Numbers & Statistics

Republic of Latvia: Staff Concluding Statement of the 2019 Article IV Mission

By  | 

Via IMF (Den Internationale Valutafond)

Republic of Latvia: Staff Concluding Statement of the 2019 Article IV Mission







June 28, 2019







A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.










Latvia’s economic fundamentals remain broadly sound, with a low and
declining debt burden and prudent fiscal and current account deficits.
Growth is projected to decelerate to just above 3 percent in 2019, amid
a less supportive external environment.


A tight labor market and adverse demographic trends create capacity
constraints and will limit long-term growth without reforms.


Efforts should continue to focus on measures that ease labor market
constraints, increase productivity, and support investment growth. The
long-term policy mix should also aim to ensure space to accommodate
demographic and social spending costs.


Improving the effectiveness of the anti-money laundering regime,
upgrading supervisory powers in bank liquidation, and de-risking the
banking sector while ensuring efficient and inclusive financial
intermediation will be critical to preserving financial sector
stability and supporting growth.


The Latvian economy has become considerably more resilient since the
global financial crisis.

Growth has averaged above 3½ percent in the last 10 years; there are no
significant economic imbalances; external and government debt are on
declining paths; and private sector balance sheets continue to improve.
Inflation has been moderate, and competitiveness has held up. The new
government has signaled a firm commitment to set the economy on a path of
rising prosperity.

Economic prospects remain favorable.

Real GDP grew 4.8 percent in 2018, led by a pick-up of private investment
along with a boom in EU-funded construction and strong growth in IT and
communications. Growth is projected to slow in 2019 to just above 3
percent, as a less supportive external environment weakens export growth
and reduced pace of EU funds absorption and wage growth moderates domestic
demand. Over the medium term, growth is projected to converge to a still
robust rate of 3 percent.

READ ALSO  Flere køber villaer til over 7,5 millioner kroner


However, important challenges and risks may test the economy’s
resilience.

  • Latvia faces significant demographic challenges.
    The population continues to decline on average by 1 percent per year.
    To a great extent this is still due to ongoing emigration, especially
    of young and skilled Latvians. This affects the size and productivity
    of the working age population, puts pressure on the labor market, and
    makes it harder to sustain high growth in living standards over the
    long term.
  • External risks have become more pressing
    . Latvia is small and relatively well integrated in the global economy
    and is thus vulnerable to external demand shocks. Weaker than expected
    global growth, especially in the euro area, and rising protectionism
    could weigh on GDP growth due to lower demand for Latvian exports. A
    sharp decline in confidence and tightening of global financial
    conditions could increase borrowing costs for the Latvian government
    and the private sector.
  • The financial system still confronts reputational risks
    . The 2018 assessment by MONEYVAL raised concerns about Latvia’s
    anti-money laundering and combating of terrorism (AML/CFT) regime.
    Failure to strengthen the effectiveness of the AML/CFT regime and
    refocus banks servicing foreign clients towards a viable business model
    could significantly undermine the stability of the financial system and
    its capacity to support investment and GDP growth.


The authorities’ policy mix should aim at raising productivity and
competitiveness while strengthening confidence in the financial system.

Reform efforts should focus on easing labor market constraints to preserve
Latvia’s competitiveness and external resilience. The planned fiscal stance
provides space to face downside risks, if needed, but over the longer-term
rising aging and health care costs will force the budget to confront
difficult trade-offs about the best use of limited public money. Higher
productivity and investment growth are needed to offset the impact of
Latvia’s exceptionally unfavorable demographic trends. Persistent efforts
would also be critical to repair the reputation of the financial system by
strengthening the effectiveness of the AML/CFT framework, upgrading
supervisory powers, and de-risking of the banking sector.

Raising Productivity to Support Long-Term Growth

The long-term growth outlook is challenging amid intensifying
demographic headwinds.

A shrinking and aging labor force is likely to reduce productivity growth
and have a negative impact on long-term growth and living standards. In the
absence of reforms, long-term growth could fall by half. Ongoing efforts to
ease labor market constraints should be redoubled, including by promoting
better skill matching and reducing long-term unemployment, increasing labor
participation of targeted groups, encouraging Latvian emigrants to return
and allowing skilled immigrants to enter the domestic labor market. Raising
productivity growth will also allow more rapid wage growth to take place
sustainably and help slow emigration. Addressing structural and
institutional obstacles that inhibit greater use of new technologies and
better resource allocation could yield important productivity gains. This
could be achieved through reforms that upgrade the insolvency framework,
improve access to finance for small and productive firms, and encourage
investment in research and development and foreign direct investment.

