 26 37 27 41 29 42 30 43 32 49 34 54 38 59 40 60 41 70 43 75 53 77 55 Source: Klaus Schwab, World Economic Forum, The Global Competitiveness Report 2014–2015 2005Q4 2006 2005 2004 2003 2002 80 Finland Germany Sweden Denmark Belgium Ireland Estonia Spain Portugal Czech Republic Lithuania Latvia Poland Italy Bulgaria Romania Hungary Slovenia Slovak Republic Croatia REER (deflator: consumer price indices - 37 trading partners) REER (deflator: unit labour costs in the total economy - 37 trading partners) Source: Eurostat, Note: data on 2015/Q2 Labour Market Remains Highly Flexible Unemployment rate continues to fall. Recent wage increases will foster domestic demand and household consumption Registered Unemployment and Jobseekers Rate (%) Wages and productivity (historical average=100) Unemployment rate continuous to decline together with increased economic activity Increase in wages has been accompanied by rise in productivity 140 22 Registered unemployment rate (%) 120 20 Job seekers rate (%) 100 18 80 16 60 14 40 20 12 0 2000 Q2 Q4 2001 Q2 Q4 2002 Q2 Q4 2003 Q2 Q4 2004 Q2 Q4 2005 Q2 Q4 2006 Q2 Q4 2007 Q2 Q4 2008 Q2 Q4 2009 Q2 Q4 2010 Q2 Q4 2011 Q2 Q4 2012 Q2 Q4 2013 Q2 Q4 2014 Q2 Q4 2015 Q2 10 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 8 Source: Central Statistical Bureau; State Employment Agency, Bank of Latvia staff calculations Labour productivity per hour Real hourly wage Source: Central Statistical Bureau of Latvia Employment rate (% of population aged 20-64) Real productivity growth 2010-2014 (per worker, average YoY, %) On track to reach 73% policy target by 2020 4 75 72.6 Latvia’s labour productivity has demonstrated one of the strongest growth rates in recent years 3.3 3 70 2 EU-28 1.1% 65 62.6 0 15 Source: Eurostat data Latvia Lithuania Poland Estonia Bulgaria Slovakia Romania Spain Ireland Croatia Slovenia Sweden Portugal Germany Czech Rep. UK Denmark Finland Cyprus Belgium Netherlands Employment rate (% of population aged 20-64) Source: Eurostat Hungary Italy Austria -1 Malta 2015Q2 2015Q1 2014Q4 2014Q3 2014Q2 2014Q1 2013Q4 2013Q3 2013Q2 2013Q1 2012Q4 2012Q3 2012Q2 2012Q1 2011Q4 2011Q3 2011Q2 2011Q1 2010Q4 2010Q3 2010Q2 2010Q1 55 Greece 60 1 The Pre-crisis External Imbalances Have Been Unwound, Resulting in a More Sustainable Balance of Payments Position Resilience to external risks is increasing as net external debt is declining rapidly Financing of the Current Account (% of GDP) Current Account and its components (% of GDP) Financial account flows reflect an orderly deleveraging of the economy Current Account balance has reached a more sustainable level 20 30 10 20 10 0 0 -10 -10 -20 -30 -20 -40 -50 -30 2007 2008 2009 2010 2011 Goods Secondary income 2012 2013 Services Current account 2014 2007 2015Q1 2015Q2 2008 Primary income 2010 Current account 2011 2012 2013 Capital account 2014 2015Q1 2015Q2 Financial account Source: Bank of Latvia Source: Bank of Latvia Private sector debt (% of GDP, 2013) External Debt (Gross: EUR billion, Net: % GDP) Latvia has one of the lowest private sector debts in the Eurozone Net external debt is progressively declining as a % of GDP 58.1% 35 2009 60% 400 350 30 25 50% 300 40% 250 29.2% 20 200 30% 15 20% 10 5 10% 0 0% 91 100 50 Source: Bank of Latvia Source: Eurostat Luxembourg Cyprus Ireland Netherlands Portugal Spain Belgium Finland Malta France Greece Austria Italy Estonia Germany Slovenia Latvia 2013 2014 2015Q1 2015Q2 MFIs (excl. Central Bank) Other sectors Net Exernal Debt % of GDP (right axis) Slovakia 2012 Lithuania 0 2007 2008 2009 2010 2011 Direct investment: Intercompany Lending General Government Central Bank 16 Eurozone = 163 150 Growth Supported by FDI and Healthy Investments Shifts Towards Tradable Sector FDI is well diversified by source and sectors Non-financial investments (constant prices, structure in %) FDI Stock (EUR billion and % of GDP) Structure of investments has shifted towards tradable sector FDI has recovered after slowdown during recession 11.6 12 12.5 12.8 8.1 8.1 65% 8.2 8 50% 6 43% 45% 46% 75% 50% 52% 52% 55% 47% 45% 33% 35% 0 25% 2009 2010 2011 2012 Stock of FDI (EUR billion) 2013 2014 2015Q1 2015Q2 Sotck of FDI (% of GDP) Industry 28 30 80 17 23 19 Significant FDI inflows were in financial and insurance activities, real estate and manufacturing Financial and insurance activities Construction and real estate activities 21.0 27.0 50 10 40 11 14 17 18 30 20 9 4 6 6 7 6 5 4 7 5 5 10 20 14 17 17 2010 2012 2014 Transportation and storage Trade Real estate and construction activities Information and communication Other 0 Cumulative FDI geographic diversification in 2Q 2015 (%) EU countries have been dominant sources of FDI Luxembourg 2.9 UK 2.9 Lithuania 3.6 Denmark 3.6 Other 29.9 Manufacturing Estonia 4.5 Wholesale and retail trade, auto repair 2.7 3.6 3.1 3.9 Electricity, air conditioning and utilities supply Transportation and storage 16.4 10.6 11.7 Germany 5.4 Sweden 19.6 Norway 5.6 Agriculture, forestry and fishing Russia 6.8 Information and communication