IMF Executive Board Concludes 2024 Article IV Consultation with the Republic of Latvia
IMF News, September 5, 2024
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- Published: September 5, 2024
Overview and recent developments
- The Executive Board concluded the Article IV consultation with the Republic of Latvia and endorsed the staff appraisal on a lapse-of-time basis without a meeting.
- Recent dynamics:
- The Latvian economy contracted with significant disinflation: growth contracted by 0.3 percent in 2023.
- Headline inflation declined to 0.0 percent y/y in May 2024.
- Core inflation stood at 3.1 percent in April 2024.
- The financial sector has been resilient, though risks are elevated.
- Fiscal performance in 2023 was stronger than expected, reflecting revenue buoyancy linked to inflation and expenditure under-execution.
- The current account deficit narrowed to 4 percent of GDP in 2023 from 4.8 percent in 2022.
- Russia’s war in Ukraine and related geoeconomic fragmentation are adding to structural challenges affecting investment, productivity, labor supply, and income convergence.
Outlook and risks
- Growth projections:
- Real GDP growth is projected to increase to 1.7 and 2.4 percent in 2024 and 2025, respectively.
- Growth in the medium-term is projected to continue at an average of around 2.5 percent, supported by public investment and reforms.
- Inflation projections:
- Headline inflation (annual average) is projected to decline to 2.0 percent in 2024.
- Core inflation (annual average) is projected to slow to 3.3 percent in 2024, reflecting persistent services inflation.
- Balance of risks:
- Downside risks dominate, including risk to competitiveness associated with recent high wage growth, rising geopolitical tensions and deeper geoeconomic fragmentation, and weaker external demand.
- Credit risks related to variable-rate loans and the potential for weaker-than-expected external demand are highlighted.
- Over the medium term, delays in public investment and structural reforms could weigh on potential growth.
Executive Board assessment and policy recommendations — fiscal
- Recommended fiscal stance:
- Staff recommends a less expansionary, neutral fiscal stance for 2024 and a tighter fiscal stance in 2025.
- In 2025, the fiscal stance should be tighter to build buffers for future spending needs.
- Policy options and structural fiscal measures suggested:
- Reduce tax exemptions.
- Raise revenue from property taxation.
- Strengthen tax enforcement.
- Improve investment spending efficiency and better target social support while protecting the most vulnerable.
- Over the medium term, options for fiscal consolidation include:
- Broadening the bases of corporate income tax (CIT) and personal income tax (PIT), including by reducing the shadow economy.
- Broadening the base of property taxes.
- Reducing tax exemptions and fossil fuel subsidies.
- Rationalizing spending on goods and services.
- Enhanced public investment management is warranted given scaling-up of public investment amid high uncertainty and cost overrun.
- Staff welcomes healthcare reform aimed to generate efficiency gains, and welcomes government’s pension reform efforts; recommends linking the retirement age to life expectancy.
- Latvia should swiftly implement the NRRP.
Financial sector and macroprudential policy
- Financial sector condition and guidance:
- The banking sector remained well capitalized and liquid, with a low NPL ratio.
- Continued monitoring of macrofinancial vulnerabilities and spillovers is warranted, including regular risk-based monitoring of banks’ asset quality and liquidity supported by tailored stress tests.
- Any households’ financial distress related to variable-interest-rate mortgage loans should be addressed through the consumer bankruptcy framework, supplemented by the social protection system for the most vulnerable.
- The new untargeted interest subsidy scheme for variable-interest-rate mortgages should not be renewed at its expiration in 2024.
- The authorities should refrain from further initiatives to increase taxation on bank profits given their adverse impact on bank capital and financial stability.
- Staff welcomes continued efforts to mitigate cybersecurity risk.
- Macroprudential stance:
- The current macroprudential policy stance is broadly appropriate.
- The recent adjustment to the borrower-based measures for energy-efficient housing loans should be reconsidered.
- Borrower-based macroprudential measures should be relaxed only when their presence is overly stringent from the financial stability perspective.
Structural reforms, governance, and climate/energy transitions
- Governance and AML/CFT:
- Significant progress has been made in strengthening AML/CFT frameworks and governance reforms; staff commends authorities’ efforts and supports priorities to prepare for the 6th round of MONEYVAL evaluation.
- Staff welcomes reforms to digitalize the procurement system and continued implementation of Latvia’s anti-corruption plan and national strategy.
