1. EXECUTIVE SUMMARY 

Political outlook 

In 2020 Latvia experienced significant changes in the political ecosystem. Looking ahead to 2021, pressing issues include the COVID-19 crisis, the ongoing municipal reform and money laundering prevention efforts.

Macroeconomic outlook 

Taking into account the coronavirus (COVID-19) health crisis, the GDP growth forecast for 2021 has been revised downwards to 5.1%, from the 6.7% projected earlier.

Over the medium term, GDP is expected to increase on the back of higher external demand as well as the financing under the European economic recovery instrument, which will facilitate new investment and exports in 2021.

Budget and debt outlook 

In the 2021 government budget, expenditure will be €10.758bn and revenue €9.579bn. Spending has been increased for 2021 by more than €300mn.

Real economy outlook 

Service sectors such as tourism and transport are likely to suffer permanent losses from the coronavirus crisis. 

Construction, on the other hand, is set to perform particularly well due to growing demand for housing and large infrastructure plans, including Rail Baltica. 

Markets outlook

The potential for prolonged lockdowns over the coming months could portend a bumpy economic road ahead, creating above average volatility. 

 

2. POLITICAL OUTLOOK 

In 2020, Latvia experienced significant changes in the political ecosystem. The year brought multiple pressing issues and a variety of uncertainties to the politics of Latvia that will continue into 2021, stemming not only from the COVID-19 crisis but also the ongoing municipal reform and money laundering prevention efforts.

The current coalition government, formed after the October 2018 general election, is composed of “Who owns the state?”, the New Conservative Party, Development/For!, the National Alliance and New Unity. Despite being from the smallest party, Arturs Krisjanis Karins of New Unity was chosen as prime minister. 

Extraordinary elections to the Riga City Council were held on August 29, 2020. The results deeply rocked the political landscape of the Latvian capital. Riga is the capital city of Latvia and Riga City Council provides municipality services to a third of the total population of Latvia. Because of the number of citizens, Riga makes a high contribution to the national economy. 

Harmony, the leading Latvian Russian-speakers' party, which had run the city since 2009, lost its top position to the alliance of the social liberal Development/For! party and the Progressives social democrat / environmental party.  

The election resulted in the following breakdown of 60 Riga City Council seats: Development/For! and Progressives (joint list) — 18, Harmony – 12, New Unity – 10, National Alliance and the Regional Party (joint list) – seven, Honour to Serve Riga – five, and Latvia’s Russian Union and the New Conservative Party – four each.

The results show rising support for progressive liberalism and the fragmentation of the Russian-speaker vote. However, the low participation rate (40.58%) indicates a worrying trend of disengagement from municipal politics, which can be explained by voter fatigue after many months of turmoil within Riga’s City Council. At the same time, it shows a decrease of ethnic political polarisation in Riga, as neither ethnic Latvian nor Russian-speaking voters found it necessary to actively mobilise themselves in favour of the so-called Russian or the so-called Latvian parties. It seems that the election might mark the beginning of the end of ethnic voting in Riga. 

The joint victory of Development/For! and Progressives in the 2020 Riga elections was the first time since Latvia’s 1991 restoration of independence that socially liberal and leftwing forces have obtained an electoral victory in the capital. In 2020, the Progressives changed their strategy and joined forces with Development/For! This decision turned out to be beneficial for both, but especially the Progressives. Their victory was first and foremost due to an ideological shift in Latvian society. Over the last 20 years, support for an inclusive and open society — defined in the Latvian context as a liberal society — has been gradually rising. 

Meanwhile, Harmony has attempted to brand itself as a social democratic party, but its stances on migration, LGBTQ rights and the environment have varied from indifference to conservative antagonism, while its concern for social inclusion has been inconsistent and often cosmetic. 

In the context of general post-election optimism about long-awaited change in the Latvian capital, the low participation rate of 40.58% was a harsh reminder that a significant number of the city’s inhabitants feel disengaged from city politics. The low participation numbers might be explained by disillusioned Russian speakers staying away from the polls. 