Cyprus 7.1 Netherlands 8.0 Other 17 20 Source: Central Statistical Bureau of Latvia FDI distribution by sector 2Q 2015 (%) Source: Bank of Latvia 27 Public administration and defence 2008 Source: Bank of Latvia 31 70 60 2 2008 100 90 10.3 9.4 10 4 12.1 Source: Bank of Latvia Inflation Driven by External Factors Remains Low Currently low level of inflation reflects oil price effects and subdued food prices Inflation (CPI) 12-month average HICP in October 2015 (YoY, %) 5 1.2 4 0.8 -0.4 October-0.2% -0.8 0 -1.2 -1 -1.6 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 -2 Energy (contribution, pp) Food (contribution, pp) Inflation (y-o-y, %) Inflation excl. energy and food (y-o-y, %) Source: Central Statistical Bureau of Latvia, Bank of Latvia calculations Malta Austria Sweden Belgium Portugal Czech Republic Latvia Denmark Netherlands Germany (until 1990… France Italy Estonia Ireland Finland Luxembourg Hungary Romania Croatia Slovakia Lithuania Slovenia Spain Poland Bulgaria Greece Cyprus 1 Source: Eurostat Inflation (HICP, YoY, %) Recent developments and outlook Inflation pressures are contained over the medium-term ● The level of inflation reflects moderate growth of economy, and particularly negative contribution of oil price and subdued food prices. Lower global energy and food prices are expected to influence inflation in the short-term. 15 10 5 October-0.1% 0 -5 Jan/99 Aug/99 Mar/00 Oct/00 May/01 Dec/01 Jul/02 Feb/03 Sep/03 Apr/04 Nov/04 Jun/05 Jan/06 Aug/06 Mar/07 Oct/07 May/08 Dec/08 Jul/09 Feb/10 Sep/10 Apr/11 Nov/11 Jun/12 Jan/13 Aug/13 Mar/14 Oct/14 May/15 -10 Source: Eurostat 18 EU-28 0.0% 0 2 20 0.3 0.4 3 ● In the medium-term, economic growth and a gradual increase in purchasing power could intensify the impact of demand on inflation and that will determine further convergence of the price level to the European Union average. A Stable and Well Capitalised Banking Sector Prepared to Restore Credit Growth Stable and Well Capitalised Banking Sector (1/2) Latvia’s largest banks successfully passed the comprehensive assessment conducted by the European Central Bank (ECB) in 2014 Key highlights ● The banking system returned to profits in 2012, as the quality of the banks’ loan portfolio increases steadily since the mid of 2010 — The banking sector has reached an 12.6% ROE in the end-September 2015(1) ● While total loan portfolio continues to shrink, the most recent Euro area bank lending survey indicates increasing demand for loans from both household and business sector in the near future(2) ● The three largest banks, including the largest bank focused on nonresident deposit business, were subject to ECB’s comprehensive assessment in 2014, and successfully passed the asset quality review and the forward looking stress tests — Since November 2014 the three largest banks are subject to the Single Supervisory Mechanism led by the ECB. Source: (1) - Financial and Capital Markets Commission; (2) – Bank of Latvia Assets and Profits of the Banking system 35.0 400 29.8 300 250 200 150 100 31.6 30.8 29.2 28.8 1,000 500 25.0 311 85 174 20.0 246 419 0 -254 15.0 -500 -513 10.0 -1,000 -1,100 5.0 0.0 -1,500 2008 2009 2010 2011 2012 Total Assets (EUR billion) 2013 2014 2015 IX* Profit (EUR million, rhs) Source: Financial and Capital Market Commission Loans to residents (annual change, %) and contribution to the change (pp) Growth in loan portfolio hasn’t recovered fully, as newly granted loans do not offset amortization of loans issued in pre-crisis years and write offs 70 60 50 40 30 20 10 0 -10 -20 350 -3.4 I V IX I V IX I V IX I V IX I V IX I V IX I V IX I V IX I V IX I V IX 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 50 0 2011 2012 Mortgage loans (EUR million) Source: Financial and Capital Market Commission 20 31.3 30.8 30.0 New Loans granted to households 2011-2014 (EUR million) Rising new household loans point to a credit recovery 33.1 2013 2014 Other loans to households (EUR million) Government Financial institutions Households Total Non-financial corporations Source: Bank of Latvia; Note: *Lending data are corrected to exclude one-off effects due to withdrawal of credit institution’s licences (for the period March 2012–May 2013 Parex banka and Krājbanka effects; for the period 2013 June-2014 May GE Money Bank, Mortgage and Land bank and UniCredit Bank effects) Stable and Well Capitalised Banking Sector (2/2) Latvia’s banking sector consists primarily of foreign owned institutions that have shown commitment to their local subsidiaries and branches, reducing contingent liability risk to the government Key highlights Capital ownership of the Banking system (3Q 2015) ● The banking sector is in position to satisfy anticipated increase in demand for loans and restore credit growth, as sector’s capitalisation is high with Tier 1 ratio comprising 18.8% and liquidity ratio amounting to 67% at the end of September 2015, well in excess of regulatory requirements ● At the end-September 2015, around 62%(1) of banking capital, about 48%(2) of