Abstract
2017 Article IV Consultation-Press Release; Staff Report
On July 7, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with the Republic of Latvia, and considered and endorsed the staff appraisal without a meeting.2
Growth eased to 2 percent in 2016, as gross investment contracted significantly by 11.7 percent on the back of lower than expected absorption of EU funds. This effect was compounded by a drag from net exports, as import volume growth accelerated markedly, while export growth remained modest. Despite a strong rise in imports, the current account recorded a surplus of 1.5 percent in 2016 as the terms of trade, driven largely by falling energy prices, improved by over 4.7 percent—the largest improvement in 10 years.
Growth accelerated in Q1 2017, to 4.0 percent year-on-year, faster than expected, driven by strong consumption and exports, and a pick up in investment. Growth is expected to pick up to 3.2 percent in 2017 on the back of an accelerated pace of disbursement of EU funds and continued robust private credit growth. Inflation remained low in 2016, but picked up quickly in the first months of 2017, reaching 3.3 percent in April, on the back of increasing international energy prices and strong base effects.
The general government structural balance recorder a surplus of 0.2 percent of GDP (ESA definition). Revenues overperformed, following measures adopted by the authorities, while expenditures were under executed.
Supported by the broader economic environment and low inflation, together with a decrease in debt levels, the financial position of domestic borrowers improved and credit growth started to pick-up in 2016. Credit to the non-financial private sector grew by 2.3 percent y-o-y in March 2017, reflecting growth of 5.1 percent to corporates and −1.1 percent to households.
Executive Board Assessment
In concluding the Article IV consultation with the Republic of Latvia, Executive Directors endorsed the staff’s appraisal as follows:
Latvia has made great strides since the crisis. After some modest slowing in 2013–16, growth is expected to rebound in the short term to around 3.2 percent on the back of a resumption of EU funds and a recovery of domestic credit alongside a favorable external environment. However, post-crisis growth seems to have settled at a more modest pace than the rapid pace achieved immediately post-crisis: low hanging fruits from productivity gains have been picked, and the challenge now is to raise potential growth by addressing crisis legacies and combatting economic headwinds such as demographics.
Policies to raise potential growth will need to focus on boosting productivity. For Latvia to accelerate its convergence path with western Europe, policies should focus on hiking TFP, raising investment and capital utilization, and strengthening the labor market. In addition to tax reform, broader priorities should include: i) structural and institutional reforms to boost TFP growth, for example protection of property rights, improving the legal system, increasing access to finance and reducing regulatory and administrative burdens; ii) raising investment and capacity utilization including through efficient use of EU funds, improved energy and transportation networks, and attracting FDI, and iii) improved labor market policies, such as active labor market policies, tax and benefit reform to improve incentives and efforts to reduce skills and regional mismatches. Many of these reforms could also help reduce incentives to participate in the shadow economy.
Fiscal policy, if properly calibrated, can support medium term growth, but needs to become more neutral over the medium term. With low gross financing needs and public debt, and given the small yet still negative output gap, there is some fiscal space to accommodate a temporary boost to the economy. In the short term, the main challenge for fiscal policy is to make the most efficient use of the large inflow of EU investment funds and allocate these resources to growth-enhancing investments. In addition, action is needed to boost the revenue share to compensate for the future loss of EU funds and finance stronger social safety nets. Looking forward, fiscal policy should become more neutral over the medium term, to avoid risks of procyclical policy.
The initiative to reform the tax system is welcome. The goals of supporting growth, increasing equity, and boosting revenues are appropriate. As the details of the final proposal are yet to be determined, the authorities face three immediate challenges to ensure these objectives can be achieved: i) finalizing plans swiftly to reduce uncertainty for households and firms, ii) carefully managing the macro impact to avoid procyclical policy and undermining future competitiveness, and iii) sustainably boosting the revenue share to ensure robust public finances even after EU funds phase out.