The ongoing Latvian municipal reform aims to decrease the number of municipalities from 119 to 42 by joining multiple districts. The reform will continue throughout 2021. However, there is expected to be resistance to the changes. Additional changes within public services due to the municipal reform are expected in 2021. Latvia is due to hold regular municipal elections on June 5, 2021. 

Money laundering prevention has remained a hot-button issue in Latvia for the last few decades, and this continued in 2020. Despite this, no major actions were taken in 2020 to further clamp down on money laundering. However, on September 24, Finance Minister Janis Reirs, head of the Financial Intelligence Unit Ilze Znotiņa, and the US ambassador to Latvia, John L. Carwile, signed a terms of reference between the Republic of Latvia and the US Department of Treasury, prescribing the provision of technical assistance of the US Department of Treasury in the field of anti-money laundering and countering terrorism and proliferation.

Within the scope of the planned technical assistance project, expert support during 2021-2023 will be provided by the US for three main courses of action: strengthening the preventive pillar of the anti-money laundering and terrorism and proliferation countering regime, inter alia, in the field of supervision of subjects of law; capacity building and development of the Financial Intelligence Unit; and, support to law enforcement authorities with respect to the field of investigation of predicative crimes and money laundering, terrorism financing and other financial crimes.

Within the scope of the project, the US Department of Treasury’s Office of Technical Assistance will ensure a full-time expert in Latvia for provision of qualified support to institutions involved in anti-money laundering, attracting also additional experts from the US institutions, based on the needs of the relevant authorities.

Despite the measures taken so far, Latvia still has a reputation for less strict banking policies than neighbouring Lithuania and Estonia.

 

3. MACROECONOMIC OUTLOOK 

Taking into account the COVID-19 health crisis, the GDP growth forecast for 2021 has been revised downwards to 5.1%, as opposed to 6.7% projected in June.

The recovery in 2021 is projected to be the slowest in Latvia’s hospitality sector, as well as the recreational and cultural services sectors, since mass events can no longer take place or have been postponed. 

The official Latvian forecast is broadly in line with forecasts from international financial institutions (IFIs). The European Commission forecast the dip of Latvia's economy at 5.6% in 2020 in its Autumn Forecast, but says the Latvian economy is expected to recover most of the lost ground in 2021 thanks to a rebound in consumption and private investment. Growth should remain solid in 2022 at around 3.5%. 

The European Bank for Reconstruction and Development (EBRD) forecast Latvia's economic drop this year at 5%, followed by 3.5% growth in 2021. 

Due to the gradual lifting of restrictions along with a relatively successful COVID-19 containment during the first wave of the pandemic in the spring of 2020, Latvia’s 2Q 2020 economic downturn was less pronounced than expected, and in the summer months several sectors almost reached their previous business volumes. However, in Q3 and Q4, Latvia was significantly impacted by the second wave of the coronavirus, with the economic outlook for 2021 emerging as uncertain, albeit more optimistic than pessimistic.

With external demand recovering, manufacturing growth is expected to improve in 2021. The development of the construction sector will be supported by government investment over the medium term, so the outlook for the sector is rather optimistic in 2021.

Economic sentiment both in Latvia and its major trade partners at the end of 2020 was positive due to the government support measures and the expected financing under the Next Generation EU European economic recovery instrument. This contributed to a slight upward revision of the external demand assessment, as well as the assessment of domestic income and consumption, which have been estimated to be more resilient.

Over the medium term GDP is expected to increase on account of higher external demand as well as financing under the European economic recovery instrument that will facilitate new investment and exports in 2021.

Adverse factors for the Latvian economy include the escalation of the political situation in Belarus and the potential imposition of economic sanctions that could result in a decline in the demand for freight transportation. It should be noted, however, that GDP growth may be stronger in the projection period in the event that a medical solution for COVID-19 is developed rapidly and the use of funds available under the Next Generation EU is oriented towards innovation and productivity and their provision is not delayed significantly.

With EU COVID-19 relief money and national funding available throughout 2020-2021, consumption in Latvia is expected to strengthen in 2021 as household confidence and net disposable incomes increase. Investment will also gradually regain momentum in 2021. 