assets and nearly 80% of total resident loan portfolio were held by subsidiaries and/or branches of banks from European Economic Area, mostly Nordics, which have maintained their commitment to local subsidiaries, reducing contingent liability risk to government ● In April 2015 Latvia concluded sale of its shareholdings in AS Citadele bank, marking a successful exit from a successor of Parex bank, which was taken over by the Government of Latvia in November 2008 Foreign owned banks 86% Nordic Banks 62% Domestically owned banks 14% Source: Financial and Capital Market Commission Source: (1) - Financial and Capital Markets Commission; (2) - Association of Commercial Banks of Latvia Capital Adequacy (%) Composition of FCMC liquidity ratio (EUR billion) Latvia’s banking sector capitalisation is well above regulatory requirements(1) 22 20 18 16 14 12 10 8 6 4 2 0 20.7 20.8 20.6 20.9 20.7 21.3 21.6 18.9 18.2 18.5 18.8 18.1 17.2 17.7 17.6 17.0 17.4 14.2 14.2 15.2 14.6 15.2 15.1 17.0 17.3 16.3 16.6 14.0 14.0 11.1 11.2 12 18 18.1 17.9 18.1 18.0 18.4 18.4 75 12 70 8 65 60 0 11.5 12.0 12.0 % 16 4 14.9 14.9 15.2 15.2 Other liabilities with residual maturity up to 30 days Deposits with residual maturity up to 30 days Liabilities to MFIs with residual maturity up to 30 days Liquid securities 55 -4 50 -8 45 -12 Total capital ratio (%) CET1 ratio (%) CET ratio (%) Source: Financial and Capital Markets Commission Note: *Capital adequacy has been calculated in accordance with the Capital requirements regulation as from Q1 2014 and is not directly comparable to the previous calculations due to methodology differences.** Tier 1 ratio equals CET 1 ratio. Note: (1) The regulatory minimum capital adequacy comprises 8%. Since 28 May 2014 the FCMC also applies a 2.5% capital conservation buffer 21 Liquidity remains at high level -16 40 -20 35 -24 Claims on MFIs with residual maturity up to 30 days Claims on the BoL with residual maturity up to 30 days Vault cash 30 123412341234123412341234123412341234123 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Financial and Capital Market Commission FCMC liquidity ratio (rhs) Quality of Loan Portfolio Improves Steadily Still decreasing loan portfolio reflects deleveraging of the real sector Non-financial Corporations (EUR million) % 2,500 25 2,000 Households (EUR million) Loan loss provisions 20 1,500 15 1,000 10 5.3 500 Loans over 90 days past due Share of loan loss provisions in outstanding loans (rhs) 5 0 0 1Q 2008 1Q 2009 1Q 2010 1Q 2011 1Q* 2012 1Q 2013 1Q 2014 1Q 2015 Share of loans over 90 days past due in outstanding loans (rhs) Source: Financial and Capital Market Commission. Data on 3Q 2015 Note: *The credit institution’ s license of Parex banka was withdrawn in 2012 Q1 and that of Latvijas Krājbanka – in 2012 Q2 20 1,500 15 500 5 0 0 1Q 2008 Securities 25 Loans 20 Claims to MFI 15 Vault cash and claims to BoL 10 20 22 1Q 2011 1Q* 2012 1Q 2013 1Q 2014 1Q 2015 200% 30 25 Source: Bank of Latviia 1Q 2010 Share of loans over 90 days past due in outstanding loans (rhs) Loan-to-deposit ratio has fallen below 70% on a back of growing deposits base and shrinking loan portfolio Other assets I IV VII X I IV VII X I IV VII X I IV VII X I IV VII X I IV VII X I IV VII 2009 2010 2011 2012 2013 2014 2015 1Q 2009 Share of loan loss provisions in outstanding loans (rhs) Source: Financial and Capital Market Commission. Data on 3Q 2015 Note: *The credit institution’ s license of Parex banka was withdrawn in 2012 Q1 and that of Latvijas Krājbanka – in 2012 Q2 30 0 10 Loans over 90 days past due 35 35 5 8.6 1,000 Loan loss provisions Liabilities of Banks (EUR billion) A contraction of the banks’ loan portfolio, which replicates deleveraging of the real sector, has stabilized in 2014 10 25 2,000 Assets of Banks (EUR billion) 15 % 2,500 150% 100% 50% 5 0 I IV VII X I IV VII X I IV VII X I IV VII X I IV VII X I IV VII X I IV VII 2009 2010 2011 2012 2013 2014 2015 Liabilities to parent MFI Liabilities to other MFI Deposits Provisions Equity Other liabilities Loan-to deposit ratio Source: Bank of Latvia 0% Banks Engaged in Non-resident Deposits (NRD) Business are Subject to Much Stricter Capital and Liquidity Requirements The FCMC requires NRD focused banks to hold an additional capital buffer ranging from 0.4 to 9.5 percent of risk-weighted assets since mid-2011 Total banking sector non-resident deposits to assets and GDP (%) Relative amount of NRD has grown since the 2nd half of 2014 and till 1Q of 2015, mainly due to strengthening of USD against EUR Growth rates of resident and non-resident deposits (%) Growth rate of non-resident deposits has stabilized, and has been in line with a growth rate of resident deposits in recent years 55 30 25 20 15 10 5 0 -5 -10 -15 50.5 47.6 50 49.0 43.9 45 40 35 33.5 34.1 37.1 35.7 36.6 29.1 29.8 30.2 30 25 I IV 2011 VII X I IV 2012 VII X I IV 2013 VII X I IV 2014 VII X I IV 2015 VII 20.4 21.9 23.8 25.0 40.9 40.7 39.8 39.6 39.6 39.7 31.7 31.5 32.1 31.6 33.5 34.1 35.6 37.2 39.1 38.1 26.9 20 1Q 2Q 2011 Anual