Latvia

Latvia’s economic prospects have significantly deteriorated as a result of the war in Ukraine. This is mostly due to the country’s geographic proximity to Russia and its significant (pre-war) trade relations (accounting for 7% of Latvia’s exports, 9% of its imports and, notably, 100% of its natural gas imports). Following a solid post-Covid-19 recovery with +4.1% real GDP growth in 2021, economic activity in Latvia slowed down markedly in 2022 amid surging inflation, rising interest rates, weakening external demand and deteriorating business confidence. In quarter-on-quarter terms, real GDP was flat in Q2 2022 and contracted by -1.7% in Q3. We expect a recession lasting into 2023 as the projected sharp economic slowdown in Western Europe will additionally weigh on trade in Latvia. That said, government fiscal stimulus and EU funding inflows should mitigate the impact on growth to some extent, though winter energy rationing in Europe is a key downside risk. We expect full-year real GDP to expand by around +1.5% in 2022 and to contract by close to -1% in 2023. Our tentative forecast for 2024 is a recovery to modest growth of about +2%.

Inflationary pressures will remain substantial in 2022-2023. Consumer-price inflation has been on the rise since mid-2021 and surged to well over 20% y/y in H2 2022, driven by soaring energy and food prices as well as interrupted supply chains. We expect it to remain above 20% until Q1 2023 at least and to be in double digits for most of 2023 before base effects, monetary tightening by the ECB and slowing domestic demand will bring gradual relief. Meanwhile, Eurozone membership provides for moderate transfer and convertibility risk in Latvia.

The Latvian business environment is generally strong. The World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are generally business-friendly while a certain level of corruption is still perceived as present. The Heritage Foundation’s Index of Economic Freedom 2022 survey assigns Latvia rank 18 out of 184 economies, an improvement from rank 30 in the previous year. Our proprietary Environmental Sustainability Index ranks Latvia 33rd out of 210 economies, reflecting strengths in energy use and CO2 emissions per GDP, water stress and general vulnerability to climate change, though there are still moderate weaknesses in renewable-electricity output and the recycling rate.

Overall systemic political risk has deteriorated somewhat from a previously low level because geopolitical risk in the region has increased with the war in Ukraine. Latvia is a well-established democracy and has good international relations – except with Russia – reflected in its EU, OECD and NATO membership. The war has led to increased parliamentary unity and the parliamentary election in October 2022 confirmed Prime Minister Karins in office, leading to a three-party center-right coalition. However, there is a risk that social and cultural push-back is emerging from the sizeable Russian-speaking minority in Latvia.