Economics, Good for Business, Latvia, Rating

The issue ratings on Latvia's senior unsecured foreign and local currency bonds have also been affirmed at 'A-'. The Country Ceiling has been affirmed at 'AAA'. The Short-Term Foreign and Local Currency IDRs have been affirmed at 'F1'.

Fitch informs that Latvia's ratings are supported the sovereign's institutional strengths and a credible policy framework aided by eurozone membership, as well as a more favorable fiscal position relative to 'A' rated peers.

However, the country's weaker external finances, lower per capita income, and smaller, more open economy compared with the 'A' median constrain the ratings. Economic growth in the first half of 2016 performed below Fitch's expectations. A slower rate of absorption of EU funds contributed to a larger-than-expected contraction in gross fixed capital formation, weighing down headline GDP. A weak external environment meant growth in exports continued to lag imports, which are being supported by strong household consumption benefitting from higher real wages and employment, Fitch points out.

Fitch forecasts real GDP in 2016 to grow 1.7%, a 0.8pp downward revision from its May forecast, and well below the median 2.5% growth of 'A' peers. Latvia's economy is highly dependent on EU funds; its outlook will be tested on how effectively these funds are channelled into the real economy.

Currently, Fitch expects average GDP growth of 3.1% in 2017-2018 as absorption of EU funds picks up. Latvia's lower general government deficit and debt/GDP ratio, relative to 'A' rated peers, remain a key support to the ratings. After a fiscal deficit of 1.3% of GDP in 2015, a deficit of 1% is forecast by Fitch for 2016 ('A' median: 2 percent), reflecting debt service expenditure and capital spending, in addition to higher tax receipts. For 2017, the draft budget projects a fiscal deficit of 1.1% of GDP, including a fiscal reserve of 0.1% of GDP. Draft budget plans include increasing expenditure on healthcare, education and defence, and improving tax administration by tackling the shadow economy, Fitch points out.