growth rate of non-resident deposits (corrected for exchange rate fluctuation) Anual growth rate of resident deposits Source: Bank of Latvia Latvia, Financial and Capital Market Commission; ¹ - as of 31 December 2014 38.8 38.9 39.3 3Q 4Q 1Q 2Q 2012 3Q 4Q 1Q 2Q 2013 NRD to Assets 3Q 4Q 1Q 2Q 2014 NRD to GDP 3Q 4Q 1Q 2Q 2015 Source: Bank of Latvia Banks assets (with foreign branches) at the end of September 2015 (%) Banks which are focused on actively engaging in NRD business have little domestic operations FCMC liquidity ratio (%) Additional liquidity requirements for non-resident servicing banks provide significant liquidity buffers to counter potential liquidity outflows Total lending to residents 100 Residents servicing banks* 13.3 80 78.3 67.0 60 44 53.5 40 Total resident deposits 9,5 56 20 Banks focused on NRD business** Source: Bank of Latvia; Note: * Credit institutions which grant more than 50% of loans to residents and receive more than 50% of deposits from residents ** Other banks 23 0 1Q 2Q3Q4Q1Q 2Q3Q4Q1Q 2Q3Q4Q1Q 2Q3Q4Q1Q 2Q3Q4Q1Q 2Q3Q4Q1Q 2Q3Q4Q1Q 2Q3Q 2008 2009 2010 2011 2012 2013 2014 2015 Total banking sector Resident servicing banks* Non-resident servicing banks** Minimum requirement for liquidity ratio Source: Bank of Latvia; Note: * Banks which grant more than 50% of loans to residents and receive more than 50% of deposits from residents ** Other banks ; Outstanding Track-record of Fiscal Consolidation and Structural Reforms Latvia is Committed to Policy Implementation and Reforms Latvia’s macroeconomic adjustment programme achieved its goals, but further reforms remain as permanent component of the Government’s policy Successful implementation of adjustment programme (2008-2011) 25 Further Key Policy Goals Fiscal Discipline Correction of budgetary imbalance achieved through fiscal consolidation Continue implementation of fiscal discipline framework and conduct fiscal policy in sustainable manner Fiscal targets constantly exceeded, public finance on sound foundations Efficient use of EU funds to stimulate economic growth and promote competitiveness Bank supervision improved Investor and consumer confidence restored Absorption of EU funds Structural Reforms Ensure long-term stability and sustainability of financial and social systems Public Sector Efficiency Enhance management of state-owned assets, improve tax compliance and reduce informal economy Latvia is Determined to Ensure Fiscal Sustainability Conduct policies in a fiscally responsible way equally renewing quality and amount of public services and addressing potential risks Budget Balance – 2014 (% of GDP) General Government nominal balance (% GDP) -3.5 Prudent fiscal management with one of the lowest deficits in EU -3.3 2 Draft Medium-term Budgetary Framework Law 2016 – 2018 (* - assessment; ** - target) -1,5 EU-28 -3% -4 -2 2016** 2017** 2018** Source: Ministry of Finance Recent results and fiscal forecast ● In 2015 the deficit is planned to be at 1.4% of GDP which is in line with EU fiscal discipline rules; ● Draft Medium-term Budgetary Framework Law 2016 – 2018 was elaborated by implementing substantial net deficit-reducing measures: ─ A number of revenue-increasing measures (2016 – 0,8%, 2017 – 1,2%, 2018 – 1,6% of GDP), which include cancellation of planned Personal income tax cut and introduction of Solidarity tax ─ Revision of State budget base expenditure for 2016 with horizontal expenditure reduction of 3% ─ Additional financing for priority sectors – external and internal security, healthcare and education. ● Aforementioned measures ensure that Draft Medium-term Budgetary Framework Law is not only in compliance with national and EU fiscal discipline rules, but also addresses (I) deterioration in regional security situation, (II) income inequality, shadow economy and provision of financing for other government priority sectors. Ministry of Finance Denmark Estonia Lithuania Germany Latvia Romania Sweden Malta Austria Hungary Italy Poland Greece Luxembourg 2015* Czech Republic 2014 Netherlands 2011 Slovakia 0 Ireland -10 France -0.5 Croatia 2013 -8 -0.8 Slovenia 2012 -1 United Kingdom -0.7 Spain -1 -0.8 Cyprus -1 -6 Bulgaria -1.5 -1.4 Portugal -1.5 26 Source: 0 -2 Belgium -2.5 Finland -3 Source: Eurostat General target of fiscal policy in Latvia Specific targets 2016 – 2018 Course of actions Ensure responsible and sustainable fiscal policy, respecting fiscal discipline Legal framework (FDL) and institutions (Fiscal council) have been created. Alterations are not foreseen. Implementation is crucial Facilitate improvements quality of life of citizens; in Foster favourable environment for economic development Provide adequate capacity for internal/ external security given geopolitical risks Tax policy measures; Rational distribution of public resources towards medium term budget priorities Increase of defence expenditure on faster pace Long Term Sustainability of Public Finances Recent measures taken by Latvia address sustainability of the age-related expenditure