Mr Repse gives a short speech on
monetary policy in Latvia and exchange rate strategies
Speech given by Mr Einars Repse, Governor of the Bank of Latvia, at the ECB Seminar on the
Accession Process, held in Helsinki on 11 November 1999.
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Ladies and Gentlemen,
Accession to the European Union (EU) is a strategic aim of Latvia, and we see joining the European
Monetary Union (EMU) as an integral part of this process. We strongly hope that the European
Council will accept the Commission's recommendations and a decision will be made to commence
accession negotiations with Latvia in year 2000. The Bank of Latvia will be well prepared for these
negotiations, as we have already established our status and policies with a perspective of future
membership in the EU.
The Bank of Latvia enjoys a high degree of independence, fully compatible with the requirements of
the EMU. Price stability is clearly defined as the main objective of the Bank of Latvia, and its
monetary policy instruments and procedures largely correspond to the monetary policy framework
used within the European System of Central Banks. And we are implementing a very conservative
monetary policy, which, as we believe, is in line with the policy principles of the European Central
Bank (ECB).
Since 1993, Latvia has been using the exchange rate based stabilisation programme. In February 1994,
the Bank of Latvia pegged the national currency to the SDR basket. We based our decision on the
belief that a fixed exchange rate regime, if it is durable and credible, reduces uncertainty, eliminates
currency risk and provides businesses with a sound basis for planning and pricing. It fosters
investment and international trade, which are of a particular importance for the restructuring of a
small, open economy like Latvia.
The Bank of Latvia has indeed ensured that the exchange rate arrangement is credible and durable, and
the Latvian economy has benefited from the stability. Inflation has declined to a level consistently
below 3%, there has been considerable growth in exports, especially to the EU countries, and it has
contributed to the strong GDP growth over the last years. The achieved macroeconomic stability
allows us to set the target of fulfilling the nominal convergence criteria at the time of Latvia's
accession to the EU.
Pegging the national currency to the SDR rather than to a single currency, the Bank of Latvia has
made the lats fluctuate less against any individual currency than it would otherwise. Furthermore, the
structure of Latvian foreign trade by settlement currencies largely corresponds to the composition of
the SDR basket, thus providing extra rationale for the current peg.
To sustain the current exchange rate regime, the Bank of Latvia intervenes in the foreign exchange
market by selling or buying the national currency at a predetermined exchange rate, thus acting in a
close analogy with the currency board arrangement. We are also in line with another important feature
of the currency board: Latvia's monetary base is permanently covered by Bank of Latvia's net foreign
reserves at more than 100%. At the same time, the Bank of Latvia is not bound by the legal and
institutional restrictions of the currency board arrangements. As a full-fledged central bank we flexibly
manage liquidity in the banking system by steering short-term interest rates. The current exchange rate
arrangement has allowed us to develop the full set of market-based monetary instruments and
operational practices.
In our opinion, the present exchange rate regime is the best option for Latvia on our way towards the
membership in the EU and the EMU. Therefore we intend to maintain the existing peg to the SDR
until the accession to the EU.
We are aware of the currency stability requirement as set out in the Maastricht Treaty and the Protocol
on the convergence criteria. It is our understanding that the current interpretation of said criterion
prescribes mandatory participation of the new Member States, including those with a fixed exchange
rate regime, in the ERM II before the eventual adoption of the euro. This requirement does not
represent any difficulty for Latvia. Due to its peg to the SDR, exchange rate fluctuations of the lats
against the ECU (and later against the euro) have not exceeded 10% in either direction for the last six
years. In effect, we are already observing the required fluctuation margins without a formal
participation in the Exchange Rate Mechanism. The Bank of Latvia is strongly committed to ensure
stability of the national currency also in the future, so formal participation in the ERM II will hardly
affect our daily operations.
Let me conclude by saying that we highly appreciate the opportunity provided by the ECB to
exchange opinions on the challenges the candidate countries will be facing in the coming years. We
look forward to increased cooperation with the Eurosystem and individual central banks of the
EU countries.