Continued efforts to address the shadow economy can bring multiple benefits. The shadow economy hinders economic development—preventing Latvia from reaching its full potential—and complicates policy making. Efforts to improve the business environment, reduce regulatory and administrative barriers, and improve transparency, will not only strengthen incentives to operate in the formal economy, but will also support growth. Reducing the share of the shadow economy is also associated with greater tax compliance and higher revenues. In parallel, such efforts can support credit growth by increasing financial inclusion, and improving the transparency of corporate and household balance sheets.
Financial stability is the necessary foundation for sustainable credit growth to boost output in the medium term. Recent financial indicators suggest that the credit cycle in Latvia has turned, yet credit growth remains somewhat constrained by demand and supply factors. Continued and sustainable credit growth will be needed to support investment and boost long term growth. The authorities should pursue policies to address lingering market failures from the crisis, including by promoting programs that facilitate SMEs access to credit, and continuing the implementation of insolvency reforms. Furthermore, vigilant supervision and enforcement are needed to safeguard financial stability and underpin sustainable credit growth. Continued strengthening implementation of AML/CFT measures will also support this objective.
Latvia: Selected Economic Indicators, 2011–18
National definition. Includes economy-wide EU grants in revenue and expenditure.
Gross external debt minus gross external debt assets.
Latvia: Selected Economic Indicators, 2011–18
| 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |||
|---|---|---|---|---|---|---|---|---|---|---|
| Projections | ||||||||||
| National accounts | (Percentage change, unless otherwise indicated) | |||||||||
| Real GDP | 6.4 | 4.0 | 2.6 | 2.1 | 2.7 | 2.0 | 3.2 | 3.2 | ||
| Private consumption | 3.0 | 3.1 | 5.0 | 1.3 | 3.5 | 3.4 | 3.3 | 3.2 | ||
| Public consumption | 3.0 | 0.3 | 1.6 | 2.1 | 3.1 | 2.7 | 3.5 | 3.4 | ||
| Gross capital formation | 49.8 | −1.0 | −5.8 | −4.3 | −0.9 | 2.2 | 8.6 | 7.5 | ||
| Gross fixed capital formation | 24.0 | 14.4 | −6.0 | 0.1 | −1.8 | −11.7 | 8.0 | 7.5 | ||
| Exports of goods and services | 12.0 | 9.8 | 1.1 | 3.9 | 2.6 | 2.8 | 3.1 | 3.3 | ||
| Imports of goods and services | 22.0 | 5.4 | −0.2 | 0.5 | 2.1 | 4.6 | 4.8 | 5.0 | ||
| Nominal GDP (billions of euros) | 20.3 | 21.9 | 22.8 | 23.6 | 24.4 | 25.0 | 26.6 | 28.0 | ||
| GDP per capita (thousands of euros) | 9.8 | 10.7 | 11.3 | 11.8 | 12.3 | 12.7 | 13.6 | 14.4 | ||
| Savings and Investment | ||||||||||
| Gross national saving (percent of GDP) | 22.0 | 22.6 | 21.2 | 21.2 | 21.3 | 21.4 | 20.8 | 20.7 | ||