READ ALSO  Flere køber villaer til over 7,5 millioner kroner

latvia-chart-1

Fiscal Policy Mix: Balancing Social and Fiscal Sustainability

The medium-term fiscal stance provides some space to respond to
potential downside risks.

The authorities’ planned fiscal stance reverses past procyclicality—when
the budget position was allowed to weaken despite strong growth—and is
appropriate given the expected deceleration of the economy. In the short
term, given pressures on overall wages in the economy, the authorities
should avoid further public sector wage increases that are not aligned with
productivity growth to protect competitiveness. Given Latvia’s relatively
low and declining government debt and favorable financing terms, some
fiscal space is available to react to shocks. The authorities should
carefully assess the potential fiscal costs of new spending initiatives and
identify stable revenue sources to preserve this fiscal space. If negative
shocks affect the economy, the authorities should accommodate the decline
in revenues and rise in spending to protect vulnerable population. In the
event of a severe economic downturn, temporary high-quality measures could
be considered to support the economy.

latvia-chart-2

Fiscal space

could be more limited over the long term due to demographic challenges.

Government spending pressures may increase to address the needs of Latvia’s
rapidly aging population and deal with relatively high poverty and
inequality levels. Thus, long-term policies should focus on securing new
revenue sources to accommodate the impact of demographic and social
spending costs and to support reforms that boost productivity and growth:
public spending is already relatively low in Latvia, meaning that
expenditure savings alone are unlikely to be adequate to cover growing
age-related demands on the budget. Given Latvia’s vast investment needs and
scarce resources, the authorities should focus capital spending on projects
that have the potential to catalyze private investment and have high social
impact. Poverty and inequality concerns could be addressed by improving the
adequacy and targeting of existing social programs. Furthermore, reforms to
improve the efficiency of public services and strengthen the transparency
and governance of local authorities and state-owned enterprises can help
improve the use of public resources and prevent misuse.

READ ALSO  Flere køber villaer til over 7,5 millioner kroner


Restoring Confidence in the Financial System and Reviving Credit Growth


Money laundering concerns continue to weigh on Latvia’s financial
sector, and steadfast actions are necessary to restore its reputation.

The authorities have demonstrated strong political commitment at the
highest level for such actions. Their efforts to reduce exposure to risky
banking operations, address MONEYVAL’s recommendations through legislative
and institutional changes, and oversee new business plans of banks
servicing foreign clients are welcome. The task ahead remains challenging
due to the need to demonstrate effectiveness of the AML/CFT regime,
including through long-term reforms. Such reforms should aim at enhancing
risk-based supervision, the quality and use of financial intelligence, the
application of preventive measures, investigation and prosecution, and
coordination among relevant national and regional authorities. Upgrading
the supervisory powers for bank liquidation to include mandatory
out-of-court administrative liquidation would reduce legal uncertainty and
limit potential contingent liabilities for the government, consistent with
EU harmonization efforts.


Banks are stable, profitable and liquid, but credit growth remains
elusive.

Despite record low borrowing costs, lending standards have tightened amid
structural changes in the sector and growing uncertainty. Mortgage lending
is slowly recovering, supported significantly by the state guarantee
program for families with children and young professionals, but other
lending programs remain underused. Efforts to revive credit growth should
focus on completing the ongoing insolvency reforms to accelerate the
rehabilitation of debtors and to lower lending costs through improved
expected recovery rates.
 Steps are also needed to strengthen the revenue administration to more
effectively combat the shadow economy and improve borrowers’ transparency.
Careful oversight of banks’ de-risking and business model re-orientation
towards the real economy should encourage consolidation and ease lending
constraints. Improving access to and knowledge about the system of state
loan guarantee programs could spur SME lending. New preemptive
macroprudential measures, applied to both banks and non-banks, should
support sound lending standards through the cycle. This, alongside a review
of the side effects of state guaranteed mortgage programs, would mitigate
medium-term financial sector vulnerabilities amid persistently rising
property prices.

latvia-chart-3

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


IMF Communications Department
MEDIA RELATIONS

PRESS OFFICER: Gediminas Vilkas

Phone: +1 202 623-7100Email: MEDIA@IMF.org






Print Friendly, PDF & Email

Hold dit netværk orienteret