Mission Concluding Statement 

Latvia’s strong economic recovery continues. We expect the economy to grow in a balanced way at around 4 percent this year. But risks are tilted to the downside, especially given the recent financial difficulties of a large steelmaker in Liepāja, and potential production losses as a result. Inflation and the current account deficit are low and projected to remain so in the medium term.

Following continued strong fiscal performance last year, the fiscal stance for 2013 remains appropriate, as does adherence to the new fiscal framework. Latvia’s 2012 headline fiscal outturn was better than previously expected. Adjusting for the economic cycle, Latvia met its Medium Term Objective (MTO) under the Stability and Growth Pact, namely a structural fiscal deficit of 0.5 percent of GDP. Budget implementation in 2013 is on track. But over the medium term, Latvia will likely face fiscal headwinds from several factors, such as a gradual reduction in payout ratios from state-owned enterprises, restored indexation of pensions, and government guarantees on a loan to the troubled steelmaker. As a result, compensatory measures—including reconsideration of planned further cuts to the personal income tax—may be needed to keep fiscal performance in line with the recently approved Fiscal Discipline Law.

Structural measures to address still-high unemployment remain a priority, and should build on forthcoming World Bank analysis. Policy efforts are needed to upgrade labor force skills and further improve the business environment; ongoing reforms to vocational education and the judicial system are therefore welcome. At the same time, the social safety net should be strengthened to protect the most vulnerable and redress high levels of inequality. The authorities have recently, and appropriately, signaled their willingness to consider new measures aimed at reducing inequality, including more generous and differentiated non-taxable thresholds. The mission hopes that the findings of the World Bank study envisaged for release in early June will help the authorities in their efforts to frame policy measures in this area.

Recent regulatory and supervisory measures will help to contain risks from the rise in non-resident deposits (NRDs), though continued vigilance is warranted. Macroeconomic risks associated with a large NRD sector include the potential drain on international reserves in the event of outflows, and contingent fiscal liabilities owing to sovereign backing for the deposit guarantee scheme. The tightening of liquidity requirements for NRD-specialized banks since February 2013 is appropriate, and complements already higher minimum capital requirements imposed on these banks. The growth rate of NRDs in Latvian banks has moderated since mid-2012.