Mission Concluding Statement 

Latvia: Staff Concluding Statement of an IMF Staff Visit

December 9, 2015

December 9, 2015

Latvia continues to make steady progress. Unemployment continues to fall, and now stands at just under 10 percent, half its crisis peak. The current account deficit remains modest, and inflation is picking up slowly towards the euro area target. While overall economic sentiment shows little change, consumer confidence has reached levels not seen since the crisis. The supply of bank lending, though still shrinking, shows some signs of stabilizing.

Growth appears to be accelerating. This is despite somewhat softer growth earlier in the year, and production at a large steelmaker—Liepajas Metalurgs—remaining below capacity. The acceleration is being driven by a pick-up in private consumption, supported by strong real wage growth, and also by investment, in part associated with the use of EU funds. As a result, growth is likely to reach around 3 percent this year, and be somewhat higher still next.

The medium-term outlook is favorable, but there are risks. The favorable outlook reflects strong domestic demand, and a less adverse external environment. However, risks remain tilted to the downside: prolonged stagnation in the euro area or Russia would undermine growth prospects, and a deepening of geopolitical tensions could adversely affect both the real and financial sectors. In such an environment, there is a need for continued vigilance, adequate buffers, and prudent policy making.

Maintaining competitiveness remains vital. Both public and private sectors have a role to play. The government should press ahead with reforms in justice, education, health, and infrastructure. Consistent and rigorous implementation of the new insolvency framework will be important to ensure its credibility and promote new lending. While wage growth and a higher minimum wage can support domestic demand, raise living standards, and reduce inequality, if wage growth is allowed to exceed productivity gains then competitiveness will suffer.

The 2016 budget is broadly appropriate. It strikes a balance between delivering the needed fiscal consolidation and supporting growth, while being broadly consistent with Latvia’s own fiscal rules, and its European Union fiscal commitments. Measures to enhance revenues are welcome, including not reducing the PIT, introducing the so-called Solidarity Tax, and others to broaden the tax base. This should be complemented by further efforts to tackle the shadow economy and deficiencies in tax collection. Furthermore, effort should be made to shift the revenue burden towards property taxes, and more is needed to address inequality, including enhancing the Guaranteed Minimum Income (GMI) benefits. At the same time it will be be important to ensure the efficiency of public spending informed by a review of expenditures.

The banking system remains well capitalized and liquid. The moderation of growth in non-resident deposits (NRDs) is welcome. Nevertheless, this sector should continue to be subject to vigilant supervision. In this context, it is appropriate that minimum capital and liquidity requirements on NRD-specialized banks are higher than for others. Continued resolute implementation and enforcement of AML/CFT regulations and requirements will be important in mitigating reputational risks, to the ultimate benefit of the system overall. In this regard, initiatives that encourage offshoring should be carefully weighed against these risks.

The IMF team is grateful for the generous hospitality of the Latvian authorities and would like to thank all interlocutors in government, the Bank of Latvia, and the private sector, for constructive and fruitful discussions.