Minister of Finance Arvils Ašeradens (JV) states that Fitch’s decision to raise Latvia’s future credit rating from stable to positive at the current “A-” level and to increase Latvia’s gross domestic product (GDP) growth forecast for this year to 1.4% confirms the stability of Latvia’s economy against external shocks and the sustainability of government decisions.
Fitch” indicates that the change in the future assessment of the credit rating reflects the flexibility of the Latvian economy against new shocks, reduced exposure to Russia, an expected sharp drop in inflation and a reduction in the fiscal deficit, the maintenance of the national debt at a stable level, the support of European Union (EU) funds for economic growth, and external risk preservation.
Latvia has shown relative resilience to new severe external shocks, even though it has a small and open economy, and real GDP has exceeded its pre-Covid-19 pandemic level. The result of the shock caused by the pandemic is a decrease in GDP at a much lower level than the EU average, while the negative impact of this shock on energy supply and prices has been less than initially expected, despite Latvia’s historically high dependence on Russian energy imports. “Fitch” predicts that inflation will decrease sharply and GDP growth will recover to about 3% in 2024-2025, which will be supported by faster investments by absorbing EU funds, and private consumption will recover.
Latvia has eliminated its historical dependence on Russian energy imports and reduced non-energy trade ties, although they are still a potential source of vulnerability. The share of trade with Russia has fallen to 5.9% of the total export of goods and 2.3% of the total import of goods in May 2023, compared to 10.9% and 9.7% in 2014, respectively. Latvia remains exposed to a potential new shock caused by high energy prices. The rapid adoption of high energy prices in the real economy led to the third highest inflation among EU countries in 2022 – 17.2% in Latvia compared to 9.2% on average in the EU.
Recent declines in global energy and food prices will continue to contribute to a slowdown in headline inflation in the coming months, with Fitch forecasting a decline in the harmonized consumer price index (CPI) to 2.3% in 2024 and 2.9% in 2025, compared to an average 9.4% in 2023. Risks to the agency’s forecast are, however, high core inflation and significant wage growth.
“Fitch” predicts that the state budget deficit will decrease to 3.8% of GDP in 2023 compared to 4.4% of GDP in 2022. The agency also forecasts a reduction in the budget deficit to 2.1% of GDP in 2024 and 1.8% of GDP in 2025, ending support measures related to energy, the pandemic and Ukrainian refugees. Taking into account the geopolitical situation, Latvia aims to increase defense spending to at least 3% of GDP by 2027, compared to 2.2% of GDP in 2021.
The agency predicts a reduction of the national gross debt to less than 40% of GDP at the end of 2023 compared to 40.8% in 2022 and 43.7% in 2021. According to the “Fitch” scenario, the ratio of national debt to GDP will remain stable until 2027. Latvia has less exposure to the current high interest rate environment, given its moderate level of public debt and high share of fixed-rate debt (80.9% of public debt), while the average debt repayment term is around seven years.
“Fitch” forecasts that interest payments on the national debt will increase to 1.7% of revenues in 2023 and 2.2% in 2024 compared to 1.3% of revenues in 2022, but will be lower than the current “A” median in the amount of 3.6%.
It is expected that the average level of absorption of EU funds will be 3.1% of GDP per year in the period from 2023 to 2025.
Despite Latvia’s relative resilience to new shocks, significant risks remain, including the rate and extent of deflation, the short-term growth outlook, the implementation of fiscal consolidation, and geopolitical risks.
“Fitch” indicates that the “A-” level of Latvia’s credit rating reflects the strengths and weaknesses of the rating, the economy’s avoidance of recession, the improvement of external finances, the preservation of the flexibility of the banking sector, the ESG (environmental, social responsibility and corporate governance) assessment.
Latvia’s rating is maintained by a lower level of public debt and debt servicing costs than countries of a similar rating, a reliable economic policy framework strengthened by membership in the EU and the Eurozone, governance indicators that are slightly higher than the average of “A” category countries, and a moderate amount of private sector indebtedness. Weaknesses are the small size of Latvia’s economy, GDP per capita, which is lower than other “A” category countries, current account deficit and net external debt, which are higher than countries of similar rating, and negative demographic trends.
“Fitch” has changed the Latvian GDP growth forecast to 1.4% in 2023, although in the previous assessment in February it predicted that the Latvian economy would fall by 0.3% in 2023. This shift reflects the better-than-expected performance of the economy over the past two quarters, as well as the expected easing of inflationary pressures, which will result in positive real wage growth.
The agency predicts that the fall in global commodity prices will contribute to the reduction of the current account deficit to 3.6% of GDP in 2023 from 6.4% in 2022. “Fitch” does not foresee a further significant reduction of the current account deficit in 2024 and 2025 and a return to pre-pandemic trends. The agency predicts that the capital account surplus will increase in 2023, but the inflow of foreign direct investment will remain stable at the level of 3% of GDP from 2023 to 2025. Net external debt decreased to 6.1% of GDP at the end of 2022 and is expected to remain mostly stable from 2023 to 2025.
The Latvian banking sector remains stable with high capitalization and improving asset quality. Rising interest rates have boosted banks’ net interest income, but the conditions have not changed significantly, and as a result, the profitability of the sector has significantly increased in 2022.
The previous assessment of Latvia’s credit rating was published by “Fitch” at the beginning of February this year, when it was maintained at the “A-” level with a stable future assessment of the credit rating.
2023-07-29 11:30:20
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