Republic of Latvia: Staff Concluding Statement of the 2025 Article IV Mission
IMF News, June 9, 2025
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- Published: June 9, 2025
Key findings and context
- Latvia’s economy is navigating a complex global environment while addressing structural challenges at home, including geoeconomic fragmentation, geopolitical tensions, higher trade barriers and trade policy uncertainty, and labor and skills shortages.
- Significant medium- and long-term spending pressures arise from population aging, defense needs, and investments for energy security.
- To address spending needs, staff recommends mobilizing additional revenue and accelerating structural fiscal reforms.
- Improving pension adequacy requires strengthening the second and third pillars of the pension system.
- Authorities should monitor financial-sector risks, including banks’ exposure to the commercial real estate sector, and reassess the solidarity contribution on banks.
- Measures to boost productivity are recommended: increase the quantity and quality of corporate investment, support reallocation of labor and capital to higher value-added products and services, and enhance digital technology adoption in traditional sectors.
Outlook and risks
- Growth projection:
- Real GDP growth is projected to recover to about 1 percent in 2025, underpinned mainly by higher public investment, a recovery in private consumption, and a gradual recovery of external demand.
- Inflation projection:
- Headline inflation is projected to increase to about 3 percent in 2025, reflecting higher energy prices in the early months of 2025 and higher food prices.
- Core inflation is expected to moderate but remain above headline reflecting persistent services inflation.
- Downside risks to the outlook:
- Rising geopolitical tensions, higher tariffs and trade policy uncertainty.
- A further slowdown in growth of Latvia’s trading partners, delays in absorption of EU funds, new increases in global energy and food prices, and an increase in electricity prices.
- Fiscal downside risks from higher defense spending, contingent liabilities with state-owned enterprises that could be in excess of the Fiscal Safety Reserve, and higher capital expenditure with large infrastructure projects.
- Upside scenarios:
- Strong recovery in main trading partners, improved security boosting confidence, faster-than-expected disbursement of EU funds, and swift implementation of structural reforms could yield higher-than-expected growth.
Fiscal policy: addressing public spending pressures
- 2025 fiscal stance:
- The moderately expansionary budget in 2025 is appropriate, given the currently negative output gap.
- The headline fiscal deficit is projected to increase to about 3 percent of GDP in 2025 because of higher defense and investment spending needs.
- The 2025 budget includes tax reforms to simplify the personal income tax that will generate minimal revenue gains.
- Medium- and long-term pressures:
- Government commitments include increasing defense spending to 5 percent of GDP from 2026 onwards.
- In the absence of measures to raise fiscal revenues and reprioritize spending, Latvia’s structural fiscal deficit (including one-off expenses) is projected to average about 3 percent of GDP in the medium-term.
- This would raise public debt close to 50 percent of GDP in 2030, eroding fiscal space.
- Fiscal consolidation needs:
- Staff estimates that bringing public debt to its pre-Covid level of 40 percent of GDP in 2030 requires a fiscal consolidation of about ½ percent of GDP per year between 2026 and 2030.
- Revenue and efficiency measures recommended:
- Strengthen tax compliance.
- Broaden the bases of corporate and personal income taxes (e.g., reduce the shadow economy).
- Continue to improve VAT collection efficiency through further narrowing the compliance gap.
- Reduce tax exemptions and fossil fuel subsidies.
- Raise property tax revenue.
- Improve public spending efficiency: improve procurement, eradicate rent-seeking activities, simplify regulation, reduce bureaucracy, and increase efficiency of public administration and public investment management.
- Pension policy recommendations:
- Adopt a comprehensive approach to improve pension adequacy while ensuring the financial balance of the pension system.
- Pursue active labor market policies to increase labor force participation and incentivize pensioners to work.
- Link retirement ages to future life expectancy gains.
- Increase contribution rates and returns to the mandatory defined contribution pension pillar.
- Strengthen incentives for higher voluntary savings through a more flexible and accessible system design.
Financial policies: countering risks and building resilience
- Commercial real estate (CRE) exposure:
- Loans to the CRE sector are around 31 percent of banks’ total corporate loan portfolio, warranting close monitoring given structural changes in the office CRE segment globally.
- Solidarity contribution on banks:
- Authorities should reassess the solidarity contribution on banks; if maintained long, it could distort lending toward less productive uses such as real estate and reduce lending to corporates because banks can spread increased tax costs over mortgage terms but not over shorter-maturity corporate loans.
- Macroprudential stance:
- The macroprudential policy stance remains broadly appropriate.
- Implementation of a positive neutral countercyclical capital buffer requirement, which will be raised to 1 percent in June 2025, helps build up releasable macroprudential buffers.
- The looser debt-to-income and debt service-to-income limits implemented in 2024 to promote loans for the purchase of energy-efficient housing should be reconsidered.
- AML/CFT:
- Latvia has made further progress in strengthening its AML/CFT framework.
Structural reforms: boost investment and productivity
- Growth drivers and constraints:
- Latvia’s low productivity growth is driven by sluggish capital accumulation and inefficient allocation of productive resources.
- Low capital stock results from inadequate investment partly driven by financial constraints and low risk-adjusted expected returns.
- Structural bottlenecks include costly and lengthy insolvency processes and limited occupational and regional mobility of the labor force, hindering reallocation to high-productivity firms.
- Corporate and capital market reforms:
- Insolvency reforms focused on micro companies and timely initiation of insolvency cases to facilitate exit of non-viable firms.
- Initiatives to develop capital markets to improve access to finance for smaller firms.
- Expand venture capital and equity financing to support startups and scaling of young firms.
- Deepening the EU single market would help firms leverage economies of scale and improve access to capital markets.
- Labor and skills policies:
- High-quality education and training systems, targeted upskilling and reskilling measures to reduce labor and skills shortages.
- Facilitation of skilled migration and targeted active labor market policies to enhance labor market participation.
- Product and service market reforms:
- Reduce use of retail price regulation.
- Streamline spatial planning and construction regulations.
- Simplify administrative procedures and accelerate digitalization in the construction sector.
- Innovation, digital transformation, and energy security:
- R&D spending remains among the lowest in Europe despite a modest rise; accelerate support for innovation.
- Accelerate digital transformation: centralize governance of digital platforms and systems in the public sector, expand digital training for public employees, promote digitalization in businesses and education, and enhance broadband infrastructure.
- Enhance energy security by increasing the share of renewable energy, including biomass, and improving interconnections to other European power grids.
Mission and publication details
- An IMF team conducted meetings in Riga during May 26–June 6, 2025.
- The mission was led by Mr. Luis Brandao-Marques and included Gianluigi Ferrucci, Bingjie Hu, and Keyra Primus (all EUR). Carlos Acosta and Anjum Rosha (all LEG) participated virtually. Gundars Davidsons (OED) participated in the meetings.
- Press information:
- Publication headline date: June 8, 2025.
- Washington, DC – June 9, 2025.
Republic of Latvia: Staff Concluding Statement of the 2025 Article IV Mission