Studi Economici
Latvia

Latvia

Population 1.9 million
GDP 13573 US$
A3
Country risk assessment
A3
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Synthesis

major macro economic indicators

  2014 2015  2016 (e) 2017 (f)
GDP growth (%) 2.1 2.7 2.0 3.4
Inflation (yearly average) (%) 0.7 0.2 0.0 1.7
Budget balance (% GDP) -1.6 -1.3 -0.9 -1.1
Current account balance (% GDP) -2.0 -0.8 -0.2 -1.0
Public debt (% GDP) 40.7 36.3 40.0 37.0

 

(f) Forecast

STRENGTHS

  • Membership of Euro zone (2014) and OECD (2016)
  • Financial system dominated by Swedish banks (85 % of domestic credit)
  • Reform of insolvency law and legal reform
  • Transit point between European Union and Russia (coastline ant its ports)
  • Advanced digitisation of the country

WEAKNESSES

  • Decline in economically active population (low birth rate, emigration) and 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 and high income inequalities
  • Heavy taxation of labour, which hits those on low wages and encourages under-declaration
  • Problem of corruption
  • Declining competitiveness and profitability: wage increases above productivity growth
  • Importance of bank deposits of non-residents (half of the total)

RISK ASSESSMENT

Activity sustained by domestic demand

After slowing, growth is expected to return to a moderate pace in 2017. Public investment will pick up, after falling in 2016 because of the gap between two European funding programmes. Transport infrastructure will again be the big winner. Private investment will not be lacking with credit levels potentially stabilising after 6 years of decline, provided the worries over Russia subside. Household consumption will continue to be the main driver, sustained by a moderate increase in employment and higher wages prompted by the shortage of labour resulting from the emigration of young, skilled workers, as well as from the inadequacy of higher education and vocational training to meet needs. The minimum wage is expected to rise again, with GDP per capita equal to 60% of the EU-15 average. Exports, particularly foodstuffs (19% of exports), timber and furniture (17%), telephones and screens will benefit from favourable economic conditions on their principal markets, namely the other Baltic States (31%), Scandinavia (12%), Poland and Germany. However, exports to Russia (still 7% of exports in 2015, transhipping excluded, despite declining by 25% compared with 2014), and also to the other CIS countries (5%), could fall further as a result of continuing Russian counter-sanctions and the adverse economic conditions in those countries. Despite being redirected towards other destinations, sales of dairy products, fish and beverages have been particularly hard hit. Sales of timber to the United Kingdom could suffer from the depreciation of sterling. Meanwhile, because of the erratic operation of the only steel mill, Liepajas Metalurgs, because of movements in steel prices, exports of steel products will remain irregular. International road and rail transport, as well as warehousing will depend on their use by Russia which wants to foster its own ports to the detriment of Latvian ports.

 

Satisfactory budget situation

The public accounts will continue to run a small deficit. The increase in spending on defence, (from 1.4% of GDP in 2014 to 2% in 2018), infrastructure, education, health and, more generally, on welfare, all still in need of improvement, is expected to be counterbalanced by an increase in revenues which represent only 35% of GDP. Boosting growth, combating tax evasion connected to the informal economy (24% of GDP) and increasing taxes on a variety of products should be completed under tax reforms implemented in 2017, which will introduce more progressive income tax and raise the currently very low tax rate on property and businesses. The public debt burden, already moderate, will start to fall again after peaking temporarily in 2016 in connection with the early refinancing of a repayment due in early 2017. Although largely held by non-residents and denominated in euro, there is no exchange rate risk.

 

Low current account deficit and significant non-resident bank deposits

The small current account deficit covers a balance of goods deficit (8.7% of GDP in 2015). The low added value of exports exposes them to competition, while reduced diversification of production favours imports. Moreover, inadequate port facilities and land-based infrastructure connections with the rest of the European Union slows the geographic diversification of trade. Dependence on external energy, specifically from Russia, has lessened thanks to the new Lithuanian gas terminal and the two electric cables linking Lithuania with Sweden and Poland. The services surplus from tourism and goods transhipment (to and from Russia) and remittances from expatriate workers offsets this deficit to a large extent. The balance is financed by European funds and that foreign investment which has not been hit by the deterioration of relations with Russia. The gross external debt, although steadily declining, is still considerable (128% of GDP, but only 11% as net debt). A third is owed by Swedish bank subsidiaries to their parent companies and is shrinking as local deposits increase. Another third corresponds to deposits by non-residents, mostly Russians, in specialized banks.

 

Ministerial Instability and large Russian-speaking minority

The October 2014 elections returned the traditional centre-right coalition of the Unity Party, the Alliance of Greens and Farmers and the National Alliance Party to power. It has 61 of the 100 seats in the Assembly. However, disagreements between its members and ministerial instability are rife: Maris Kucinsskis is the third prime minister during the coalition's term. The country's biggest party is in opposition. This is the centre-left Harmony Party, which has 24 seats and is led by the Mayor of Riga. It brings together the Russian-speaking minority, which comprises 27% of the population and is concentrated in the capital and in the poor region of Latgale in the east of the country. It has been unable to form a coalition because of the ethnic vote, which has been reinforced by the cooling of relations with Russia.

 

Last update : March 2017

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