Studi Economici
Latvia

Latvia

Population 1.9 million
GDP 17,549 US$
A3
Country risk assessment
A1
Business Climate
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Synthesis

major macro economic indicators

  2019 2020 2021 (e) 2022 (f)
GDP growth (%) 2.5 -3.6 4.6 4.8
Inflation (yearly average, %) 2.7 0.1 3.4 3.7
Budget balance (% GDP) -0.6 -4.5 -9.5 -4.3
Current account balance (% GDP) -0.7 2.9 0.8 -0.3
Public debt (% GDP) 36.7 43.2 48.4 51.0

(e): Estimate (f): Forecast

STRENGTHS

  • Member of the Eurozone (2014) and the OECD (2016)
  • Domestic financial system dominated by Swedish banks (85% of domestic credit)
  • Efforts to improve the regulation of the offshore financial system
  • Rapid reduction in non-resident bank deposits (non-EU residents account for only 7% of total deposits)
  • Transit point between the European Union and Russia (coastline and ports)
  • High level of digitalization

WEAKNESSES

  • Declining workforce (low birth rate, emigration) and high structural unemployment
  • Poor recovery in the event of default despite reforms to insolvency and justice law
  • High labour taxation, which hits people on low wages and encourages under-reporting
  • Inadequate land links with the rest of the European Union
  • Wealth concentrated in the capital, high income inequality

RISK ASSESSMENT

Strong growth in 2022

The economy already returned to its pre-pandemic level in 2021. Sizeable government measures and exports’ acceleration supported economic activity, especially in the first three quarters of 2021. However the last quarter of 2021 indicated a weaker performance due to rapidly rising infection rates that prompted a tightening of containment measures. Nevertheless, the economic recovery is expected to strengthen in 2022, against a backdrop of rising vaccination rates. Strong wage growth and accumulated savings will support household consumption as the main growth driver. The labour market already improved in 2021, and the services sectors will be willing to hire more employees in 2022. Wage growth is supported by increasing job vacancies, while the unemployment rate (6.7% in October 2021) has not yet declined to the pre-pandemic level. However, the acceleration in household consumption will be hampered by high inflation. Global energy prices have soared, pushing up the domestic prices of fuel, heating, gas and electricity. Pressure on prices are expected to decrease in the second half of 2022, at the earliest. Furthermore, exports will be supported by demand from the EU, which remains the main trading partner. Latvia already benefitted from a surge in foreign demand, particularly for mineral products, iron and steel, machinery and equipment, and chemical and wood products. Nonetheless, imports are expected to rebound even stronger and, therefore, make the contribution of net exports to GDP growth negative. Gross fixed capital formation will benefit from EU funds inflows. Moreover, investments in real estate are expected to increase, which is already reflected in the rising number of building permits. After the pandemic receded following the initial wave, households are again willing to incur mortgage loans. Nonetheless, companies’ investments were relatively stagnant with still a relatively high level of uncertainty. Their willingness to invest should improve in 2022.

 

Lower deficit amid fiscal support

Last year’s fiscal deficit soared on the back of support measures (totalling nearly 5% of GDP), not only at the beginning of 2021, but also during the final months due to the re-introduction of pandemic-related restrictions. In 2022, the deficit will decrease as those are scaled back, but they would still amount to 2% of GDP. Additional support measures mostly include an increase in non-taxable income tax allowance (from EUR 300 in 2021 to EUR 500 in June 2022), increases in wages for healthcare and social workers as well as teachers, and an investment package to support the economic recovery. Additional funds are also allocated for regional and municipal development. Latvia has been allocated with 6.7% of 2020 GDP in grants from the EU recovery fund, of which 35% is expected to be spent by 2023. About 60% will be devoted to tackle climate change and accelerate Latvia’s digital transformation. Although public debt surged during the pandemic, it remains relatively low by European standards. It contributes to low debt-servicing costs (less than 1% of GDP).

 

In 2022, the current account balance will shift back to a (small) deficit, amid the continuing economic upswing, which will contribute to a larger trade deficit. Growth in goods exports will remain solid while imports will pick up in line with household consumption. The services account surplus is expected to keep recovering, as ICT and other business services should remain buoyant. Moreover, services exports will be boosted once travelling recovers, as the Latvian tourism sector contributed close to 10% to GDP before the pandemic. However, it is unlikely to return to a similar level in 2022. The external debt exceeds 120% of GDP and is a consequence of previous high current account deficits. It remains the highest among EU countries, but is diminishing.

 

Upcoming elections could bring changes on the political scene 

Krišjānis Kariņš was appointed prime minister in 2019 and leads the governing broad coalition of the New Conservative Party, the populist KPV, the Liberal AP! party, the Nationalist Alliance and the Liberal-Conservative New Unity party. Although the pro-Russian Harmony party came out on top in the 2018 legislative elections (20% of votes resulting in 23 out of 100 seats), the lack of political representation for the large Russian-speaking minority (30% of the population) in successive governments reflects their exclusion from Latvian society, in a country where language is an important identity issue. Relations with Russia have become tense again since the construction of a fence at the border in 2019. Although officially intended to limit smuggling and the illegal entry of migrants into Latvia, the fence is perceived by some Russian media outlets and politicians as a gesture by Riga against Moscow. Risks to political stability could increase due to tighter pandemic measures. The government introduced a four-week lockdown in response to a rapid increase in new coronavirus cases and severe pressure on hospitals in October 2021. The measures were eased in November 2021, however, all services except basic ones are available only with a COVID-19 certificate. The acceleration of new COVID-19 cases could lead to the re-introduction of more restrictive measures in 2022. With the government being increasingly unpopular, the October 2022 parliamentary elections could bring another centre-right coalition.

 

Last updated: February 2022

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