in the long term ● Since 2001 Latvia maintains a reformed pension system consisting of three tiers, whereby state compulsory unfunded pension scheme (the 1st tier) is complemented with a state funded pension scheme (the 2nd tier) and private voluntary pension scheme (the 3rd tier) ● In 2012 a number of progressive measures were introduced to address long term sustainability of the pension system: — starting with 2014 retirement age is gradually increased by 3 months each year until it reaches 65 years in 2025; — minimum contribution period to secure full pension was increased from 10 to 15 years starting from 2014 and up to 20 years starting from 2025; — contributions to the funded, e.g. 2nd tier, pension scheme increased from 2% to 4% in 2013, and to 5% in 2015, and are planned to rise further to 6% in 2016. Source: The State Social Insurance Agency 2.5 8.3% 6.1% 6.6% 2.0 0.5 2.7% 7.5% 5.0% 1.2 1.2 2.5% 0.3 0.0% 2009 2010 2nd tier pension net assets (EUR billion) 2011 2012 2013 2014 2nd tier pension net assets (% of GDP) Source: Financial and Capital Markets Commission, Central Statistical Bureau of Latvia 27 -3.0 -1.6 Age-related spending, in percentage points of GDP, 2013 Latvia’s age-related spending is one the lowest in the EU 30.0 EU-28 24.6% 20.0 16.7 15.0 10.0 1.0 0.0 2008 1.0 -1.0 25.0 0.7 2007 EU-28 1.8% 10.0% 1.7 1.5 1.5% 3.0 Romania Lithuania Latvia Estonia Bulgaria Slovakia Luxemburg Czech Republic Ireland Cyprus Hungary Poland Croatia United Kingdom Malta Germany Spain Netherlands Slovenia EU28 Sweden Portugal Belgium Austria Italy Greece Denmark Finland France 6.5% 1.0 5.0 7.2% 5.3% 1.5 7.0 Source: European Commission Ageing Report, May 2015 The 2nd Tier Pension Net Assets under Management (EUR billion and as % of GDP) 2nd tier pension scheme will gradually take over part of the pension obligations from the public, e.g. 1st tier, pension scheme 2.0 Age-related spending, projected change in percentage points of GDP, 2013-2060 Latvia is well positioned to withstand fiscal challenges arising from the aging population Croatia Latvia Greece France Denmark Cyprus Italy Bulgaria Estonia Sweden Spain Hungary Portugal Poland EU28 Romania Lithuania United Kingdom Ireland Czech Republic Austria Finland Slovakia Netherlands Germany Belgium Luxemburg Malta Slovenia Latvia’s Pension System and recent reforms Source: European Commission Ageing Report, May 2015 Practical Actions and Strong Commitments are in Place to Continue Structural Reforms Aiming to Improve Public Finances Structural reforms to ensure efficient use of budgetary and public resources is contributing to fiscal sustainability Financial System Public Administration Banking system recapitalised, role of regulator strengthened, deposit guarantee laws streamlined Making public administration more efficient, unified public wage grid to keep wages under control, optimization of public services Improving tax compliance and combating shadow economy Reforming management of state-owned enterprises ● The Tax Policy Strategy aims to increase the overall tax burden to 1/3 of GDP(1) mainly through increasing the tax compliance. ● In 2014 Latvia established a conceptual model (based on OECD guidelines) and adopted a legislation to reform the management of state-owned enterprises. ● The aim of the reform is to increase the efficiency and corporate governance of capital companies owned by the public sector — Latvian state fully owned 66 enterprises and had a decisive influence in 5 companies at the end of 2014; — an aggregate value of the state participation in the capital of the state-owned enterprises amounted to 18.2% of GDP. ● The reform envisages appointment of institution responsible for monitoring financial performance and implementation of corporate governance principles to increase the accountability, transparency, and return on capital (e.g., dividends) of state-owned companies — dividend income from state-owned enterprises amounted to 1.6% of general government budget revenues in 2014 and the budget planned for 2015 totals 1.4% of general government budget revenues. ● Recently introduced measures include — Since 2015 under certain criteria in order to avoid tax fraud and tax avoidance, company board members may become personally responsible for tax debts of their companies; — Improvements of the exchange of information between Financial Investigation Unit and Tax administration to improve business environment and fair tax collection is on the political agenda. ● January 2015 increase in the national minimum wage from EUR 320 to EUR 360 shall have a positive effect on tax collection because it reduces the prevalence of envelope, e.g. underreported, wages. ● Moreover, changes to the public procurement law to be introduced in 2015 will require the main contractors and sub-contractors to have no tax debts and to have wage levels comparable to an industry’s average. Source: Ministry of Finance, Ministry of Economy; (1) - The overall tax burden is estimated at 28% of GDP in 2014; 28 