Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Latvia (Latvia)’s long-term issuer and senior unsecured debt-category ratings at A-, in both local- and in foreign-currency, with Stable Outlooks. Scope has also affirmed Latvia’s short-term issuer rating at S-1 in both local and foreign currency with a Stable Outlook.

The affirmation of Latvia’s credit ratings reflects a strong institutional framework which supports sound macroeconomic policy-making and a robust long-term growth potential. Medium-term growth prospects will benefit from sizable EU fund allocations and structural reforms agreed under the country’s Recovery and Resilience Plan (RRP). The affirmation furthermore accounts for Latvia’s moderate public debt levels. These should remain broadly stable over the medium-term given robust nominal growth prospects and debt affordability, which should contain the effects of sustained budget deficits.  

The main credit challenges reflect: i) its exposure to external shocks, given the Latvian economy’s moderate income levels, small size and relatively elevated openness; and ii) the adverse demographic trends that are increasing labour shortages and fiscal pressures.

Download the rating report.

Key rating drivers

Sound institutions, robust growth prospects. Latvia’s A- ratings benefit from effective policymaking anchored to the country’s EU and euro area memberships. These provide a sound and credible framework for macro-fiscal policymaking and support the Latvian government’s ability to access capital markets even in periods of market stress. Together with ample access to, and efficient absorption of EU funding for public investment, these memberships have supported the country’s remarkable economic convergence over recent years. Latvia’s GDP per capita amounted to 52% of the euro area average last year, up from just 40% in 2014, although significantly lagging the other Baltic economies. Measured in purchasing power standards, Latvia’s GDP per capita is over 67% of the euro area average.

The Latvian economy contracted by 0.3% in 2023, reflecting weak private demand and exports, amid high inflation and weak external demand. Growth is expected to increase to 1.6% this year and 2.2% in 2025. The improving outlook is driven by recovering household consumption as robust nominal wage growth and decelerating inflation increase real disposable incomes. HICP inflation averaged 0.9% year-on-year (y-o-y) in the first eight months of 2024, down from 13.3% over the same period last year. The economic momentum will also be supported by improving investment dynamics, underpinned by the implementation of EU-funded projects and the gradual decline in interest rates.

Scope estimates Latvia’s medium-term growth potential at about 2.5% annually, underpinned by significant allocations of EU funds, totalling EUR 6.4bn (15.9% of 2023 GDP) over 2021-27 under the Recovery and Resilience Plan (RRP) and Cohesion funds). Reforms included under the RRP should also support the long-term growth trajectory thanks to measures aimed at improving the business environment and fostering stronger skills accumulation. This comparatively robust growth outlook will support the convergence in income levels and productivity towards euro area averages, in turn yielding further improvements regarding the Latvian economy’s resilience to shocks.

Finally, Latvia's economic resilience has also been bolstered by significant progress regarding energy security, in line with authorities’ decision to phase out natural gas imports from Russia in H1 2022. This shift was supported by an infrastructure push that enhanced interconnectedness with EU neighbours and expanded the country’s own energy storage and regasification capacities. The connection of the Baltic states’ and continental Europe’s electricity networks is expected to be completed by 2025, with synchronisation under emergencies already possible. Looking ahead, further improvements in energy independence are expected as Latvia continues to invest in the development of its own renewable energy generation capabilities.

Moderate public debt levels, sound fiscal trajectory. The affirmation of Latvia’s ratings also reflects the government’s moderate debt levels, robust debt affordability and expectations of a broadly stable public debt trajectory. Latvia’s public debt-to-GDP ratio remains moderate at 43.6% as of year-end 2023 compared to peers despite increasing since the Covid-19 pandemic from 36.7% in 2019. It is expected to remain broadly stable over coming years, concluding a forecast horizon up to 2029 at around 44%, as robust nominal growth balances the effects of persistent fiscal deficits and gradually increasing interest payments.

