OECD Economic Outlook, Volume 2020 Issue 2

Latvia

GDP is set to contract by 4.3% in 2020, before growing by 2.4% in 2021 and 4.0% in 2022. Activity rose rapidly in the third quarter of 2020 after containment measures had been withdrawn. However, the recovery has been interrupted by the recent tightening of containment measures in response to a renewed virus outbreak, and is projected to resume at a slow rate when the restraints are relaxed. Private consumption will strengthen as household confidence and net disposable incomes increase. Investment will also gradually regain momentum. The labour market has been quite resilient. However, unemployment will remain elevated in 2021 due to a slow recovery in labour-intensive sectors.

Fiscal policy helped to prevent a more severe downturn, and will continue to support the recovery. The strong fiscal position leaves room for the government to provide further help to households and businesses, if needed. To facilitate the reallocation of workers and capital, training programmes should be enhanced and insolvency procedures should be made more effective.

New restrictions have been imposed to combat the second wave

Incidence and mortality rates related to COVID-19 have been low compared with other European countries so far. However, the number of confirmed cases has risen rapidly from mid-September and a state of emergency took effect on 9 November. No more than two households can gather at private events, public recreation facilities are closed, and restaurants can only provide takeaway services. Other national containment measures include wearing masks in public transport and stores, and allowing only certain retailers to open during weekends. Unlike in the spring, elementary schools and kindergartens remain open. Google data indicate that mobility to places like restaurants and shopping centres, while higher than most OECD countries, was about 17% below pre-COVID-19 levels in mid-November. Midweek traffic congestion in Riga has declined since mid‑October.

Latvia: Consumption and recovery

1. Weekly year-on-year percentage change. Average over past 4 weeks.

2. Google retail and recreation community mobility trend. The baseline is the median value, for the corresponding day of the week, during the 5-week period January 3-February 6, 2020. Average over past 14 days.

Source: OECD Economic Outlook 108 database; Google LLC, Google COVID-19 Community Mobility Reports, https://www.google.com/covid19/mobility/ ; and Swedbank.

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Latvia: Demand, output and prices

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Effective containment enabled a swift recovery from the first wave

A sharp fall in private consumption led to a GDP contraction of 9% in the second quarter of 2020 compared with the same quarter of 2019, but data for the third quarter point to a strong rebound across most sectors, including manufacturing and retail. The swift recovery owes in part to less stringent restrictions and effective policy responses that limited the early spread of the virus. The seasonally adjusted unemployment rate had increased by about two percentage points at its peak in July, but already declined to 8.4% in September despite the end of the job retention scheme. Wage growth for full-time employees has slowed but remains above zero. Card spending and cash withdrawals are below last year’s levels and have recently begun to decline.

The fiscal response has focused on boosting investment

The government took significant steps to support firms’ cash flow, the health system and jobs in companies hit hard by the crisis, with measures that amounted to 4¾ per cent of GDP. However, limited demand for some of the programmes, particularly loan guarantees, and some delays in implementation have led to lower spending than expected. The income support measure for inactive workers closed at the end of June, but was reintroduced in November. Compared with neighbouring countries, Latvia's fiscal response has focused more on boosting investment, and the European Recovery Facility has potential to achieve further progress. The 2021 draft budget proposes a structural deficit of about 2% of GDP, excluding EU grants. The government plans to reduce the structural deficit to about 1% of GDP in 2022. It also intends to raise the monthly minimum wage from EUR 430 to EUR 500 as of January 2021. In addition, social security contributions will be reduced by one percentage point and the threshold for personal income tax will be increased by 50%. Accommodative ECB monetary policy is mitigating the recession through low borrowing costs.

A slow recovery lies ahead as health risks remain

A slow recovery is projected as virus containment measures are assumed to ease gradually from December. GDP should recover to its pre-crisis level during the first half of 2022. Higher minimum wages and a lower tax wedge for low-income workers will improve households’ disposable income and foster consumption. Nonetheless, restrictions on several activities, and high precautionary saving, until an effective vaccine is deployed, will moderate private consumption until consumers regain confidence. Business investment will pick up slowly, supported by low interest rates and declining uncertainty. Exports will recover slowly as economic activity gradually improves in Europe. Unemployment will remain high as long as labour-intensive sectors, such as tourism, cannot operate normally. High public investment is projected to support the labour market recovery and offset some of the possible negative employment effects of the minimum wage increase. Inflation will edge up only slowly due to significant spare capacity. Failing to contain the spread of the virus until a vaccine becomes available would reduce private consumption and further slow the recovery in the short term. Conversely, a swift use of European recovery funds could lead to a stronger rebound.

Policies should support the reallocation of workers and productivity

Measures to improve relevant skills and support the reallocation of workers and capital should complement higher public investment. Latvia’s rental housing market offers few affordable choices, reducing opportunities to match workers to jobs. Increasing spending on active labour market policies and reforming the private rental market would ease labour reallocation. To strengthen access to housing, Latvia should expand the competencies of municipal housing companies and facilitate the development of non-profit or limited-profit providers. Improving insolvency procedures would help restructure viable firms and liquidate unprofitable ones more rapidly. Accelerating the digital transformation has become more urgent; in particular, training to improve digital skills would encourage greater uptake of digital technologies.