Source: Ministry of Economy, Ministry of Finance; OECD Review of the corporate governance of state-owned enterprises Latvia Government Policy Measures Building Foundation for the Sustained Growth Structural reforms in education, employment and judicial environment help improving labour market and business conditions, while efficient use of EU funds will promote competitiveness and stimulate economic growth Education & Social Sector Business Environment Education and healthcare system reforms aimed to increase efficiency Addressing labour market issues through education and employment policies Improving judicial system by strenghtening role of Judicial Council, strenghtening competence of courts and law enforcement authorities and reorganising the position of insolvency administrators Legal Environment Labour Market SME access to financing, export oriented programmes, reduction of administrative burden Source: National Reform Programme 2015; European Commission, Country Report Latvia 2015 Allocation of EU funds for 2014-2020 by priority axes 3% 4% 4% 26% 7% 9% 13% 11% 11% 12% Promoting sustainable transport and removing bottlenecks in key network infrastructures Protecting the environment and promoting resource efficiency Investing in education, skills and lifelong learning Supporting the shift towards a low-carbon economy in all sectors Strengthening research, technological development and innovation Promoting social inclusion and combating poverty Enhancing the competitiveness of small and medium-sized enterprises Enhancing access to, and use and quality of, information and communication technologies Promoting employment and supporting labour mobility Other areas EU cohesion policy accompanies structural reforms ● Latvian economy and the goals envisaged by the National Development Plan are strongly supported by implementation of EU cohesion policy and effective utilization of EU structural funds ● EUR 4.4 billion were allocated to Latvia in EU structural assistance for the 2014 - 2020 programming period. During 2007 - 2013 programming period Latvia has absorbed EUR 4.5 billion of structural funds ● The funds were allocated and will be utilised across major nine priority areas with an aim to enhance competitiveness of Latvia’s economy, and to build foundation for the sustained growth Source: Ministry of Finance Source: Ministry of Finance 29 Structural Reforms and High Institutional Strength Facilitate Favorable Business Environment and Encourage Investments World Bank ‘Ease of Doing Business’ Ranking World Bank Worldwide Governance Rankings Strong Governance supports the Economy and Business Latvia is consistently ranked as a top 2 CEE country Denmark Norway United Kingdom Finland Sweden Ireland Germany Estonia Austria Latvia Lithuania Portugal Netherlands France Poland Spain Slovak Republic Bulgaria Belgium Czech Republic Romania Slovenia Hungary Italy 4 6 Voice and Accountability 8 9 11 21 Government Effectiveness 23 24 25 23 32 33 42 80 75 73 75 64 63 48 76 51 54 Latvia 56 31 32 29 30 30 26 25 25 25 17 15 15 16 22 22 21 21 21 19 19 20 20 13 13 Malta France Belgium Italy Portugal Spain Germany Luxembourg Austria Greece Netherlands Sweden Source: Eurostat, Taxation trends in the European Union 2014 Denmark Slovakia Estonia United Kingdom Finland Hungary Poland Croatia Slovenia Czech Republic Romania 10 Lithuania Regional Average Income Group Average Source: World Bank, 2013 Rankings 38 Latvia 66 Control of Corruption 44 76 76 69 Rule of Law 37 38 34 35 Ireland 75 68 Regulatory Quality 27 Latvia has one of the lowest corporate Income tax rates in the EU Cyprus 70 17 Implicit tax rate on capital (2012), % Adjusted Top Statutory Tax Rate on Corporate Income (2014), % Bulgaria 66 65 63 Political Stability and Absence of Violence 13 14 Source: World Bank, Doing Business 2015 30 61 Light taxation of capital provides stimulus to business investments Estonia Lithuania Latvia Ireland Netherlands Slovakia Czech Republic Poland Slovenia Hungary Germany Austria Spain Cyprus Portugal Finland Sweden Belgium United Kingdom Italy France 8.1 9.8 9.9 13.0 13.7 16.7 18.0 19.0 19.6 21.4 22.2 Source: Eurostat, Taxation trends in the European Union 2014 25.0 25.3 26.0 29.5 29.9 30.6 35.5 35.7 37.0 46.9 Government Debt and Funding Strategy Public Debt Remains at Moderate Levels Latvia remains committed to keeping government debt at moderate levels General Government Debt Key Characteristics of Latvia’s Government Debt (EUR million; Year End, % of GDP, ESA methodology) ● Fiscal consolidation and reduction of the deficit along with economic growth has helped stabilise levels of government debt ● General government debt is amongst the lowest in the EU at 41% of GDP at the end 2014 — General government debt increased slightly in 2014 due to prefunding for 2015, but has fallen sharply with a repayment of EUR 1.2 billion to European Commission in January 2015 — Latvia enjoys one of the lowest debt servicing costs across the region, significantly lower than the EU and