Latvia’s economy appears poised for growth, fueled by household savings, a stable housing market, increasing credit availability and investment in export-oriented industries. However, rising global uncertainty surrounding energy prices and supply chain vulnerabilities casts a shadow over this potential, according to a recent economic outlook from Luminor bank. The question now is whether Latvia can overcome these headwinds and emerge as a leader in the Baltic economies – a possibility highlighted in the report presented yesterday by Luminor’s chief economist, Pēteris Strautiņš.
The anticipated easing of inflation has been delayed, complicated by geopolitical events. Before the recent developments in the Middle East, forecasts for this year and next were more optimistic. However, rising costs for energy, metals, and other raw materials now suggest inflation could remain near 4%, similar to last year’s levels. A prolonged closure of the Strait of Hormuz, a critical global shipping lane, would have catastrophic consequences for the world economy, including disruptions to food supplies, though analysts believe such a scenario is unlikely to persist. Global energy markets are already signaling these concerns. In Latvia, the most significant price increases are being seen in fuel, with ripple effects expected in housing costs and, to a lesser extent, food prices.
Luminor’s analysis suggests Latvia is “waking up” from a period of relative economic dormancy. Last year, the country’s gross domestic product (GDP) grew by 2.1%, exceeding initial expectations. This positive trend, the bank noted, was anticipated as early as their September forecast. Despite ongoing geopolitical instability, Latvia’s economic activity is projected to increase by 2.5% this year. Looking ahead to 2027, Latvia could potentially become the leading economy in the Baltic region, with a projected growth rate of 3.2%. This growth is expected to be driven by investments in manufacturing, the development of export-oriented services, and support from European Union funds.
Unlike its neighbors, Latvia has maintained an intact second pillar pension system, which, combined with growing exports – particularly in high-tech sectors – and investments in defense, is expected to ensure long-term financial stability. This stability is a key factor in the optimistic outlook, despite the external pressures.
Wage Growth Continues, But at a Slower Pace
The Latvian labor market remains competitive, benefiting workers with favorable conditions. The unemployment rate remained stable at 6.9%, whereas registered unemployment decreased, and both employment numbers and the employment rate saw slight increases. Wage growth continued to outpace expectations, reaching 7.7%, and real net wages increased by a substantial 6.3% due to tax changes. However, the rapid development of artificial intelligence introduces uncertainty into the labor market, presenting both opportunities and challenges.
Technology Sector Reclaims Export Leadership
Last year, the industries related to metals – including metalworking, machinery, and electronics – along with high-value service exports, overcame a two-year period of weakness, contributing significantly to overcoming economic stagnation. The wood processing and food industries continued to develop steadily, meaning Latvia’s exports currently have no significant weaknesses, except for transport services. The growth of Latvian drone manufacturers and European investment in the defense sector are seen as particularly promising areas.
However, the potential disruption to the supply of metals and chemical raw materials caused by a closure of the Strait of Hormuz remains a concern for global industrial value chains. The response of central banks to rising inflation is similarly a key factor, as interest rate hikes could weaken demand in the construction sector and related industries, crucial for Latvia’s manufacturers.
Consumer Spending and Credit Availability Increase
Household credit experienced rapid growth last year, with a year-on-year increase exceeding 10% in November. The credit portfolio increased by over 100 million euros in a single month, a first since the global financial crisis. The housing market is well-balanced, with prices high enough to incentivize construction but low enough for buyers to afford them. Latvia is in a stronger position than other Baltic states where price levels are considerably higher. Significant growth in corporate lending was also observed.
Despite these positive indicators, a persistent “mystery” remains in the Latvian economy: consumer spending. Household real incomes have grown almost continuously since the global financial crisis, with the exception of 2022, but this growth has not translated into a corresponding increase in consumer spending.
The overall outlook for export sectors remains positive for this year and the next two years. Luminor’s report emphasizes that Latvia is prepared for faster growth, but external geopolitical instability remains the primary obstacle, potentially leading to temporary increases in the cost of living and hindering the development of export industries. However, the bank anticipates that the previously forecasted acceleration of growth will only be delayed, not derailed.
Disclaimer: This article provides general economic information and should not be considered financial advice. Consult with a qualified financial advisor before making any investment decisions.
The next key indicator to watch will be the release of first-quarter GDP figures, expected in May, which will provide a clearer picture of Latvia’s economic performance in the face of ongoing global challenges. We encourage readers to share their perspectives on these developments in the comments below.
