of the baltic economies – each of the three had and still has its own – unique – character. one of the obvious differences among the baltic countries was their policy stance in the runup to crisis. fiscal discipline differed considerably among the three countries throughout the boom years that largely shaped their performance during the crisis. latvia was clearly the most quick - tempered one on the fiscal front. experiencing the fastest economic expansion and extremely strong cyclical upturn in tax revenue, we still managed to spend more than we earned and recorded a budget deficit every single year during the boom. while being rather moderate in nominal terms, the deficits were extremely large when cyclically adjusted – amounting to 7 – 8 % of gdp, in turn adding extra fuel to the already severely overheated economy. budgetary discipline was extremely weak. every single year when revenue performance turned out better than expected, budget laws were amended to further boost expenditure. between 2004 and 2008, expenditure picked up 2½ times, and most of that was of a structural nature. as many of you know – there was really one industry which was overheating – namely construction and nothing was done to prevent it. this meant an accumulation of an enormous fiscal gap – over 20 % of gdp – that was temporarily obscured by the economic boom but became obvious with the burst of the bubble. as authorities rapidly ran out of available liquidity and no investors were ready to finance the massive fiscal needs, latvia had to turn for international support, becoming a program country under the imf stand - by arrangement and european commission support. lithuania was not materially better in terms of fiscal management, but was lucky to lag behind in terms of the economic cycle, which resulted in a less overheated economy before the crisis took off. estonia, however, showed much more prudence in pursuing countercyclical policies accumulating considerable liquidity cushion to support economy during the downturn. every single year since 2002 estonia ran budget surpluses that increased over time as the economy accelerated. this made a significant difference in the way economies adjusted during the crisis with strong implications to their future growth prospects. while latvia and lithuania ended up with skyrocketing public debts, estonia ’ s debt remained contained, allowing for a greater fiscal space and stronger growth potential in future. already now estonia has a faster gdp growth and its future looks much brighter. in other words – it is the combination of prudent fiscal and monetary policies which is behind the most notable difference with the other

##r 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.