Eurozone averages ● Since March 2014 Latvia participates in the European Stability Mechanism, which provides additional financial stability to its members 50% 46% 15,000 43% 45% 41% 41% 38% 40% 36% 38% 35% 35% 10,000 30% 25% 20% 15% 8,418 8,700 9,079 8,876 2010 2011 2012 2013 9,861 9,137 2014 2015 (f) 10,126 9,965 2016 (f) 2017 (f) 5,000 10% 5% 0% 0 Source: Eurostat, The Treasury; Forecasts: 2015 – 2017 General Government Debt as % of GDP are the Treasury forecasts General Government Debt – 2014 (% GDP) Interest costs (% GDP) 3.00 2.50 2.00 1.50 1.00 2011 2012 Latvia 2013 Lithuania 2014 EU-28 Source: European Economic Forecast, Autumn 2015, European Commission 2015(F) Eurozone 2016(F) Estonia Luxembourg Bulgaria Romania Latvia Lithuania Czech Republic Sweden Denmark Poland Slovakia Finland Netherlands Malta Germany Hungary Slovenia Austria Croatia United Kingdom France Spain Belgium Ireland Cyprus Portugal Italy Greece 200 Conservative Conservativedebt debtposition position 180 160 140 120 100 EU-28 86.8% 80 60 41% 40 20 0 3.50 Source: Eurostat NB: General government debt includes that of central government, local government and social security funds. The debt ratio is calculated in accordance with European System of Accounts (ESA) standards, a methodology which differs from that used to calculate the cash flow based budget deficit numbers 32 Central Government Debt Profile International Loan Programme has been largely refinanced in international capital markets, while government debt redemptions remain moderate in the short-term Debt Redemption Profile (30 September 2015, EUR million) 1,800 Domestic debt redemption 1,600 Other external debt liabilities World Bank loan (Program) EC loan (Program) 1,400 1,200 1,000 Eurobonds 800 Debt structure by instruments (EUR million) 100% Other 90% 80% 60% Loans from financial institutions (incl.IMF and EC loans) 50% Eurobonds 70% 40% 600 30% 400 20% Domestic T-bonds 10% 200 Domestic T-bills Debt redemptions and borrowings (EUR billion) 2Q15 Sep-15 1Q15 4Q14 3Q14 2Q14 1Q14 4Q13 3Q13 2Q13 1Q13 4Q12 3Q12 0.4 0.4 1 0.6 0.3 -0.7 -1 2.0 1.7 -0.4 0.4 -0.4 -1.2 2011 Eurobond issues Eurobond redemption Repayment of IFI's loans 2012 -0.4 -0.4 Eurobonds 63% -1.0 2013 Domestic securities 14% Total domestic debt 18% Other domestic debt 3% 2014 Domestic securities issues Domestic securities redemption Net borrowings Source: The Treasury; Note: Total borrowing requirement 2016-2018 is estimated at EUR 3.5 billion. Foreign loans from financial institutions (incl. EC) 20% Total foreign debt 82% -2 33 2Q12 1Q12 Composition of Central Government Debt (as of September 2015) Debt redemption for 2015 was largely pre-funded in 2014 2 0 4Q11 Source: The Treasury, as of the end of September 2015 Source: The Treasury 3 3Q11 0 2Q11 1Q11 0% Source: The Treasury Conservative Borrowing Strategy, Based on Pre-funding Latvia has prudent debt management strategy Outstanding Benchmark issues Medium-term Borrowing Strategy ● Goal: In 2014 Latvia has successfully extended its EUR curve with 7 and 10 — To ensure continuous borrowing opportunities in the international and year benchmark issues domestic financial markets on optimal terms and conditions ● Curr Principles: — Flexibility (towards timing, maturities and currencies) EUR — Achieve balance between risks and costs — Consistency and transparency to markets ● Tasks: — Foster development of the domestic financial market in order to promote its gradual integration into the single financial market of the euro area — Broaden the investor base with borrowings in the international financial markets, maintain regular communication with the investor community Source: The Treasury USD Issue Date Maturity Date Issue Size Cpn (%) 05/03/2008 05/03/2018 EUR 400m 5.500 21/01/2014 21/01/2021 EUR 1,000m 2.625 30/04/2014 30/04/2024 EUR 1,000m 2.875 22/02/2012 22/02/2017 USD 1,000m 5.25 12/12/2012 12/01/2020 USD 1,250m 2.75 16/06/2011 16/06/2021 USD 500m 5.25 Source: The Treasury Broadening of investor base (allocation of Latvia’s 2024s) ● In both of its 2014 EUR benchmark offerings Latvia achieved a broad distribution in terms of investor centres as well as investor types, with a high share of allocations going to the real money institutional investors 1% 1% Germany/Austria Fund Manager 6% CEE Switzerland 46% UK 17% Other Source: The Treasury 34 Banks/Private banks Central banks Asia/ME 18% Insurance/Pension funds 18% 47% 27% Parameters Strategy 30 Sep 2015 31 Dec 2014 Not less than at the end of preceding year EUR 1,189 million(1) EUR 1,047 million — up to 1 year ≤ 25% 10,1% 21% — up to 3 year ≤ 50% 30,6% 36% Share of fixed rate(2) ≥ 60% 93,2% 82% 3.65 - 5.15 4.54 4.16 100% EUR with a deviation of +/- 5% 100% 100% Domestic debt securities at the end of year Maturity profile (%) 3% 16% Debt portfolio management Hedge funds Macaulay duration (years) Net debt(3) currency composition Source: The Treasury; (1) - This parameter is measured annually as of the end of year - outstanding amount of domestic debt