OECD Economic Outlook, Volume 2025 Issue 1

Latvia

Real GDP is projected to grow by 1.1% in 2025 and 2.1% in 2026. High inflation and rising geopolitical uncertainty are bearing down on the recovery of private consumption and investment. Increasing public investment will gradually strengthen domestic demand, while export demand is weakened by rising global trade barriers. Core inflation will remain high due to strong wage growth related to labour shortages. Further delays in the absorption of EU funds could adversely affect the recovery in domestic demand.

Increasing revenue and reallocating spending to finance the strengthening of defence capacity are key to ensure medium-term fiscal sustainability. Improved capacity for infrastructure planning and policy impact evaluation would help increase spending efficiency. Listing large state-owned enterprises could help deepen capital markets and improve access to finance for firms. Reducing the labour tax wedge for low-income earners and shifting the tax burden towards other income, property and environmental taxes would help lower informality. Strengthening competition enforcement and addressing skills shortages by improving training opportunities and facilitating skilled immigration would support business dynamism, innovation and investment.

Weak confidence and slow absorption of EU funds have weighed on growth

GDP has stagnated in the fourth quarter of 2024. Private consumption fell due to low confidence and a surge in food price inflation, despite strong wage growth in the fourth quarter. Slow absorption of EU funds has weighed on public and private investment, despite easing financing conditions. Industrial production fell by 2% in March compared to February and was about 2½ per cent lower than a year earlier. Annual inflation rose from 3.5% in March to 4% in April due to rising food prices, and core inflation increased to 4.2%, reflecting strong wage growth and high services price inflation. The unemployment rate was 6.7% in March, and the vacancy rate was 2.6% in the fourth quarter of 2024, reflecting increased shortages of technicians, professionals and managers.

Declining relative import prices and an increase in demand for defence equipment contributed to import volumes, which increased by 1.8% in the fourth quarter of 2024 compared to the third quarter. Exports increased by 2.2% over the quarter, particularly driven by IT and business services. The merchandise trade deficit narrowed in the first quarter of 2025 but widened in March due to a rapid rise in import values. Although less than 3% of goods and services exports go to the United States, tariff increases could hurt exports in industries such as wood, wood products and electronics. Mortgage rates have fallen about 190 basis points from a year ago, supported by euro area monetary easing and recent reforms to strengthen competition in financial markets that reduced refinancing costs.

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.

Source: OECD Prices database; Eurostat; Statistical Central Bureau of Latvia; Ministry of Finance of Latvia; OECD Economic Outlook 117 database; and OECD calculations.

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Latvia: Demand, output and prices

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Fiscal policy will ease significantly

The fiscal stance will ease by about 1.7% of GDP over 2025-26 and the public debt-to-GDP ratio is projected to increase. EU Recovery and Resilience Facility grants will finance public investment and measures to improve training and digital adoption in small businesses, with average yearly spending of about 1.7% of GDP in 2025-26. Spending on internal security and defence will increase by 0.5% of GDP in 2025 and by an additional 0.9% of GDP in 2026. Legislated expenditures in social protection and public services, 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 in 2025-26. There are also plans to transfer some public administrative functions to the private sector but it remains uncertain if these measures will effectively expand fiscal space.

Economic activity will gradually recover, driven by domestic demand

Real GDP growth will rebound to 1.1% in 2025 and 2.1% in 2026. Private consumption will recover gradually, accelerating in 2026 as confidence improves. Public consumption will further increase due to rising spending on defence and public services. Trade policy uncertainty will weigh on exports and business investment. Tight labour markets and planned increases in minimum wages will support wage growth and lead to sticky core inflation. However, a cap on public sector wage growth will moderate wage increases. Delays in the absorption of EU funds due to skilled labour shortages, rising 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.

Strengthening competition and addressing skills shortages will support business dynamism, innovation and investment

Reducing high credit costs calls for lowering switching costs for loans to businesses and strengthening competition enforcement. Listing large state-owned enterprises would help improve their governance and attract investors. Strengthening the powers of the Competition Council to conduct market investigations and enforce competitive neutrality of state-owned enterprises would foster business dynamism, innovation and investment. Reducing social security contributions for low‑income earners, raising progressivity of personal income taxes and stepping up enforcement efforts would help reduce informality. This also requires raising trust in institutions and continuing the fight against corruption, for example by applying the heavy fines for tax evasion and bribery that current legislation allows, while ensuring that they are proportionate. Lowering occupation-specific restrictions and facilitating administrative procedures for migrants can help to reduce skilled labour shortages, while investing more in childcare facilities would increase the labour supply of women. Establishing a tri-partite training fund and improving cooperation in training design and implementation among firms and training providers is also key.