Latvia: Risk Assessment
Country Risk Rating
Business Climate Rating
- 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
- Declining workforce (low birth rate, emigration) and high structural unemployment
- Technological lag (R&D = 0.6% of GDP, EU average = 2%)
- Declining competitiveness and profitability: wage increases exceed productivity gains
- Poor recovery in the event of default, despite reforms to insolvency and justice law
- Weak credit growth
- High labor 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
Activity expected to rebound in 2021
Although mildly affected by the coronavirus in March, Latvia was nevertheless economically impacted and experienced a severe recession in 2020, which is expected to be followed by a strong recovery in 2021. The recession can be attributed in particular to an 8% drop in consumption in 2020. Consumption, which accounts for 58% of GDP, is set to increase by 5% in 2021, but will likely remain constrained by the household deleveraging process underway since the end of the 2008 crisis (household debt now represents 22% of GDP and 42% of net disposable income). Investment slowed in 2020 but will be supported in 2021 by a EUR 2.2 billion plan announced by the Minister of the Economy in May for the implementation of infrastructure projects by 2023, as well as by European funding. Exports (wood products, metals, machinery, and equipment) declined by around 5% in 2020 following the slowdown in international trade but should increase again in 2021. Wood exports, which account for 20% of exports, decreased following the global downturn in construction in 2020 but will benefit in 2021 from the recovery in pulp prices.
Unlike other sectors, agriculture, which accounts for just over 3% of GDP, was not severely affected by the crisis. The industry fell by 7% in 2020, although some sectors, including electronics and chemical manufacturing, managed to resist. The secondary sector is expected to grow by 5% in 2021, driven especially by the resumption of construction owing to the growing demand for housing and major infrastructure projects, including Rail Baltica, a European rail project to link Helsinki and Warsaw, the cost of which for Latvia is estimated at EUR 2 billion (7% of GDP). Services declined sharply during the crisis (-8%) but are expected to grow by 5% in 2021, driven by solid results in financial and business services.
Prudent fiscal management impacted by the crisis
Since March 2020, the government has announced a series of measures to support household incomes and the hardest-hit sectors, totaling approximately EUR 3 billion, or 11% of GDP. However, demand is likely to be limited for some measures such as state-guaranteed loans, which will reduce the initially planned spending. The public deficit has necessarily worsened due to the implementation of this plan but should be reduced in 2021. Public debt also increased by several percentage points of GDP in 2020 and is expected to rise slightly next year. The public accounts will benefit from European support, including EUR 5 billion under the EU Recovery and Resilience Facility, of which 70% will be disbursed before 2022, and EUR 7.97 billion under the 2021-2027 multiannual financial framework, of which 14% will be distributed in 2021.
The current account showed an unusual surplus in 2020, as, despite declining because of the drop in exports related to tourism and transport (including a collapse in transit traffic with Russia, which accounts for the vast majority of rail freight), the services surplus for once exceeded the goods deficit, which narrowed slightly in 2020 due to a steep drop in imports (fossil fuels, oil, and capital goods). The trade balance (goods and services), which showed a small surplus in 2020, is expected to return to a deficit in 2021, as the pick-up in consumption and investment will drive an upturn in imports. This also explains why the current account will return to a deficit in 2021. The financial account will continue to be affected by the fact that FDI inflows are lower than investments abroad. Gross external debt, almost 80% of which is owned by the private sector, has been slashed in recent years and reached 122% of GDP in 2020.
Political stability threatened by community tensions and a flawed financial system
Krišjānis Kariņš was appointed prime minister in 2019 and leads the governing coalition of the New Conservative Party, the populist KPV, the Liberal AP! party, the Nationalist Alliance, and the Liberal-Conservative New Unity party. 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 the language is an important identity issue, and even though the pro-Russian Harmony party came out on top in the 2018 legislative elections. Relations with Russia have become strained again since the construction of a fence at the Russian border in 2019. Although officially intended to limit smuggling and the illegal entry of migrants into Latvia, the fence is seen by some Russian media outlets and politicians as a gesture by Riga against Moscow.
Finally, many Latvian banks serve foreign clients associated with a high risk of money laundering. Although the value of non-resident deposits has decreased, falling from EUR 8.1 billion in 2017 to EUR 3.2 billion euros in 2019, and that the country signed an agreement in 2020 on this subject with the United States, the most recent FinCEN report of September 2020 singles out Latvia and the country’s inadequate political response to this issue.