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European credit rating agency Scope has granted Latvia an A- credit rating, stating that its economy is set for stable growth. Fitch Ratings and Standard & Poor’s Global have also granted Latvia a rating of A-.
Scope’s report, released on 27 April, highlights Latvia’s strong public finances; its commitment to structural reforms; its sound economic performance; and its Euro area membership. The report notes that the Latvian government has reduced public debt and implemented structural reforms driving higher growth potential. Scope expects the Latvian economy to grow by 4% this year, and 3.5% in 2019. This contrasts sharply to the pre-crisis period (2003-2007), where potential GDP grew by an average of 7.6%.
Robust private consumption buoyed by an upturn in real wages and domestic credit, alongside investments and a favourable external environment, will drive growth, says Scope analyst Levon Kameryan. Careful debt management, structural reforms and increased economic resilience also contribute positively to Latvia’s rating.
The country continues to face challenges though. Its weaknesses lie in its external vulnerabilities, including the high volume of non-resident debt in the banking sector. Further difficulties are the falling labour supply due to high volumes of people emigrating; an ageing population; and lagging productivity. The size of the labour force has continued to decline by an annual average of around 1% since 2012, and productivity rates remain amongst the lowest in Europe.
Latvia also has a need to improve the quality and accessibility of its healthcare. This, combined with its ageing population, will put pressure on public finances. According to the European Commission, Latvia has one of the fastest increases among EU countries of its old-age dependency ratio: it will increase to 65.2% in 2060, from 30.5% in 2016. In response, authorities have adopted measures to address the poor demographic outlook and low-pension concerns, such as increasing outlays for child benefits, indexing pension growth to 50% of wage growth, and raising the retirement age by three months annually to 65 years through 2025.
While Latvia has an open economy, it remains vulnerable to external shocks and continues to be reliant on external demand, reflected by its high external debt. About a quarter of its external debt stock consists of short-term deposits (mostly from Russia and other CIS countries), concentrated in banks servicing foreign clients. This leaves the economy susceptible to shifts in investor confidence. The share of external deposits has decreased since 2015 due to Russia’s economic slowdown and more stringent regulations.
Latvia is a leading financial centre in the Baltic region, and its banking sector consists of Nordic banks, which provide most of the credit to the economy, and banks serving mostly foreign clients. The past decade has seen the collapse of several major banks. Earlier this year ABLV Bank went into liquidation due to deposit outflows after money laundering and corruption allegations by the U.S. Department of the Treasury. This led to the transfer of the full amount of guaranteed deposits (EUR 480m) to Latvia’s Deposit Guarantee Fund, covering 88% of the bank’s clients. As such, Scope does not expect material fiscal risks stemming from the liquidation of ABLV Bank, but the liquidation has shaken investor confidence.
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