securities as of 31 December 2013 was EUR 967 million; (2) - Fixed rate debt with a maturity in excess of one year; (3)- central government debt at the end of the period less the liquid assets that are not classified as risky, and increased by guarantees classified as risky, and derivative financial instrument liabilities not classified as risky Domestic Market Continues to Perform Strongly Demand is steady and average yields remain low Achievements in the domestic market Domestic securities outstanding by original maturity (as of 30 September 2015) 11 years bonds 2% Savings bonds <1% 12 months T-bills 7% 10 years bonds 21% November Jan-Feb Mar-Apr May 2014 June July 6-m* 3-y 5-y 12-m 5-y 3-y 5-y 3-y 3-y 6-m* 3-y 3-y 3-y 5-y 6-m* 9 8 7 6 5 4 3 2 1 5-y 45 40 35 30 25 20 15 10 5 0 12-m ● Primary dealer system in Latvia is operating since 11 February 2013 ● The outstanding amount of domestic T-bonds and T-bills constituted EUR 1.2 billion as of September 2015 ● The Treasury maintains regular domestic debt securities auctions by offering T-bills and T-bonds — In 2014 a new long-5-year T-bond programme was opened, and in January 2015 a new 3-year and in June 2015 a new 5-year Tbond programmes were opened — In 2014 a positive net issuance amounted to EUR 80 millions — For the first time in history Latvia achieved a negative yield (-0.012%) on its 6 months T-bills benchmark auction in April 2015 ● In 2014 Savings Bonds were introduced to target retail investors — EUR 5 million were outstanding as of the end of September 2015 Domestic T-Bill and T-Bond Competitive Multi-Price Auctions Sept-Oct Nov 2015 Amount sold, million EUR (LHS) Bid-cover Ratio (RHS) Source: The Treasury Bid-to-Cover ratio: Bid Amount to State Treasury offered amount * - Note: Since 2015 6m T-Bills benchmarks are tap issues of original 12m T-Bills in maturity brackets from 4.5 to 9 months. Weighted Average Yields on Domestic securities auctions (%) Low yields reflect continued investor confidence 2.4 1.9 1.4 3 years bonds 27% 0.863 0.9 0.201 0.045 0.02 2015/07 2015/11 0.4 Source: The Treasury 35 6 months* 12 months 3 years 2015/09 2015/05 2015/03 2015/01 2014/11 2014/09 2014/07 2014/05 2014/03 2014/01 2013/11 2013/09 2013/07 2013/05 2013/03 5 years bonds 42% 2013/01 -0.1 5 years Source: The Treasury; * Note - Since 2015 6m T-Bills benchmarks are tap issues of original 12m T-Bills in maturity brackets from 4.5 to 9 months. Credit Positioning of Latvia Latvia’s Strong Credit Fundamentals vs. its Peer Group Inside and Outside of the Eurozone Credit Ratings and outlook (M/S&P/F) Latvia Lithuania Poland Slovakia Czech Republic Belgium A3/A-/A(st/st/st) A3/A-/A(st/st/st) A2/A-/A(st/pos/st) A2/A+/A+ (st/st/st) A1/AA-/A+ (st/st/st) Aa3/AA/AA (st/st/neg) 105.1 106.7 106.7 Debt/GDP(1) 2013 2014 2015(F) 39.1 Deficit/GDP(1) 2013 2014 2015(F) -0.9 GDP growth(1) 2013 2014 2015(F) GDP per capita(2) (EU-28=100) 2012 2013 2014 CA/GDP(1) 2013 2014 2015(F) 40.6 38.3 -1.5 -1.5 38.8 40.7 -0.7 42.9 54 55.9 2.4 2.4 53.5 52.7 -2.8 -2.6 -2.8 -2.7 -3.3 3.3 3 -1.9 -1.9 -3.1 -2.7 60 64 69 73 74 66 67 68 1.3 -2.1 -2 -1.8 74 75 0.7 -0.8 -0.9 -1.1 -0.5 -3 87.8 -2.5 76 82 82 -1.1 -2 1.9 120 119 1 0.8 119 84 0 -0.8 1.4 1.3 0.2 3.9 1.4 -3.3 2 0 64 88.6 3.2 1.4 1.3 41 -2.9 2.5 1.7 42.7 87.3 4.3 3.5 Source: (1) - European Commission, Autum Forecast 2015 (2) - Eurostat (3) - European Commission in the forecast years 2015-16 publishes aggregates for general government debt on a non-consolidated basis (i.e. not corrected for intergovernmental loans). To ensure consistency in the time series, historical data are also published on the same basis. For 2014, this implies 1.8 percentage points higher debt-toGDP ratio in the EU-28 than the consolidated general government debt ratio published by Eurostat. 37 45.2 -1.3 -4 3.5 54.6 -1.1 -2.6 3 50.4 EU-28(3) -2.5 1.8 1.5 1.6 2.2 Conclusion Latvia Investment Highlights Latvia recovered from the economic recession and managed to build-up an outstanding fiscal position, together with a sustained growth, based on an increased competitiveness and strengthening domestic demand Strong and Sustainable Economic Growth (3,9% average in the last 4 years)(1), Decreasing Unemployment and Increasing FDI Latvia’s Economy remains Competitive and is supported by the Tradable sector Resilient Export Growth has improved the Balance of Payments and led to a Sustainable Current Account Balance, while rapidly Declining External Debt reduced vulnerability to external risks Long Term Growth is reinforced by Predictable Public Policies as the Government has established a Track Record of Successful Structural Reforms Well Capitalised Banking Sector is in Position to Restore Credit Growth and to Promote Economic Development Strong Governance Indicators and Institutional Strengths increased by joining the Eurozone Source: (1) - Central Statistical Bureau of Latvia 39 Sustainable Debt Levels accompanied by Prudent Fiscal Management Latvia is benefiting from Eurozone Membership since 1 January 2014 Thank You 40