CAIE A-Level Economics 5.2 Fiscal policy Question Bank

Latvia becomes a banking capital between the European Union's (EU's) east and west

Latvia regards itself as a financial bridge between Europe's east and west. Since the Soviet Union's collapse in 1991, Latvia (population 2.2 million) joined the EU (population 510 million) in 2004. It has since built itself into a banking centre for people from all parts of Europe and many other parts of the world, although its reputation as a financial centre has been growing since 1988 when two entrepreneurs founded a private bank, Parex Bank, in the capital, Riga.

In the early years of the 21st century, favourable credit conditions in Latvia contributed to an economic boom, but in the global financial crisis of 2007-2008 Parex Bank, by then Latvia's second biggest bank, needed government assistance and was nationalised.

The financial crisis caused Latvia's annual inflation rate to rise rapidly to $17.7 \%$ in May 2008, which was significantly higher than its average annual inflation rate of $3.7 \%$ for the period 1998-2018.

In 2008, the Latvian government decided to substantially reduce the size of the budget deficit, in an attempt to reduce the relatively high rate of inflation, through a series of fiscal measures such as increasing taxation and reducing public spending.

Latvia emerged from the global financial crisis to become the EU's fastest-growing economy. The intention was that Latvia would eventually join the EU's common currency (the euro). Fig. 1.1 below shows the exchange rate of Latvian Lats (the country's former currency) per euro from 2007 to 2013.

In January 2014, Latvia did join the euro and this was welcomed by business leaders and economists in Latvia, stating that it would improve Latvia's credit rating and attract foreign investors. The governor of Latvia's central bank said: "The euro brings stability and certainty, definitely attracting investment."

However, not everybody in Latvia supported the introduction of the euro. Many people thought that Latvia would lose a certain amount of economic independence and that it would lead to an increase in prices and taxes.

Sources: Adapted from The Financial Times 20 February 2018
Latvijas Banka, accessed October 2018

What is the equivalent of a country's national debt?

Nigeria has about half of West Africa's population with approximately 202 million people and one of the largest populations of young people in the world. With an abundance of natural resources, it is Africa's biggest oil exporter, and has the largest natural gas reserves on the continent.

Nigeria is highly vulnerable to the global economic disruption caused by the COVID-19 pandemic, particularly due to the steep decline in oil prices. Nationally, $40 \%$ of Nigerians live in poverty, while another $25 \%$ are vulnerable and could fall into poverty due to the pandemic.

Oil accounts for $80 \%$ of Nigeria's export revenues, a dominant position that it has occupied since the 1970s. Many people believe that Nigeria needs to move further away from its dependence on oil and natural gas. Initial attempts at diversification have produced limited gains as the policies have been aimed mainly at the domestic market to create jobs and to improve living standards. There needs to be a focus on export-orientated manufacturing that should boost economic growth as it has done in countries such as Malaysia and Indonesia.

Based on the experience of these countries, more open trade and competition policies would help to diversify the economy, especially as the African Continental Free Trade Area (ACFTA) takes effect. Nigeria needs to create at least five million new jobs each year to employ its growing population of young people.

Source : Global economy.com

Nigeria's economy entered a recession in 2020 due to fall in crude oil prices caused by falling global demand and measures to fight the spread of COVID-19. Inflation rose in 2020 due mainly to higher food prices, the removal of fuel subsidies and an increase in the price of electricity. The budget deficit also worsened in 2020 because the COVID-19 pandemic caused higher government spending and lower tax revenues, adding to the national debt.

Nigeria's national debt is sustainable at $25 \%$ of GDP, but interest payments are high, accounting for about $50 \%$ of government spending. Nigeria's government could improve its finances by reforming domestic tax collection. Non-oil tax revenue is equivalent to just $4 \%$ of GDP. An increase in the rate of value-added tax (VAT) from 5\% to 7.5\% in 2020 resulted in less revenue than forecast because of the recession. A wider tax base could help the budget, but this will require significant reform to reduce both tax evasion and a large informal economy.

Sources: Adapted from: World Bank in Nigeria Nov 2020
and: IMF News, African Department, February 2020
and: African Development Bank Group: Nigeria Economic outlook, 2021