IMF Executive Board Concludes 2023 Article IV Consultation with the Republic of Latvia
September 12, 2023
Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with the Republic of Latvia.
Latvia is facing an inflation shock, slow growth, and geopolitical challenges. After averaging 17.2 percent in 2022, headline inflation remained elevated at 12.3 percent y/y in May, largely driven by high energy and food price increases. Core inflation also accelerated to 12.4 percent y/y in May, as the second-round effects of energy prices were broad-based and much stronger than anticipated. The tight labor markets will continue to push up wages, thereby adding to inflationary pressures. Real GDP growth slowed to 2.8 percent in 2022 from 4.3 percent in 2021, largely reflecting lower increase in inventories and slower fixed investment growth. The government will have to continue to deal with the spillovers in the Baltic region from the Russian invasion of Ukraine and the impact of sanctions imposed on Russia and Belarus, the cost-of-living crisis, and energy security.
These short-term concerns are adding to the long-term policy challenge of sustaining the income convergence process. Latvia’s income convergence has already been lagging the other Baltic countries. The geopolitical situation and high inflation will likely depress investment and productivity, with serious implications for future prosperity. To secure high long-term growth in a low inflation environment, Latvia needs to lift productivity, increase investment, and overcome skilled labor shortages.
Amid high uncertainty, the outlook is for lower growth, and the balance of risks is tilted to the downside. Real GDP growth is projected to slow to 0.9 percent in 2023, as high inflation weighs on consumption and external demand declines. Headline inflation is projected to decline to 10.4 percent in 2023 but will likely remain elevated for some time. The main risks stem from an escalation of the war and associated sanctions, which could result in renewed increases in energy prices, energy supply disruptions in Europe, and weaker external demand. Global financial conditions could further tighten, with spillovers to Latvian banks and domestic credit growth. Over the medium term, growth is projected to rebound, underpinned by reforms, a rebound in consumption, and public investment.
Executive Board Assessment[2]
Executive Directors welcomed Latvia’s economic resilience and notable progress in energy security in the face of unprecedented shocks. They noted that Latvia is facing a difficult environment with high inflation, slow growth and labor shortages, and geopolitical headwinds. In that context, Directors emphasized the need to lower inflation in the near term, while sustaining the income convergence with European peers and paving the way for the green transition and digital transformation.
Directors concurred that fiscal policy should help contain inflationary pressures and create fiscal space to increase spending in social sectors and support public investment over the medium term. They recommended pursuing a tighter fiscal stance in 2023, including by better targeting energy support measures. Such efforts would help to reduce the cash deficit, while allowing the full pass-through of international fuel prices to domestic consumers. Looking ahead, fiscal policy should remain flexible and adapt if adverse risks materialize.
Directors agreed that fiscal reforms should focus on growth-enhancing tax measures, coupled with policies to improve public investment management and to safeguard the sustainability of the pension system. Carbon tax reforms for emissions not covered by the EU Emissions Trading System could also be considered to mitigate climate change and generate revenues.
While welcoming the financial sector’s resilience, Directors underscored that tighter financial conditions warrant close monitoring and contingency plans. They encouraged vigilance of risks stemming from the housing market and urged the authorities to continue regular risk-based monitoring of banks’ asset quality and liquidity. Directors welcomed the authorities’ decision to gradually raise the countercyclical capital buffer rate. Noting Latvia’s significant progress with the AML/CFT framework, they encouraged the authorities to keep the momentum and pursue further improvements. Implementing the newly adopted Anti-Corruption Plan and National Strategy is also important.
Directors encouraged the authorities to accelerate structural reforms to build resilience and lift long-term growth, including by implementing the National Recovery and Resilience Plan. Further enhancing energy security, boosting investment in clean energy, and facilitating the transition to renewable energy would be important. Directors also encouraged advancing reforms to mitigate the impact of an aging population, address skill mismatches, and boost high-skilled labor supply. They also emphasized the need to strengthen Latvia’s digital transformation to help reduce labor shortages and support productivity.
