IMF Executive Board Concludes 2019 Article IV Consultation with the Republic of Latvia
IMF News, August 7, 2019
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- Published: August 7, 2019
Overview
- On August 6, 2019, the Executive Board of the International Monetary Fund concluded the Article IV consultation with the Republic of Latvia and considered and endorsed the staff appraisal without a meeting.
- Press Release date: August 7, 2019. Press Officer: Meera Louis.
Macroeconomic performance and outlook
- Real GDP growth reached 4.8 percent in 2018, driven by private investment, a boom in EU-funded construction, and strong growth in IT and communications.
- Growth is expected to decelerate in 2019 to just above 3 percent, with a medium-term projection to converge to 3 percent.
- Wage growth accelerated to 5.7 percent in 2018 as the labor market tightened.
- Unemployment declined to an all-time low rate of 7.4 percent (2018).
- Core inflation slowed to 2 percent in 2018.
- The current account swung into a deficit of 1 percent of GDP in 2018 as export volumes decelerated.
- Total external debt declined significantly by 20 percentage points in 2018 due to a sharp decline in non-resident deposits.
Fiscal policy and public finances
- Fiscal policy was expansionary in 2018 despite revenue overperformance, driven by fast absorption of EU investment funds and a substantial increase in public sector wages.
- The 2018 general government deficit reached 1 percent of GDP, implying a fiscal stimulus of about 0.4 percent of GDP.
- Public debt remains on a downward path amid favorable financing conditions.
- Policy guidance:
- Authorities’ planned fiscal stance that reverses past procyclicality is appropriate given expected deceleration.
- In the short run, avoid public sector wage increases not aligned with productivity.
- Carefully assess potential fiscal costs of new spending initiatives to preserve fiscal space.
- If negative shocks occur, allow automatic stabilizers to operate fully and consider temporary high-quality measures in the event of a severe downturn.
- Long-term fiscal policies should accommodate demographic and social spending costs and support productivity-boosting reforms.
- New stable revenue sources would be needed to adequately cover growing age-related demands on the budget.
- Focus capital spending on projects that can catalyze private investment and have high social impact.
- Address poverty and inequality by improving adequacy and targeting of existing social programs.
- Strengthen transparency and governance of local authorities and state-owned enterprises.
Financial system stability and reforms
- The financial system remains stable despite significant balance sheet restructuring of banks servicing foreign clients.
- Banks remain well capitalized and liquid:
- Capital levels about 40 percent higher than the euro area average.
- Average liquidity coverage four times the regulatory minimum.
- Credit dynamics:
- Total household credit declined by 5.4 percent (end-2018).
- Credit to non-financial corporations declined by 5.8 percent.
- Government-sponsored mortgage program contributed to a slight recovery of household credit by end-2018.
- Financial integrity and supervisory recommendations:
- Authorities have signaled strong political commitment to restore the reputation of the financial system.
- Efforts to reduce exposure to risky banking operations, address MONEYVAL’s recommendations, and oversee BSFCs’ new business plans are welcome.
- Long-term reforms should focus on effectiveness of the AML/CFT regime by enhancing risk-based supervision, the quality and use of financial intelligence, preventive measures, investigation and prosecution, and coordination among relevant authorities.
- Upgrade supervisory powers for bank liquidation to include mandatory out-of-court administrative liquidation to reduce legal uncertainty and limit contingent liabilities, consistent with EU harmonization.
- To revive credit growth: complete ongoing insolvency reforms to lower lending costs; strengthen revenue administration to combat the shadow economy; oversee banks’ de-risking and business-model re-orientation toward the real economy to encourage consolidation and ease lending constraints; improve access to state loan guarantee programs to spur SME lending.
- New preemptive macroprudential measures should support sound lending standards and mitigate medium-term financial sector vulnerabilities amid persistently rising property prices.
Structural and labor market reforms
- Key structural challenges and recommended actions:
- Demographics: Latvia’s population continues to decline, straining the labor market and posing a long-term growth challenge.
- Labor market: Redouble efforts to ease labor market constraints by promoting better skill matching, reducing long-term unemployment, increasing labor participation of targeted groups, encouraging return of Latvian emigrants, and allowing entry of skilled immigrants.
- Productivity: Raise productivity growth to allow more rapid sustainable wage growth and help slow emigration.
- Access to finance and investment: Reforms to improve firms’ access to finance, encourage investment in research and development, and attract foreign direct investment.
- Governance: Strengthen transparency and governance of local authorities and state-owned enterprises to improve public resource use and prevent misuse.