- Structural reform priorities:
- Accelerate corporate reforms to boost investment and productivity by improving capital allocation and access to finance.
- Address aging population and skill mismatch by boosting high-skilled labor supply, promoting training, and internal labor mobility toward priority sectors (green and transition, digitalization, health).
- Streamline product and service market regulations to boost competition, innovation, and productivity; continue administrative procedures overhaul and digitalization.
- Promote digital transformation to help reduce labor shortages and support productivity.
- Green and energy transition:
- More vigorous climate policy is needed; staff encourages expedited adoption of the climate law and the National Energy and Climate Plan (NECP).
- Authorities should aim for a robust balance between fiscal support, carbon pricing or taxation, and norms while addressing distributional concerns.
- Staff welcomes ongoing work on climate adaptation, enhancement of energy security, and boosting investment in clean energy and connection.
Key statistics (selected indicators and projections)
- Real GDP (percentage change): 2019: 0.6; 2020: -3.5; 2021: 6.7; 2022: 3.0; 2023: -0.3; 2024 (Proj.): 1.7; 2025 (Proj.): 2.4.
- Private consumption (percentage change): 2019: 0.0; 2020: -4.3; 2021: 7.3; 2022: 7.2; 2023: -1.3; 2024 (Proj.): 2.3.
- Gross fixed capital formation (percentage change): 2019: 1.5; 2020: -2.2; 2021: 8.2; 2022: 3.1; 2023: (table shows) 5.1; 2024 (Proj.): 2.6; 2025 (Proj.): 2.7.
- Nominal GDP (billions of euros): 2019: 30.6; 2020: 30.1; 2021: 33.3; 2022: 38.4; 2023: 40.3; 2024 (Proj.): 42.4; 2025 (Proj.): 44.8.
- GDP per capita (thousands of euros): 2019: 15.9; 2020: 15.8; 2021: 17.6; 2022: 20.5; 2023: 21.4; 2024 (Proj.): 22.5; 2025 (Proj.): 23.9.
- Gross national saving (percent of GDP): 2019: 22.2; 2020: 24.3; 2021: 21.1; 2022: 20.3; 2023: 19.0; 2024 (Proj.): 19.1; 2025 (Proj.): 18.9.
- Headline HICP inflation, period average: 2019: 0.1; 2020: 3.2; 2021: 9.1; 2022: 2.0.
- Core HICP inflation, period average: 2019: 1.1; 2020: 11.3; 2021: 9.8; 2022: 3.3.
- Unemployment rate (LFS; period average, percent): 2019: 6.3; 2020: 8.1; 2021: 7.6; 2022: 6.9; 2023: 6.5.
- Nominal wage growth: 2019: 6.2; 2020: 11.7; 2021: 7.5; 2022: 11.9; 2023: 8.5.
- Consolidated General Government — Total revenue (percent of GDP): 2019: 37.3; 2020: 37.7; 2021: 37.6; 2022: 37.2; 2023: 38.5; 2024 (Proj.): 38.6; 2025 (Proj.): 38.7.
- Consolidated General Government — Total expenditure (percent of GDP): 2019: 41.4; 2020: 43.2; 2021: 40.9; 2022: 42.0; 2023: (table lists) (see source table for full series).
- General government gross debt (percent of GDP): 2019: 36.7; 2020: 42.7; 2021: 44.4; 2022: 41.8; 2023: 43.6; 2024 (Proj.): 44.7.
- Current account balance (percent of GDP): 2019: -0.6; 2020: 2.9; 2021: -3.9; 2022: -4.8; 2023: -4.0.
- Trade balance (goods) (percent of GDP): 2019: -8.6; 2020: -5.1; 2021: -8.3; 2022: -10.7; 2023: -9.3; 2024 (Proj.): -8.8.
- Gross external debt (percent of GDP): 2019: 117.1; 2020: 122.1; 2021: 110.5; 2022: 102.3; 2023: 98.5; 2024 (Proj.): 94.9; 2025 (Proj.): 86.6.
- U.S. dollar per euro (period average): 2019: 1.12; 2020: 1.14; 2021: 1.18; 2022: 1.05; 2023: 1.08.
Source: IMF Executive Board Concludes 2024 Article IV Consultation with the Republic of Latvia (Press Release No. 24/319).