Impact of possible Lat devaluation on Lithuanian financial system: scenarios and policy choices Stasys Jakeliūnas Discussion at Lithuanian Shareholders Association Vilnius July 02, 2009

Objectives of the discussion Find out more about current situation in Latvia and Lithuania Learn about factors and dynamics of possible Lat devaluation in Latvia Explore consequences of possible Lat devaluation for Lithuania Weigh up advantages and dissatvantages of currency devaluation Is Latvian peg sustainable? At what cost? Consider policy choices available to GVTs and CBs

Recent developments in Latvia Further deterioration of economic and fiscal prospects in Latvia Depletion of foreign exchange reserves at BoL Freezing of lat money and interbank markets Credit losses in banks growing fast - recapitalisation needed Dependency on IMF and EU financing Statements on possibility of devaluation by Latvian government advisor, officials Intensive discussion in international media

International focus on Latvia IMF made a mistake agrreing not to devalue, no alternative now (N.Roubini) Latvia - new Argentina (P.Krugman) Latvia has an exit - euro, devaluation would lead to major losses and regional contagion (D.Rosenberg) Only Estonia could have euro in 2010-2011, others - will have to devalue before joining eurozone(Morgan Stanley) Time to give up (E.Hugh) Latvia shoud not devalue (WSJ Europe) Latvia choosing economic torture over chaos (The Economist)

Is competitiveness an issue? (Real effective exchange rate) % Source: Eurostat

Currency devaluation vs. deflation Deflation much worse for economy than mild inflation Currency devaluation - faster and easier road to recovery Private sector debt in euros would bring massive losses, but they will come anyway Negative expectations, possible panic and runs on banks Export and local producer competitiveness could be boosted Import prices would go up, risk of inflation

If Lat is devalued, how would contagion spread to Lithuania? Trade channel - is 10% of exports an issue? Foreign exchange reserves at Central bank: depletion risks and scenarios Banks: common lender problem - more credit crunch and possible run on banks in Lithuania? Litas liquidity and rates: VILIBOR at new highs? Lending to GVT freezing - knocking on IMF door? Could market perception and expectations break litas peg?

Is Latvian peg sustainable? Foreign exchange reserves position and future: is depletion sustainable? Is cost/price cutting feaseable and sustainable? Would devaluation help Latvian exports at all? Is there and exit - euro 2012 or later: what about Maastricht criteria, incl. 60% gvt. debt/GDP? Is financing guaranteed and is gvt. debt growth sustainable? How credible are Latvian institutions?

Policy choices: thinking outside the box Euro debt redenomination to local currency? Freezing the mortgage rates? Unilateral euro introduction/pressure on EC to speed/modify entry process? Would you devalue currency provided you can do one or more of the above? After that, go to IMF for “insurance”? Any other “outside the box” tricks? What other major risks do you see in both scenarios - devaluation and not?