OECD Economic Outlook, Volume 2025 Issue 2

Latvia

Real GDP is projected to grow by 1.2% in 2025, 2.1% in 2026 and 2.5% in 2027. Slowly declining inflation and improving consumer confidence will support the recovery of private consumption. Strongly increasing public investment will crowd in business investment and strengthen domestic demand, with export demand remaining weak due to high trade barriers. Core inflation will remain high in 2026 due to strong wage growth, before easing as public wage growth moderates. Delays in the absorption of EU funds could adversely affect the recovery in domestic demand.

Increasing revenue and reallocating spending to finance rising defence expenditures are key to ensure medium-term fiscal sustainability. Accelerating the modernisation of the public administration, reducing administrative burdens and enhancing policy impact evaluation would raise spending efficiency and support growth. Listing large state-owned enterprises could help deepen capital markets and improve access to finance for firms. Strengthening competition enforcement and addressing skills shortages by improving training opportunities and facilitating skilled immigration would support business dynamism.

Weak investment and exports have weighed on growth

GDP growth slowed in the second quarter of 2025, driven by falling exports and investment. Strong real wage growth, related to increasing minimum and public wages as well as significant labour shortages, supported private consumption. Industrial production rose by 1.7% in September compared to August and was 6½ per cent higher than a year earlier. Annual inflation stood at 4.3% in October due to rising food and energy prices, and core inflation rose to 3.8% from 3.2% in September due to rising services prices. The unemployment rate was 6.4% in September, and the vacancy rate was 2.2% in the second quarter of 2025, reflecting increased shortages of technicians, professionals, craft workers and tradespeople.

Export volumes fell in the second quarter of 2025 due to weak external demand, while import volumes rose, reflecting increasing demand for defence equipment and leading to strong inventory build-up. The merchandise trade deficit widened in the third quarter of 2025, with import values rising by 10% year-on-year in September. Although less than 4% of goods and services exports go to the United States, tariff increases could hurt exports in certain industries such as wood products. Mortgage rates have fallen 145 basis points from a year ago, supported by euro area monetary easing and recent reforms to reduce costs for refinancing loans and strengthen competition in financial markets.

Latvia

Note: Core inflation refers to the harmonised index of consumer prices excluding food, energy, alcohol and tobacco. Wage refers to average net monthly wages and salaries of employees. The right-hand panel shows the projected allocation of revenue from the Recovery and Resilience Facility funds and defence spending in line with Latvia’s national escape clause from EU fiscal rules, which was approved by the European Union Council in July 2025.

Source: OECD Prices database; Eurostat; Statistical Central Bureau of Latvia; Ministry of Finance of Latvia; OECD Economic Outlook 118 database; and OECD calculations.

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Latvia: Demand, output and prices

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Fiscal policy will tighten gradually

Fiscal policy will strongly ease by 1.5% of GDP in 2025 before tightening by 0.7% of GDP over 2026-27, leading to an increase in public debt. EU Recovery and Resilience Facility grants will finance public investment and measures to improve training and digital adoption in small businesses in 2025 and 2026. Their phase-out will offset the increase in defence spending by 0.8% of GDP in 2026 and a further 1% of GDP in 2027. About half of the forthcoming defence spending is public investment, which will also increase due to Rail Baltica related investments. Planned expenditures in education, health and social benefits, and interest expenses add to spending pressures. A tax on undistributed profits of credit institutions, the transfer of 1 percentage point of gross wages from the mandatory asset-backed private pension pillar to the solidarity-based public pension pillar, and rising excise taxes will partly finance the increased spending as well as reduced tax revenue due to a recent personal income tax reform.

The recovery will be driven by domestic demand

Real GDP growth is expected to rise from 1.2% in 2025 to 2.1% in 2026 and 2.5% in 2027. Private consumption will recover gradually as confidence improves and inflation falls. Public consumption will grow robustly due to rising spending on defence, health and education. Business investment will improve due to strong public investment growth, improving confidence and broadly neutral monetary policy in the euro area. Trade policy uncertainty will weigh on exports. Despite planned increases in minimum wages, a cap on public sector salary growth will moderate wage increases and ease headline and core inflation. Delays in the absorption of EU funds due to labour shortages, rising input costs and weak capacity in infrastructure planning could weigh on domestic demand. On the upside, a stronger-than-expected impact of fiscal expansion in Germany on euro area growth would raise export demand.

Reducing administrative burdens and improving the capacity of the public administration would support growth

To address rising spending pressures in defence, health and education and stabilise public debt, it is key to raise spending efficiency, reallocate spending and increase tax revenue from income and property taxes. Improving the data infrastructure and knowledge about methodologies for cost-benefit and impact analysis of policies, and greater cooperation across the public sector are key for increasing the quality of public services and spending efficiency, and reducing administrative burdens. Plans to simplify and accelerate public procurement procedures should be combined with increasing transparency, and further centralisation of procurement for standardised goods and services. Listing large state-owned enterprises would help improve their governance and deepen capital markets. Strengthening the powers of the Competition Council to conduct market investigations and enforce competitive neutrality of state‑owned enterprises would help foster business dynamism. Lowering occupation-specific restrictions and facilitating administrative procedures for migrants can help to reduce skilled labour shortages, while investing more in childcare facilities would help increase the labour supply of women.