OECD Economic Outlook, Volume 2023 Issue 1

Latvia

Economic growth will slow to 1.1% in 2023 before rebounding to 2.4% in 2024. High inflation will weigh on private consumption. Business investment will slow due to less favourable financial conditions and high uncertainty. Exports will improve gradually due to higher external demand. Inflation will ease but remain high as elevated producer prices pass through to consumers. Unemployment will rise slightly, but high wage demands and the rise in the minimum wage will support strong wage growth.

Untargeted measures to mitigate the impact of higher energy prices should be phased out as planned to limit additional inflationary pressures, incentivise energy savings and restore fiscal space to support structural changes. Raising the effective carbon price in sectors not covered by the EU-ETS and phasing out fuel subsidies while increasing public investment could help to accelerate the green transition and raise energy security. Active labour market policies should be expanded to reduce skill mismatches and facilitate job reallocation.

Inflation remains high

Latvia's economy entered a recession after Russia’s war of aggression against Ukraine started, with the war hitting supply chains, private investment and trade. However, private consumption proved more resilient than expected during the winter despite high inflation and the reduced purchasing power of households. Economic sentiment has improved since September 2022, especially consumer confidence. In the first quarter of 2023, GDP grew by 0.6% compared to the previous quarter, led by strong non-residential investment. The labour market remains tight, even though pressures are starting to ease. The number of job vacancies declined by 14% in the fourth quarter of 2022 and is now lower than in 2019. Even so, the unemployment rate decreased from 7% in August 2022 to 6.5% in March 2023. Headline consumer price inflation has fallen since September 2022 due to declining energy prices but remains high at 15.0% in April 2023. Housing prices declined in the fourth quarter of 2022 after experiencing rapid growth since the beginning of 2021.

Latvia: Inflation and activity indicators

1. Headline prices refer to the harmonised index of consumer prices, core prices refer to the harmonised index of consumer prices excluding food, energy, alcohol and tobacco, energy prices refer to the harmonised index of consumer prices of energy goods, producer prices refer to the producer prices index for all industry.

Source: OECD Prices database; and Statistical Central Bureau of Latvia.

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Latvia: Demand, output and prices

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The energy and commodity price shocks and the war in Ukraine impact the economy through high energy inflation, increased uncertainty, and disruptions to the trade of commodities and materials, as well as to logistics and transport. However, in 2022, the effect on exports to Russia and Belarus was limited. Price growth remains driven by changes in energy and food prices, whose share in the CPI basket is higher than in other countries of the euro area. Although energy prices have decreased from their peak, they are about 30% higher than at the end of 2019. About 40 000 Ukrainian refugees had entered Latvia by the end of 2022 (2.1% of Latvia’s population); 30% were children.

The government deficit is set to decline

Fiscal deficits will narrow over the next two years, with cumulative fiscal tightening of around 2% of GDP in 2023-24. Most of the support to mitigate the impact of high energy prices on households is to end in April 2023, and lower energy prices are reducing the fiscal costs. In addition, most spending for COVID-19 support has been phased out. Expenditures amounting to about 0.9% of GDP are assumed to be financed by grants from the EU Recovery and Resilience Facility in 2023 and 2024. Defence spending will rise from 2.2% of GDP in 2022 to about 2.4% in 2024. The minimum wage was raised by 22% in January 2023, from EUR 500 to EUR 620.

Higher interest rates will weigh on private investment

GDP growth will slow in 2023 as high inflation dampens private consumption, while high uncertainty and tightening monetary policy moderate business and real estate investment. Public investment will partially counteract this with an accelerated deployment of EU funds. The uptick in unemployment will be modest as the expected rebound in activity and labour shortages due to a shrinking population incentivise businesses to retain their employees. Wage growth will increase in 2023 due to the minimum wage rise. Exports will lead the recovery as declining energy prices increase demand from main trading partners. A major risk to the outlook is a cold winter in 2023-24 leading to higher-than-expected energy prices. The rapid rise in interest rates might lead to growing macro-financial vulnerabilities, while a sluggish absorption of European Union funds could slow public investment.

Investing in the green transition and addressing skilled labour shortages

Accelerating investment in renewables and the green transition is necessary to raise energy security but will require tackling skilled labour shortages. Providing tertiary students with greater financial support and improving access to, and the quality of, training (including by establishing training funds) is key. Raising skilled migration would require simplifying and accelerating administrative procedures including the recognition of foreign qualifications. Improving the supply of more affordable and better‑quality housing and upgrading public transport services would help to spur labour mobility. Addressing gender stereotypes and enforcing anti-discrimination legislation is key to reduce the growing gender wage gap.