| Gross capital formation (percent of GDP) | 25.2 | 26.2 | 23.9 | 23.2 | 22.1 | 19.9 | 21.3 | 22.1 | ||
| Private (percent of GDP) | 21.1 | 22.4 | 20.2 | 19.5 | 18.3 | 17.3 | 18.3 | 18.8 | ||
| HICP Inflation | ||||||||||
| Period average | 4.2 | 2.3 | 0.0 | 0.7 | 0.2 | 0.1 | 3.0 | 2.5 | ||
| End-period | 3.9 | 1.6 | −0.4 | 0.3 | 0.4 | 2.1 | 2.5 | 2.5 | ||
| (Percent of GDP, unless otherwise indicated) | ||||||||||
| Labor market | ||||||||||
| Unemployment rate (LFS; period average, percent)1/ | 16.2 | 15.0 | 11.9 | 10.8 | 9.9 | 9.6 | 9.3 | 9.0 | ||
| Real gross wages | 0.0 | 1.5 | 4.5 | 6.1 | 6.7 | 4.9 | 3.0 | 3.0 | ||
| Consolidated general government 1/ | ||||||||||
| Total revenue | 35.6 | 37.4 | 36.7 | 36.1 | 36.2 | 36.2 | 37.3 | 37.6 | ||
| Total expenditure | 38.8 | 37.2 | 37.3 | 37.8 | 37.7 | 36.7 | 38.2 | 38.1 | ||
| Basic fiscal balance | −3.2 | 0.2 | −0.6 | −1.7 | −1.5 | −0.4 | −0.8 | −0.5 | ||
| ESA balance | −3.4 | −0.8 | −0.9 | −1.6 | −1.3 | 0.0 | −0.7 | −0.7 | ||
| General government gross debt | 37.5 | 36.7 | 35.8 | 38.5 | 34.8 | 37.2 | 35.9 | 34.5 | ||
| Money and credit | ||||||||||
| Credit to private sector (annual percentage change) | −8.3 | −11.6 | −6.6 | −7.4 | −2.3 | 3.5 | 6.2 | 5.5 | ||
| Broad money (annual percentage change) | 1.5 | 4.5 | 2.0 | 35.5 | 7.5 | 6.6 | 7.3 | 6.7 | ||
| Balance of payments | ||||||||||
| Current account balance | −3.2 | −3.6 | −2.7 | −2.0 | −0.8 | 1.5 | −0.4 | −1.4 | ||
| Trade balance | −12.4 | −12.0 | −11.5 | −9.3 | −8.4 | −7.0 | −8.3 | −9.1 | ||
| Gross external debt | 145.8 | 138.2 | 133.9 | 143.0 | 141.6 | 147.3 | 140.2 | 134.8 | ||
| Net external debt 2/ | 47.0 | 39.8 | 36.6 | 32.9 | 28.5 | 28.6 | 26.1 | 22.6 | ||
| Exchange rates | ||||||||||
| U.S. dollar per euro (period average) | 1.39 | 1.29 | 1.33 | 1.33 | 1.11 | 1.11 | … | … | ||
| REER (period average; CPI based, 2005=100) | 124.0 | 120.1 | 120.1 | 121.9 | 120.4 | 121.6 | … | … | ||
| Terms of trade (annual percentage change) | 3.0 | −2.8 | 0.6 | −1.2 | 0.7 | 4.7 | −1.0 | −0.2 | ||
National definition. Includes economy-wide EU grants in revenue and expenditure.
Gross external debt minus gross external debt assets.
Latvia: Selected Economic Indicators, 2011–18
| 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |||
|---|---|---|---|---|---|---|---|---|---|---|
| Projections | ||||||||||
| National accounts | (Percentage change, unless otherwise indicated) | |||||||||
| Real GDP | 6.4 | 4.0 | 2.6 | 2.1 | 2.7 | 2.0 | 3.2 | 3.2 | ||
| Private consumption | 3.0 | 3.1 | 5.0 | 1.3 | 3.5 | 3.4 | 3.3 | 3.2 | ||
| Public consumption | 3.0 | 0.3 | 1.6 | 2.1 | 3.1 | 2.7 | 3.5 | 3.4 | ||
| Gross capital formation | 49.8 | −1.0 | −5.8 | −4.3 | −0.9 | 2.2 | 8.6 | 7.5 | ||
