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The acceleration has been driven by a rebound in investment due to recovery in business investment and faster EU funds absorption, robust private consumption, and a pick-up in exports supported by a favorable external environment, IMF experts said.

While average inflation has reached 2.9%, the fiscal and current account deficits remain moderate, public debt is low, and unemployment continues to fall.

"The medium-term outlook is positive, and risks must remain well-managed. Growth is expected to remain strong, and gradually converge to its potential rate of 3%. To ensure that the economy smoothly navigates the cyclical upswing, maintaining a prudent policy mix will be key to avoid the accumulation of imbalances and prevent rapid wage growth from eroding competitiveness," the IMF said.

Latvian banks are well capitalized and liquid. Continued implementation of macro prudential regulations and vigilant supervision has helped preserve financial stability, and is vital to ensure Latvia’s ongoing role as a regional financial center. Nonetheless, despite the favorable macroeconomic conditions and low interest rate environment, credit growth remains subdued as banks’ cautious supply and firms’ and households’ tepid demand for loans prevent the banking system from providing more support to the economy, according to experts.

Commenting on the 2018 budget, the IMF said that it is in line with Latvia’s EU commitments. Measures taken to partially compensate for the loss of revenues resulting from the recent tax reform are a welcome step by the authorities to maintain prudent fiscal policies and contain the growth of the deficit.

The IMF reported that the cyclical recovery is an opportune time to redouble reform efforts to support sustainable long-term growth and mitigate the impact of coming economic headwinds, including demographic challenges. Structural and institutional reforms should focus on fostering labor supply and lowering structural unemployment, enhancing productivity growth and ensuring efficient financial intermediation, including legal and insolvency reforms and further increasing access to finance, and reducing the shadow economy.