The fiscal deficit amounted to 2.2% of GDP in 2023, down 2.4 pps from the previous year thanks to stronger-than-anticipated revenue growth and the phase-out of energy-support measures, which outweighed inflation-related spending pressures. The budget deficit is expected to widen over the medium-term, to 2.8% of GDP this year and 2.9% of GDP in 2025, before gradually narrowing in subsequent years to about 2.0% of GDP by 2029. This deterioration will be driven by increased spending on public sector wages and social transfers, alongside a marked pick-up in nationally-funded capital expenditure. The medium-term fiscal outlook should benefit from continued revenue growth in line with expectations of robust nominal economic growth and employment dynamics. This is further supported by the government’s efforts to broaden the tax base and improve revenue collection, including via measures outlined in a 2024-2027 action plan to curb the size of the shadow economy¹. At the same time, commitments to raise spending on defence (to 3.7% of GDP by 2027, up from an estimated 2.9% of GDP in 2024) will weigh on the budget balance over the forecast horizon.

Finally, the public debt trajectory is anchored by robust debt affordability, which should limit the increase in debt-servicing burden resulting from durably higher interest rates. Interest payments are seen growing gradually over the forecast horizon, edging up to 3.4% of general government revenue by 2029 (in net terms), up from 1.6% last year. This moderately increasing trajectory accounts for the Latvian government’s favourable debt profile, including moderate foreign currency and interest risk exposure, a smooth refinancing profile and adequate average maturity of around 6 years. Prudent liquidity management, with a comfortable cash buffer of 3.7% of GDP as of end-2023, further underpins funding flexibility.

Rating challenges: exposure to external shocks and longer-term demographic pressures.

Latvia is a small and very open economy, with the export and import sectors accounting for around 66% of GDP each. This, coupled with still-moderate wealth levels (GDP per capita of EUR 21,400), exposes Latvia to external shocks. This vulnerability is exacerbated by the present environment of heightened geopolitical tensions following Russia’s invasion of Ukraine in February 2022. While Scope assesses direct military risks from Russia as low due to Latvia’s strong international alliances, the country’s geographical proximity to Russia and strategic location on the Baltic Sea make it one of the EU countries most exposed to spillovers from the conflict, including to broader security challenges such as cyber risks or disinformation campaigns. While Scope assesses the country’s preparedness to such hybrid forms of aggression positively compared to other Central and Eastern European peers, a protracted conflict adds significant uncertainty to the medium-term macroeconomic and fiscal outlooks.

Additionally, Latvia’s ratings are constrained by adverse demographic trends, which are likely to weigh on the country’s macro-fiscal outlooks. The country’s working-age population is expected to decline by 1.6% a year on average over 2024-30 according to projections published by the European Commission². While demographic challenges were partly alleviated in recent years by large inflows of Ukrainian refugees, an ageing population is expected to exacerbate pressures in the labour market, where labour shortages already constitute a key bottleneck to output growth and risk fuelling further wage increases, in turn potentially eroding the country’s external competitiveness. While adverse demographic trends present some risk to the fiscal trajectory in the long run, Scope notes that their impact should remain broadly moderate relative to most EU peers. The IMF estimates the net present value of changes in healthcare and pension spending through 2050 at 21% of GDP, above Estonia (2%) but well below Lithuania (50%)³.

Outlook and rating sensitivities

The Stable Outlook reflects Scope’s view that risks for the ratings are balanced over the forthcoming 12 to 18 months.

Upside scenarios for the long-term ratings are (individually or collectively):

1. Solid economic growth and income convergence continued through reform implementation and investment.
    
2. The public debt-to-GDP ratio remained moderate, supported by balanced government finances in the medium run.
    
3. External and/or financial sector vulnerabilities continued to moderate.

Downside scenarios for the rating and/or Outlooks are (individually or collectively):