| Gross fixed capital formation | 24.0 | 14.4 | −6.0 | 0.1 | −1.8 | −11.7 | 8.0 | 7.5 | ||
| Exports of goods and services | 12.0 | 9.8 | 1.1 | 3.9 | 2.6 | 2.8 | 3.1 | 3.3 | ||
| Imports of goods and services | 22.0 | 5.4 | −0.2 | 0.5 | 2.1 | 4.6 | 4.8 | 5.0 | ||
| Nominal GDP (billions of euros) | 20.3 | 21.9 | 22.8 | 23.6 | 24.4 | 25.0 | 26.6 | 28.0 | ||
| GDP per capita (thousands of euros) | 9.8 | 10.7 | 11.3 | 11.8 | 12.3 | 12.7 | 13.6 | 14.4 | ||
| Savings and Investment | ||||||||||
| Gross national saving (percent of GDP) | 22.0 | 22.6 | 21.2 | 21.2 | 21.3 | 21.4 | 20.8 | 20.7 | ||
| Gross capital formation (percent of GDP) | 25.2 | 26.2 | 23.9 | 23.2 | 22.1 | 19.9 | 21.3 | 22.1 | ||
| Private (percent of GDP) | 21.1 | 22.4 | 20.2 | 19.5 | 18.3 | 17.3 | 18.3 | 18.8 | ||
| HICP Inflation | ||||||||||
| Period average | 4.2 | 2.3 | 0.0 | 0.7 | 0.2 | 0.1 | 3.0 | 2.5 | ||
| End-period | 3.9 | 1.6 | −0.4 | 0.3 | 0.4 | 2.1 | 2.5 | 2.5 | ||
| (Percent of GDP, unless otherwise indicated) | ||||||||||
| Labor market | ||||||||||
| Unemployment rate (LFS; period average, percent)1/ | 16.2 | 15.0 | 11.9 | 10.8 | 9.9 | 9.6 | 9.3 | 9.0 | ||
| Real gross wages | 0.0 | 1.5 | 4.5 | 6.1 | 6.7 | 4.9 | 3.0 | 3.0 | ||
| Consolidated general government 1/ | ||||||||||
| Total revenue | 35.6 | 37.4 | 36.7 | 36.1 | 36.2 | 36.2 | 37.3 | 37.6 | ||
| Total expenditure | 38.8 | 37.2 | 37.3 | 37.8 | 37.7 | 36.7 | 38.2 | 38.1 | ||
| Basic fiscal balance | −3.2 | 0.2 | −0.6 | −1.7 | −1.5 | −0.4 | −0.8 | −0.5 | ||
| ESA balance | −3.4 | −0.8 | −0.9 | −1.6 | −1.3 | 0.0 | −0.7 | −0.7 | ||
| General government gross debt | 37.5 | 36.7 | 35.8 | 38.5 | 34.8 | 37.2 | 35.9 | 34.5 | ||
| Money and credit | ||||||||||
| Credit to private sector (annual percentage change) | −8.3 | −11.6 | −6.6 | −7.4 | −2.3 | 3.5 | 6.2 | 5.5 | ||
| Broad money (annual percentage change) | 1.5 | 4.5 | 2.0 | 35.5 | 7.5 | 6.6 | 7.3 | 6.7 | ||
| Balance of payments | ||||||||||
| Current account balance | −3.2 | −3.6 | −2.7 | −2.0 | −0.8 | 1.5 | −0.4 | −1.4 | ||
| Trade balance | −12.4 | −12.0 | −11.5 | −9.3 | −8.4 | −7.0 | −8.3 | −9.1 | ||
| Gross external debt | 145.8 | 138.2 | 133.9 | 143.0 | 141.6 | 147.3 | 140.2 | 134.8 | ||
| Net external debt 2/ | 47.0 | 39.8 | 36.6 | 32.9 | 28.5 | 28.6 | 26.1 | 22.6 | ||
| Exchange rates | ||||||||||
| U.S. dollar per euro (period average) | 1.39 | 1.29 | 1.33 | 1.33 | 1.11 | 1.11 | … | … | ||
| REER (period average; CPI based, 2005=100) | 124.0 | 120.1 | 120.1 | 121.9 | 120.4 | 121.6 | … | … | ||
| Terms of trade (annual percentage change) | 3.0 | −2.8 | 0.6 | −1.2 | 0.7 | 4.7 | −1.0 | −0.2 | ||
National definition. Includes economy-wide EU grants in revenue and expenditure.
Gross external debt minus gross external debt assets.
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussionss.