OECD Economic Outlook, Volume 2020 Issue 1

Latvia

Economic growth slowed before the pandemic started and is projected to contract sharply in 2020, despite a relatively lenient lockdown. Activity will recover, but gradually, as uncertainty will remain high and activity in some service sectors will remain subdued. Domestic demand will drive the recovery, while exports will be slower to pick up due to the severe recession in Europe. Investment will drop and stay low throughout 2021, particularly should a second lockdown be necessary (the double-hit scenario). Unemployment is projected to increase and remain elevated due to a slow recovery of labour‑intensive sectors. Public debt will soar but will stay low relative to other OECD countries.

The government has quickly adopted measures to support firms' liquidity through loan guarantees and tax deferrals. Some discretionary measures have also been adopted to support employment. Further fiscal policy measures will be needed to support the recovery. Accelerating infrastructure projects and reducing the labour tax wedge on low earnings could help the labour market recover faster. Rapidly ramping up the uptake of digital technologies, including through training to improve digital skills, could help minimise the disruption from a second outbreak.

An early but less stringent lockdown

The COVID‑19 pandemic reached Latvia in early March. Thanks to low population density and early containment measures, the spread of the virus was slow and did not overwhelm the health system. However, the health system is under‑resourced and effectiveness is low, increasing the potential adverse impact of a more severe second outbreak.

Latvia: Two scenarios of real GDP and economic sentiment

1. Monthly average of weekly year-on-year percentage change. Data for last week of 2019 are not taken into account.

Source: OECD Economic Outlook 107 database; European Commission; and Swedbank.

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Latvia: Demand, output and prices (double-hit scenario)

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The government imposed containment measures after declaring a state of emergency on 12 March, shutting down of most international passenger services, closing schools and banning public gathering of more than two people from 29 March. An easing of lockdown measures began on 12 May, allowing gatherings of up to 25 people and the opening of shopping centres on weekends. The stringency of the lockdown was lower than in most OECD countries: individual mobility was not restricted to certain purposes and restaurants and shopping centres were able to open on weekdays if they followed protection measures. Mobility data indicated higher mobility compared to most European countries, and midweek traffic congestion in Riga has declined considerably less than in other cities.

Economic activity plunged, after growth had already slowed

GDP fell by 2.9% in the first quarter of 2020 even though the lockdown affected the economy only from mid‑March. Output in the transportation sector fell sharply due to both the containment measures as well as a continued fall in transit cargo. Following distancing measures, private consumption fell dramatically. Card transactions and cash withdrawals plummeted from mid‑March. Air transportation and hotel activity almost entirely ceased, and restaurant and clothing store turnover was down by more than a half. Most activities related to recreation, training, culture and sports remain suspended. Registered unemployment increased from 6.3% in February to 8% in April, and inflation dropped from 2.3% to 0% as fuel prices fell. In mid-May, about 4.5% of the labour force was on furlough, receiving state benefits. Economic sentiment has plummeted, but remains above its 2009 level.

Latvia: Demand, output and prices (single-hit scenario)

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The government acted quickly to inject liquidity

The government took significant steps to support firms’ cash‑flow through loan guarantees and tax deferrals, totalling up to 3.7% of GDP. These liquidity measures aim to reduce bankruptcies and systemic risks, and to support long‑run growth. Additionally, the government has taken discretionary, within budget, fiscal stimulus measures of about ½ per cent of GDP. Most of this spending is on health and compensating workers' salaries in companies hit hard by the crisis. The impact of the discretionary fiscal stimulus on GDP growth is limited compared with the scale of contraction in activity. Accommodative ECB monetary policy is mitigating the recession through low borrowing costs.

Uncertainty will hurt investment

The single‑hit scenario is based on an eight‑week lockdown starting mid‑March. The impact of the lockdown on a few sectors will last longer, as some restrictions on travel and gathering in public will remain. An additional eight‑week lockdown in the fourth quarter of 2020 is assumed in the double‑hit scenario. A decrease of about 16% in GDP is projected during the lockdown period due to the shutdown of sectors affected directly by the containment measures. In the double‑hit scenario, the decline in GDP associated with a second lockdown is assumed to be around two‑thirds of that in the first lockdown. This scenario assumes additional government support measures, proportional to the decrease in economic activity.

A severe recession is projected in both scenarios. In 2020, GDP is projected to decrease by 10.2% in the double‑hit scenario, and 8.1% in the single‑hit scenario. Domestic demand will lead the recovery. The pick‑up in exports will be slower, due to the prolonged weak demand in major European countries. Extreme uncertainty will curtail investment. By the end of 2021, business investment is projected to be about 12% lower than prior to the crisis in the double‑hit scenario and by 5% in the single‑hit scenario. Unemployment will rise sharply and recovery will be slow, due to a higher likelihood of bankruptcies, a fall in demand and a slow recovery of labour‑intensive sectors such as tourism. Low, but positive, inflation is projected with a gradual increase in 2021 after wages resume their growth and the fall in commodity prices ends. A credit crunch is a significant risk, particularly among SMEs, as a high share of firms have difficulties in accessing credit due to insufficient collateral and business history, though government action to inject liquidity and relieve cash-flow pressures is reducing the likelihood of this occurring. A faster recovery in the other Baltic countries, thanks to lower infection rates, could support higher growth.

Ramping up digital uptake would reduce disruption from a second outbreak

Accelerating sustainable infrastructure projects and reducing the labour tax wedge on low earnings could help the labour market to recover faster and ensure that future growth will be greener. Ramping up the use of digital technologies could help to minimise the negative impact from a second outbreak of the pandemic. The number of Latvian firms with a website is low, and the share of firm turnover generated from web sales is amongst the lowest in the European Union. Training to improve digital skills (in the public and private sector) as well as enhancing e‑government would help to accelerate the digital transformation.