Analytics, Economics, EU – Baltic States, Financial Services, Latvia, Legislation

The IMF Executive Directors commended the steady economic progress in Latvia, and the generally favorable macroeconomic conditions despite the current slowdown. They noted that the medium-term outlook is broadly positive; however, higher productivity and additional fiscal space are needed to support inclusive growth and employment.

Directors emphasized the need for continued structural reforms across a wide range of areas to enhance productivity, maintain competitiveness, and improve equity. This would be vital to maintain the pace of income convergence with the rest of Europe. Reforms are needed to improve the investment climate; enhance public infrastructure; strengthen the governance of state-owned enterprises; improve the efficiency and effectiveness of the judicial system and insolvency regime; and encourage innovation.

”Measures are also needed to improve labor participation and align education and vocational training with market demand. Directors urged the authorities to monitor wage developments and their impact on competitiveness. They generally considered that increases in the minimum wage should not exceed productivity growth over the medium term, while complementary policies should address inequality and poverty,” the IMF said.

Directors noted that the gray economy is preventing Latvia from achieving its full potential by hindering the efficient allocation of resources, creating an unfair playing field, and curtailing budget revenues. They called for further efforts to improve participation in the formal economy alongside measures to enhance public services and garner public support.

”Directors noted with satisfaction that Latvia’s banking system is well capitalized and profitable. However, they expressed concern that the persisting weakness in bank credit constrains investment and growth. They encouraged the authorities to address the legal and structural constraints hampering lending to SMEs and households, and to use the benchmarking exercise to review banks’ risk models. Directors commended the authorities’ efforts to strengthen AML/CFT regulations and supervision, and urged continued vigilance to mitigate risks, especially those related to non-resident deposits. They urged the authorities to focus on implementation of the enhanced regulations and to continue to align the framework with international standards,” the IMF said.

Directors considered the fiscal stance to be broadly appropriate, while noting that vigilance will be needed to ensure adherence to targets and EU rules. They also noted that additional fiscal space is needed over the medium term to strengthen the social safety net, promote social inclusion, and boost productive public spending. They welcomed the authorities’ plan to raise tax revenue, and recommended using the ongoing reviews of tax and expenditures as an opportunity to consider comprehensive reforms to improve incentives and recalibrate the tax burden equitably.

The IMF Executive Board discussed the latest report on Latvia on June 10.