1. Geopolitical risks increased, undermining macroeconomic stability.
    
2. Fiscal fundamentals weakened, leading to a significant increase in the debt-to-GDP ratio over the medium run.
    
3. Macroeconomic imbalances increased, weakening growth prospects.
    
4. External and/or financial sector vulnerabilities increased substantially.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s Sovereign Quantitative Model (SQM) provides a first indicative credit rating of ‘a-’ for Latvia. This ‘a-’ first indicative rating receives a one-notch uplift from the SQM’s reserve-currency adjustment and no negative adjustment from the political-risk adjustment. This sees a final SQM indicative credit rating of ‘a’ for Latvia. On this basis, the final SQM quantitative rating of ‘a’ is reviewed by the Qualitative Scorecard (QS) and can be adjusted by up to three notches depending on Latvia’s qualitative credit strengths or weaknesses compared against a peer group of sovereign states identified by the SQM.

Scope identified the following QS relative credit weaknesses of Latvia: i) social factors; ii) governance factors. Conversely, Scope did not identify QS relative credit strengths for Latvia. On aggregate, the QS generates a one-notch negative adjustment affecting Latvia’s credit rating, resulting in the final A- long-term ratings. A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues within its ratings process via the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

With respect to environmental factors, Latvia displays comparatively robust scores in the SQM, reflecting low levels of CO2 per unit of GDP, a low footprint of consumption compared to available biocapacity, and low exposure and vulnerability to natural disaster risks, alongside average levels of greenhouse gas emissions per capita. Latvia’s QS evaluation on ‘environmental factors’ is ‘neutral’ against a peer group of countries. Latvia boasts one of the highest shares of renewables in its energy mix, covering 43% of energy consumption in 2022 (above an EU average of 23%). Scope notes that the European Commission expects the country to miss its greenhouse gas emission reduction targets by 2030 (expected to decline by 8.4% compared to 2005 levels, short of a 17% reduction target), highlighting the need for further policy action⁴.

Regarding social factors, Latvia’s SQM score balances strong labour-force participation, alongside average marks on income inequality and weak marks for the old-age dependency ratio. The complementary QS assessment of ‘social factors’ is ‘weak’ compared to a peer group of countries, accounting for persistent challenges as regards poverty and exclusion risks, which remain markedly above EU averages, in part reflecting limited levels of income redistribution.

The complementary QS assessment of ‘governance factors’ is ‘weak’ compared to peers to account for Latvia’s comparatively heightened exposure to spillover from the Russia-Ukraine war. External security risks for Latvia have increased materially since the escalation of the Russia-Ukraine war, though NATO and EU memberships strongly limit the risk that the conflict will expand into the Baltic region. Under governance-related factors in the SQM, Latvia performs strongly relative to peers, in line with high scores under the World Bank’s Worldwide Governance Indicators. Policy-making has been effective and enjoyed broad continuity. EU and euro area memberships also enhance the quality of Latvia’s macroeconomic policies and macroprudential framework. Prime minister Evika Siliņa has led a broad three-party coalition since September 2023, following the resignation of Krišjānis Kariņš over disagreements within the parliamentary coalition. The next parliamentary elections are expected to take place in October 2026 at the latest.
 
Rating committee
The main points discussed by the rating committee were: i) Latvia’s economic outlook and medium-term growth potential; ii) fiscal and debt-sustainability developments; iii) external-sector vulnerabilities; iv) banking-sector and non-financial private sector balance sheet developments; v) ESG considerations; and vi) peer comparisons.

Rating driver references
1. Ministry of Finance of the Republic of Latvia: Shadow Economy Curtailment Plan 2024-2027 approved by the government, January 2024
2. European Commission: 2024 Ageing Report, April 2024
3. IMF: Fiscal Monitor, April 2024
4. European Commission: 2024 Country Report - Latvia

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model Version 4.0), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party participation    YES
With access to internal documents                                  NO
With access to management                                           NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings and/or Outlooks were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Brian Marly, Senior Analyst
Person responsible for approval of the Credit Ratings: Eiko Sievert, Senior Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 28 April 2023.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings, as well as a list of Ancillary Services and certain non-Credit Rating Agency services provided to Rated Entities and/or Related Third Parties.

Conditions of use / exclusion of liability
© 2024 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.