Like its Baltic neighbours, Latvia has acutely felt the economic effects of Russia’s war on Ukraine. As purchasing power remains low and support for households affected by inflation expires, its economy will remain stagnant for much of 2023 until growth returns in 2024.
Since the end of its occupation by the Soviet Union more than three decades ago, Latvia has developed into one of emerging Europe’s most advanced economies.
As the previously state-owned industrial and agricultural sectors shrank, and the country emerged as a regional financial centre. Annual gross domestic product (GDP) growth in the early and mid-2000s was among the fastest in Europe, peaking at 12 per cent in 2006.
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However, following the collapse of Parex Bank in 2008, Latvia was the hardest hit European country by the global financial crisis of that decade; its GDP decreased 25 per cent between the fourth quarter of 2007 and the third quarter of 2009.
Financial assistance from the European Union and International Monetary Fund was needed to facilitate a speedy recovery, with GDP growth returning to seven per cent by 2012.
Today, Latvia is a technological and financial leader in the emerging Europe region. While Latvia ranked eighth out of 23 countries in the 2022 Emerging Europe Future of IT Report’s IT Competitiveness Index, it climbed to fourth place in the 2023 report. The 2023 report also ranked the country fourth for business environment, third in intellectual property and cybersecurity, and sixth for IT talent: 4.12 per cent of Latvia’s overall workforce is employed in information and communications technology.
Little growth expected
Latvia has an ‘A-’ long-term foreign-currency issuer default rating from Fitch. The ratings agency says Latvia’s governance indicators are “slightly above the median of ‘A’ category peers” and credits the country with “lower government debt levels and debt servicing costs than peer medians”.
Decoupling from Russian energy and other effects of the war in Ukraine have nevertheless caused Latvia, and its Baltic neighbours Estonia and Lithuania, to experience some of the highest commodity prices in the EU. In February 2023, consumer inflation was 20.3 per cent.
The Vienna Insititute of International Economic Studies (wiiw), a think tank, initially forecast complete economic stagnation and zero per cent GDP growth in 2023, but on April 26, it released a new forecast suggesting 0.3 per cent growth. Latvia will still lag behind neighbours Estonia and Lithuania, however.
Average real net wages declined by almost nine per cent in 2022 and are forecasted to decline by 1.5 per cent in 2023 despite the government’s raise of the minimum wage by 24 per cent in January.
Decreased purchasing power and declining real wages will curb consumption through the first half of 2023. “Expected household consumption will go down this year,” wiiw’s economist Sebastian Leitner tells Emerging Europe. “Last year there was still good growth as a result of the pent-up demand from Covid-19.”
The global economic downturn and rising cost of input goods is exerting downward pressure on external demand.
While Latvia’s real-terms exports grew in the last quarter of 2022, they began to decline in December and have continued to do so. Latvian exports to Russia have remained stable while imports from Russia and Belarus have sharply declined.
Exports to countries in the Commonwealth of Independent States (CIS)—notably Armenia, Kazakhstan, and Kyrgyzstan—have increased, and the wiiw forecast speculates this could be due to “a high share of those goods [being] re-exported to Russia and Belarus, circumventing the sanctions of the EU” placed on the two countries for their role in the invasion of Ukraine.
Effects of the war in Ukraine
Latvia halted the import of gas from Russia soon after it launched its invasion of Ukraine, and gas consumption in 2022 fell 36 per cent against a 19 per cent drop in gas consumption in the EU as a whole.
According to the wiiw forecast, “At the beginning of April, the Latvian gas storage facilities (which also serve the needs of its Baltic neighbours), were filled more than ever in this season of the year (34 per cent)”.
The Latvian government provided support to households struggling to cope with increased energy prices, but these measures expire at the end of April.
To the delight of environmental groups, the government terminated plans for a liquified natural gas (LNG) terminal in the town of Skulte on April 11. The Latvian Ministry of Climate and Energy concluded that the Baltic region has sufficient LNG import capacity as is and that, “it is not possible to build commercially self-sufficient liquefied petroleum natural gas terminals”.
Despite plans to increase public spending in Latvia last year and a nominal increase of 12 per cent, there was only a growth of one per cent in real terms.
“I think that, due to high inflation, [Baltic] governments will refrain from increasing their expenditures in normal terms that much”, Leitner says.
All three Baltic countries have seen large influxes of Ukrainian refugees, but while about half of Ukrainian refugees of working age found jobs in Lithuania and over 40 per cent did in Estonia, Leitner says only around a quarter of those in Latvia have. This could be due to higher existing demand for labour in Lithuania and Estonia.
If EU actors continue their willingness to cushion depressed purchasing power and consumption through fiscal policies and the European Central Bank refrains from being “too hawkish via interest rate increases in the coming months”, wiiw forecasts GDP growth to revive and reach 2.5 per cent in 2024.
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