Latvia’s Economy: Growth Prospects Amidst Global Uncertainty & Inflation

Latvia’s Economic Momentum Faces Global Headwinds

Latvia’s economy appears poised for growth, fueled by household savings, a stable housing market, increased lending, and investment in export-oriented industries. However, escalating uncertainty surrounding energy prices and supply chain vulnerabilities are casting a shadow over the outlook. Whether Latvia can emerge as a leader within the Baltic economies remains to be seen, according to a recent economic review from Luminor bank presented by its chief economist, Pēteris Strautiņš.

Inflationary Pressures Persist

Prior to recent geopolitical events, the forecast for inflation in both this year and next appeared promising. However, rising costs for energy, metals, and other raw materials now suggest inflation could remain near 4% – similar to last year’s levels. The potential for a prolonged closure of the Strait of Hormuz, with its potentially catastrophic consequences for global food supplies, is a key concern. While Luminor anticipates the current situation won’t persist long-term – a view echoed by global energy markets – the impact is already being felt. In Latvia, fuel prices have seen the most significant increases, with ripple effects expected in housing costs and potentially, to a lesser extent, food prices.

“Sleeping Beauty” Awakens

Latvia’s gross domestic product (GDP) grew by 2.1% last year, exceeding initial expectations. This positive performance aligns with forecasts made six months prior, according to Luminor. Despite ongoing geopolitical instability, Latvia’s economic activity is projected to increase by 2.5% this year. The bank forecasts that Latvia could develop into the leading economy in the Baltics in 2027, with growth reaching 3.2%, driven by investment in manufacturing, the development of export services, and support from European Union funds. Unlike its neighbors, Latvia has maintained its second-pillar pension system, which, combined with growing exports – particularly in high-tech sectors – and investment in defense, is expected to ensure long-term financial stability.

Latvia is showing signs of accelerating growth, but external geopolitical instability represents the primary obstacle. This instability could temporarily increase the cost of living and disrupt the development of export industries, though Luminor expects the projected acceleration in growth will only be delayed, not derailed.

Wage Growth Moderates

The labor market remains highly competitive, benefiting many in society. The unemployment rate remained stable at 6.9%, while registered unemployment decreased, and both employment levels and the employment rate saw slight increases. Wage growth exceeded expectations, reaching 7.7%, with tax changes contributing to a substantial 6.3% increase in real net wages. However, the labor market may be on the cusp of changes driven by the development of artificial intelligence, presenting both opportunities and uncertainties.

Technology Sector Reclaims Export Leadership

Last year, exports from the metal-related industries (metalworking, machinery, and electronics) and high-value services overcame a two-year period of weakness, playing a key role in overcoming economic stagnation. The wood processing and food industries continued to develop steadily, meaning Latvia currently has no significant weaknesses in its export portfolio, with the exception of transport services.

The conditions for the development of export industries are generally favorable for this year and the next two years. A promising development is the technological growth of Latvian drone manufacturers and European investment in the defense sector. Uncertainty remains regarding the potential impact of a closure of the Strait of Hormuz on the production of metals and chemical raw materials, which are essential to global industrial value chains. Another key question is how central banks will respond to rising inflation, as interest rate hikes could weaken demand – a critical factor for Latvian manufacturers – in the construction sector and related industries.

Consumer Spending and Credit Expansion

Household credit experienced significant growth last year, with a year-on-year increase exceeding 10% in November. The monthly increase in the credit portfolio surpassed €100 million for the first time 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 more favorable position than other Baltic countries, where price levels are very high. Significant growth in credit was also observed in corporate lending.

However, a persistent mystery in the Latvian economy remains consumer spending. Real household incomes have grown almost continuously since the global financial crisis (with the exception of 2022), but this growth hasn’t translated into a corresponding increase in consumer spending.

Looking Ahead: Navigating Geopolitical Risks

The trajectory of Latvia’s economic growth is inextricably linked to global geopolitical stability. While the underlying fundamentals – strong household finances, a healthy housing market, and growing investment – are in place, external shocks could easily disrupt this momentum. The ongoing situation in the Middle East and the potential for further escalation represent a significant risk.

The Luminor report highlights the importance of continued investment in high-tech sectors and the maintenance of a stable financial system. The country’s unique position with its second-pillar pension system provides a buffer against economic volatility. However, the report also acknowledges the potential impact of artificial intelligence on the labor market, a factor that will require careful monitoring and proactive policy responses.

Further information on Luminor’s economic outlook for the Baltic states can be found on their website: Luminor Baltic Economic Outlook. Additional analysis of the Latvian economy is available from Finance Latvia: Finance Latvia News. For broader context on the Baltic economies, see Luminor Lithuania’s perspective: Luminor Lithuania Economic Perspectives.