Coface Group
Latvia

Latvia

Population 2.0 million
GDP per capita 15,550 US$
A3
Country risk assessment
A2
Business Climate
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Synthesis

major macro economic indicators

 

Main economic indicators 2016 2017 2018 (e) 2019 (f)
GDP growth (%) 2.2 4.5 3.7 3.3
Inflation (yearly average, %) 0.1 2.9 2.7 2.4
Budget balance (% GDP) -0.4 -0.8 -1.2 -1.0
Current account balance (% GDP) 1.3 -0.8 -2.0 -2.6
Public debt (% GDP) 37.4 36.3 35.0 34.2

(e): Estimate. (f): Forecast.

STRENGTHS

  • Member of the eurozone (2014) and the OECD (2016)
  • Financial system dominated by Swedish banks (85% of domestic credit)
  • Transit point between the European Union and Russia (coastline and ports)

WEAKNESSES

  • Decline in the workforce (low birth rate, emigration); high rate of structural unemployment
  • Technological lag (R&D = 0.6% of GDP, EU average = 2%)
  • Inadequate land links with the rest of the European Union
  • Concentration of wealth in the capital; high income inequalities
  • Heavy taxation of labour, which hits people on low wages and encourages under-reporting
  • Importance of non-residents’ bank deposits (half of the total)

RISK ASSESSMENT

Growth driven by domestic demand

Despite the continued deceleration that began in 2018, growth is expected to remain at a good level in 2019. Private consumption is the main driver of Latvian activity. It increased by 3.2% in 2018, and an increase in real wages, coupled with a further decline in unemployment, should help to maintain this momentum. However, the chronic decline in labour force participation rates is expected to continue due to the significant emigration of skilled youth and the decline in the working-age population, but could be slightly offset by an increase in the retirement age, which is to be raised by three months each year to reach age 65 in 2025. Public consumption and investment will remain brisk, supported by EU structural and investment funds over 2014-2020 in an amount of €4.51 billion (15% of GDP), including €1 billion for infrastructure construction and rural development, and €140 million to develop maritime activity. Private investment will remain constrained by concerns about Russia, and could also be affected by recent controversies over the fragility of the financial system (central bank governor Ilmars Rimsevics has been accused of corruption, while ABLV, the country’s third largest bank, has been accused of money laundering and facilitating illegal financial transactions towards North Korea, and is now reported to be in bankruptcy). Exports of timber (16% of total exports), equipment and tooling (15%), and food products (11%) to the other Baltic countries, Poland, and Germany – the main trading partners – are set to continue, while those to Russia may still suffer from Russian counter-sanctions. Inflation is expected to remain under control.

 

Continuation of satisfactory fiscal management

The public accounts are expected to continue to show a small deficit, with rising expenditure accompanied by increasing revenues. The government aims to boost certain spending items, in particular military expenditure (which is expected to reach 2% of GDP in 2020), as well as expenditure related to infrastructure, education, and healthcare. At the same time, tax reforms will continue in accordance with the stability programme (2018/21) involving, among other things, greater progressiveness in income taxation, a 20% tax rate on corporate profits (with an exemption for reinvested profits), and a VAT rate of 21%. In addition, the government plans to cut the number of civil servants by 6% by 2020. Public debt should therefore be reduced for the third consecutive year. Although it is largely contracted from non-residents, the debt does not pose an exchange rate risk because it is denominated in euros.

Turning to the external accounts, the current account deficit is expected to widen due to a deterioration in the trade balance. Imports of capital goods (21%) and food products (17%), driven by strong domestic demand and under-diversified production, are expected to outpace exports. The surplus in services, linked to tourism and freight transit (to and from Russia), and remittances from expatriate workers largely offset the trade deficit. The small current account deficit is comfortably financed by European funds and foreign investment (equivalent to 2% of GDP in 2017). However, gross external debt, one-third of which corresponds to the public share, remains high (140% of GDP, but only 26% net).

 

A fragmented political scene and further deterioration in relations with Russia

The October 2018 parliamentary elections saw two new parties enter Parliament: the populist KPV LV Party (16 seats out of 100) and the New Conservative Party (JKP, also 16 seats), in second and third place, respectively. For the fourth time running, the pro-Russian National Harmony Party came out on top with 23 seats. In contrast, traditional parties recorded losses: the Union of Greens and Farmers (ZZS) took 13 seats compared with 23 in 2014, the National Alliance (NA) Party also won 13 seats, compared with 17 in 2014, while the Unity Party took eight seats, compared with 23 in 2014. The political scene is therefore fragmented and negotiations to set up a new coalition took a long time, with the majority requiring the cooperation of four or even five parties to have the necessary number of seats to form the government.

Relations with Russia have deteriorated further following a reform to eliminate Russian language education in schools, leading to protests by Russian speakers, who represent a quarter of the population, and drawing the ire of Russia, which threatened to respond with economic sanctions.

 

Last update : February 2018

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