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Table 1. Latvia: Selected Economic Indicators, 2019–24 |
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2019 |
2020 |
2021 |
2022 |
2023 |
2024 |
|
|
Proj. |
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|
National Accounts |
(Percentage change, unless otherwise indicated) |
|||||
|
Real GDP |
2.6 |
-2.3 |
4.3 |
2.8 |
0.9 |
2.7 |
|
Private consumption |
0.2 |
-4.6 |
8.1 |
8.1 |
2.0 |
2.8 |
|
Public consumption |
3.9 |
2.4 |
4.4 |
2.8 |
1.0 |
2.7 |
|
Gross capital formation |
10.1 |
-0.4 |
19.2 |
-1.7 |
-0.8 |
2.7 |
|
Gross fixed capital formation |
6.9 |
-2.6 |
2.9 |
0.7 |
0.9 |
3.8 |
|
Exports of goods and services |
2.1 |
-0.3 |
5.9 |
9.1 |
-0.2 |
3.0 |
|
Imports of goods and services |
3.1 |
-0.3 |
15.3 |
11.7 |
-0.5 |
3.0 |
|
Nominal GDP (billions of euros) |
30.7 |
30.3 |
33.6 |
39.1 |
43.3 |
46.3 |
|
GDP per capita (thousands of euros) |
16.0 |
15.9 |
17.8 |
20.8 |
23.1 |
24.8 |
|
Savings and Investment |
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|
Gross national saving (percent of GDP) |
22.4 |
24.5 |
20.9 |
19.4 |
21.1 |
21.4 |
|
Gross capital formation (percent of GDP) |
23.0 |
21.9 |
25.1 |
25.8 |
24.1 |
23.6 |
|
Private (percent of GDP) |
19.1 |
17.7 |
21.4 |
22.5 |
20.5 |
20.0 |
|
HICP Inflation |
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|
Headline, period average |
2.7 |
0.1 |
3.2 |
17.2 |
10.4 |
3.4 |
|
Headline, end-period |
2.1 |
-0.5 |
7.9 |
20.7 |
4.4 |
4.1 |
|
Core, period average |
2.7 |
1.1 |
2.0 |
11.3 |
11.0 |
5.0 |
|
Core, end-period |
1.9 |
0.9 |
4.7 |
15.2 |
7.5 |
4.2 |
|
Labor Market |
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|
Unemployment rate (LFS; period average, percent) |
6.3 |
8.1 |
7.6 |
6.9 |
6.7 |
6.6 |
|
Nominal wage growth |
7.2 |
4.2 |
11.1 |
7.5 |
9.3 |
8.0 |
|
Consolidated General Government 1/ |
(Percent of GDP, unless otherwise indicated) |
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|
Total revenue |
37.2 |
37.5 |
37.4 |
36.5 |
36.2 |
37.4 |
|
Total expenditure |
37.6 |
41.2 |
42.8 |
40.3 |
40.1 |
39.3 |
|
Basic fiscal balance |
-0.4 |
-3.7 |
-5.4 |
-3.7 |
-3.9 |
-1.9 |
|
ESA fiscal balance |
-0.6 |
-4.4 |
-7.1 |
-4.4 |
-3.7 |
-2.5 |
|
General government gross debt |
36.5 |
42.0 |
43.7 |
40.8 |
40.5 |
39.7 |
|
Money and Credit |
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|
Credit to private sector (annual percentage change) |
-2.3 |
-4.4 |
11.9 |
7.0 |
… |
… |
|
Broad money (annual percentage change) |
8.0 |
13.1 |
9.2 |
5.1 |
… |
… |
|
Balance of Payments |
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|
Current account balance |
-0.6 |
2.6 |
-4.2 |
-6.4 |
-3.0 |
-2.2 |
|
Trade balance |
-8.6 |
-5.1 |
-8.3 |
-11.5 |
-7.1 |
-6.6 |
|
Gross external debt |
116.7 |
121.4 |
109.6 |
100.6 |
99.6 |
98.3 |
|
Net external debt 2/ |
18.1 |
13.4 |
10.2 |
8.1 |
8.2 |
7.4 |
|
Exchange Rates |
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|
U.S. dollar per euro (period average) |
1.12 |
1.14 |
1.18 |
1.05 |
… |
… |
|
REER (period average; CPI based, 2005=100) |
123.0 |
124.5 |
125.1 |
129.7 |
… |
… |
|
Terms of trade (annual percentage change) |
0.9 |
2.8 |
1.6 |
-0.4 |
-0.6 |
0.8 |
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Sources: Latvian authorities; Eurostat; and IMF staff calculations. |
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1/ National definition. Includes economy-wide EU grants in revenue and expenditure. |
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2/ Gross external debt minus gross external assets. |
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[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm .
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