Latvia’s 2022 growth spurt is set to be cut short by an inflation surge and a slowing global economy. The doubling of energy prices ahead of the coming heating season is projected to make households scale back on consumption likely resulting in negative quarterly GDP growth around the year change. In 2023, consumption is expected to partially recover once the heating season is over. However, by that time a slowing external environment is forecast to weigh on Latvia’s exports. A pick-up in EU-funded investments is expected to give a boost to public investment in both 2023 and 2024. Energy price growth is forecast to peak before 2023 and services prices are forecast to gradually become the main inflation driver during the forecast horizon. The general government deficit is set to decrease to 3.4% of GDP in 2023 and further to 1.4% in 2024.
Last update (forecast)
Last update (11/11/2022)
|GDP growth (%, yoy)||4,1||1,9||-0,3||2,6|
|Inflation (%, yoy)||3,2||16,9||8,3||1,3|
|General government balance (% of GDP)||-7,0||-7,1||-3,4||-1,3|
|Gross public debt (% of GDP)||43,6||42,4||44,0||43,6|
|Current account balance (% of GDP)||-2,2||-6,4||-6,8||-4,0|
High inflation and slowing external demand set to bring growth to a standstill
2022 started with a strong growth in exports and a recovery in private consumption that was driven by a lifting of the pandemic-related restrictions to economic activity. However, growth is expected to slow in the second part of the year as household disposable incomes shrink amid surging energy prices and exports face headwinds from slowing foreign demand. Overall, on the back of the strong growth in the first half of the year, GDP growth for 2022 is forecast at 1.9%.
In 2023, GDP growth is expected to decline by 0.3% – while the end of the heating season is likely to provide a boost to consumption, this is expected to be a mild increase amid still high energy prices and depleted household savings. Similarly, weakened real disposable incomes and slowing construction and manufacturing elsewhere in the EU means exports are also set to struggle. Private investment growth is forecast to slow amid dwindling savings and rising interest rates. However clearing of the backlog of EU funded projects should provide a timely boost to public investments keeping the economy out of a recession in 2023.
In 2024, growth is expected to pick up to 2.6%. A stabilisation in energy prices is set to provide relief for household budgets and hence foster their consumption. EU-funded investments are expected to have gathered pace by then and private investment would benefit from a relief in construction materials’ prices, although higher interest rates are set to dampen household investment. Export growth is expected to continue struggling amid weak growth in Europe and a global investment slowdown, which is forecast to reduce demand for Latvia’s sizeable timber industry. Import growth is expected to follow demand dynamics and after a significant slowdown in 2023 it is forecast to pick up in 2024.
Labour market to remain tight
A structural decline in labour supply is set to keep the labour market tight despite the expected growth trough in 2023. The services’ delayed recovery from the pandemic-related restrictions is expected to provide a boost to employment numbers and keep wage growth rapid. Moreover, minimum wage increases in both 2023 and 2024 are set to provide further impetus to wage growth. However, real disposable incomes are forecast to decline in both 2022 and 2023 as inflation is forecast to exceed wage growth. The shock to real disposable incomes is expected to be partially cushioned by the savings accumulated during the pandemic and therefore limiting the impact on private consumption. In 2024, outlook for real disposable incomes is set to turn positive, again.
Energy prices to peak in 2022
In 2022, HICP inflation is forecast to reach 16.9%, but it is expected to peak before the end of 2022 as the full increase in wholesale energy prices is assumed to have been passed on to consumers by then. However, energy prices are expected to remain elevated throughout 2023 and combined with knock-on effects to non-energy prices, inflation is forecast at a rather brisk 8.3% growth. By 2024 energy prices are expected to begin falling, but services price inflation supported by strong wage growth is set to take over as the main inflation driver.
Deficit to remain elevated in 2022
In 2022, the government deficit is projected to remain close to the level of 2021 at 7.1% of GDP. Higher tax revenue in all main tax categories due to high inflation and wage growth is expected to be more than offset by additional public expenditure. Main expenditure increases include measures to mitigate the impact of high energy prices with a budgetary cost of 2.0% of GDP; filling up of the natural gas security reserve; increases in pensions and allowances, as well as continued support to the healthcare sector for mitigating the impact of COVID-19. Meanwhile, the growth of government investment expenditure is expected to be limited by construction capacity constraints as well as supply chain disruptions.
The government deficit in 2023 is projected to decrease to 3.4% of GDP mainly due to an increase in tax revenue in line with nominal GDP growth and the phasing out of the COVID-19 support. Nevertheless, the government’s energy support package of 1.5% of GDP will continue to weigh on the budget deficit in 2023, together with increased spending for social payments, defense and support to people fleeing Ukraine. In 2024, the government deficit is forecast to fall to 1.4% of GDP thanks to continuous growth in tax revenue and the expiry of the energy-support measures adopted for 2023.
The debt-to-GDP ratio is expected to decrease to 42.4% in 2022 given a substantial negative stock-flow adjustment. However, despite lower deficits, for the following years debt is foreseen to remain above the 2022 level, driven by the need to replenish the Treasury’s cash buffer, and is forecast at 44.0% of GDP in 2023 and 43.6% in 2024.