Executive Board assessment (summarized)
- The Latvian economy is considerably more resilient since the global financial crisis; prospects remain favorable.
- No significant economic imbalances identified; external and government debt are on declining paths; private sector balance sheets improving.
- Inflation moderate and competitiveness held up.
- The external position is assessed to be moderately stronger than implied by medium-term fundamentals and desirable policies.
- Important risks: demographic decline, weaker external growth (especially in the euro area) and rising protectionism, and financial integrity risks (AML/CFT effectiveness and BSFCs).
Selected economic indicators (2015–20)
- Real GDP (percent change):
- 2015: 3.0
- 2016: 2.1
- 2017: 4.6
- 2018: 4.8
- 2019: 3.2 (Projection)
- 2020: 3.1 (Projection)
- Private consumption (percent change):
- 2015: 2.5
- 2016: 1.4
- 2017: 4.1
- 2018: 4.5
- 2019: 3.5 (Projection)
- Gross fixed capital formation (percent change):
- 2015: -0.5
- 2016: -8.4
- 2017: 13.1
- 2018: 16.4
- Exports of goods and services (percent change):
- 2015: 4.4
- 2016: 6.2
- 2017: 1.8
- 2018: 2.2
- 2019: 2.3 (Projection)
- Nominal GDP (billions of euros):
- 2015: 24.3
- 2016: 25.0
- 2017: 27.0
- 2018: 29.5
- 2019: 31.4 (Projection)
- 2020: 33.1 (Projection)
- GDP per capita (thousands of euros):
- 2015: 12.2
- 2016: 12.7
- 2017: 13.9
- 2018: 15.3
- 2019: 16.3 (Projection)
- 2020: 17.2 (Projection)
- Gross national saving (percent of GDP):
- 2015: 21.8
- 2016: 22.3
- 2017: 22.9
- 2018: 23.2
- 2019: 23.0 (Projection)
- Gross capital formation (percent of GDP):
- 2015: 22.2
- 2016: 20.7
- 2017: 24.2
- 2018: 24.4
- 2019: 24.7 (Projection)
- HICP inflation (period average):
- 2015: 0.2
- 2016: 0.1
- 2017: 2.9
- 2018: 2.6
- 2019: 2.7 (Projection)
- Unemployment rate (LFS; period average, percent) 1/:
- 2015: 9.9
- 2016: 9.6
- 2017: 8.7
- 2018: 7.4
- 2019: 6.7 (Projection)
- 2020: 6.9 (Projection)
- Real gross wages (percent change):
- 2015: 6.6
- 2016: 4.9
- 2017: 5.7
- Consolidated general government (percent of GDP):
- Total revenue:
- 2015: 36.2
- 2016: 35.6
- 2017: 36.9
- 2018: 35.7
- Total expenditure:
- 2015: 37.8
- 2016: 36.6
- 2017: 36.4
- 2018: 37.6
- Basic fiscal balance:
- 2015: -1.5
- 2016: -0.4
- 2017: -0.8
- 2018: -0.7
- ESA balance:
- 2015: -1.4
- 2016: -0.6
- 2017: -1.0
- General government gross debt:
- 2015: 36.8
- 2016: 40.3
- 2017: 40.0
- 2018: 35.9
- 2019: 34.4 (Projection)
- Money and credit:
- Credit to private sector (annual percentage change):
- 2015: -2.3
- 2016: -5.6
- Broad money (annual percentage change):
- 2015: 7.5
- 2016: 5.8
- Balance of payments:
- Current account balance (percent of GDP):
- 2015: 1.6
- 2016: 0.7
- 2017: -1.6
- Trade balance (percent of GDP):
- 2015: -9.0
- 2016: -7.5
- 2017: -8.5
- 2018: -8.7
- 2019: -8.6 (Projection)
- Gross external debt:
- 2015: 143.7
- 2016: 148.9
- 2017: 140.5
- 2018: 121.0
- 2019: 117.4 (Projection)
- 2020: 114.4 (Projection)
- Net external debt 2/:
- 2015: 30.7
- 2016: 29.2
- 2017: 25.5
- 2018: 21.2
- 2019: 23.7 (Projection)
- 2020: 22.7 (Projection)
- Exchange rates:
- U.S. dollar per euro (period average):
- 2015: 1.11
- 2016: 1.13
- 2017: 1.18
- REER (period average; CPI based, 2005=100):
- 2015: 120.8
- 2016: 122.0
- 2017: 123.0
- 2018: 126.5
- Terms of trade (annual percentage change):
- 2015: 0.6
- 2016: 2.8
- 2017: 2.0
IMF Press Release No. 19/312 — August 7, 2019.