SEB Bank Latvia says stimulus funds are "crucial" to Latvia's recovery. “Continued fiscal and monetary relief measures, as well as selective use of restrictions, will prop up the economy,” analysts said in November.

“In the next couple of years, investments and construction will be propped up by the EU Recovery Fund and the Rail Baltica project, but in the short term the release of EU funds may lag, and the government should increase its capital spending."

So far, the labour market has been quite resilient. However, unemployment will remain elevated in 2021 due to a slow recovery in labour-intensive sectors.

According to the Central Statistical Bureau of Latvia, Latvia's unemployment rate decreased to 8.4% in 3Q 2020 from 8.6% in 2Q 2020. Still, it was the second-highest jobless rate since 2Q 2017, amid the pandemic crisis. The number of unemployed dropped in 3Q 2020 by 2,100 to 81,400 thousand, while the number of employed people increased by 700 to 892,800. A year earlier, the jobless rate was at 6%.

The strong fiscal position leaves room for the government to provide further help to households and businesses, if needed.

In October, Latvia's exports were worth €1.311bn, the highest monthly export value in the year to date, according to the Latvian Central Statistical Bureau. 

During the first 10 months of 2020, foreign trade turnover at current prices reached €23.08bn, €963.3mn or 4% less y/y. The value of exports constituted €10.77bn, a drop of €27.8mn or 0.3%, whereas the value of imports comprised €12.31bn, a fall of €935.5mn or 7.1%.

In 2020, the main export partners of Latvia in trade with EU countries were Lithuania (15.8% of total exports), Estonia (10.9%), Germany (6.3%) and Sweden (4.8%), whereas the main import partners were Lithuania (17.9% of total imports), Germany (10.6%), Poland (10.2%) and Estonia (8.6%). Russia was the main partner in trade with third countries; its share in total Latvian exports in October accounted for 9.3%, and in imports for 6.4%.

Fitch forecasts a modest current account surplus in 2020 (1.2% of GDP) as a large contraction in goods and services imports offsets a more modest fall in exports. Recovery in consumption and investment will lead to strong import growth in 2021-2022, pushing the current account into deficit, the rating agency said. Substantial net capital inflows from the EU and ongoing external deleveraging in the banking sector means the net external debt position should continue to fall gradually to 15.8% of GDP in 2022 from 19.2% in 2020.

Inflation is expected to stand at 0.2% in 2020 and reach 1.4% in 2021. The projections were revised upwards in 3Q 2020, mainly on account of a significantly better labour market situation and steeper wage growth than expected. By component, the services sector was the biggest contributor to the upward revision of inflation. 

As for HICP, risks to the inflation forecasts are balanced. If the VAT on local fruit and vegetables remains reduced for an extended period, inflation in 2021 might be 0.2 of a percentage point lower. While a significant impact of supply chain disruptions on inflation has not been observed so far, the next COVID-19 outbreak may result in tighter logistics restrictions and, thus, higher inflation.

Despite the COVID-19 factor, the outlook on Latvia's financial system in 2021 is more positive than negative, according to Fitch. Financial soundness indicators in Latvia remain strong, with banks maintaining high liquidity and sound capital ratios.

 

4. BUDGET AND DEBT OUTLOOK 

The Latvian parliament, the Saeima, adopted the 2021 government budget in the final reading on December 1, providing that expenditure will be at €10.758bn and revenue at €9.579bn.

Despite the pandemic and economic difficulties, budget expenditure has been increased in 2021 by more than €300mn. 

Latvia's GDP forecast (at current prices) for 2021 is €30.02bn. In 2021, the general government budget deficit could widen to 3.9% of GDP.

Maximum government debt can grow to €14.44bn and local governments are allowed to increase their loans by a total of €268.12mn by the end of 2021.

Under the budget bill, 75% of personal income tax revenue will go to local governments' budgets and 25% to the central government budget. The local governments' share is estimated at €1.34bn.

Fitch projects the government deficit to narrow to 4% in 2021 and 2.4% in 2022 as revenue recovers and support measures are gradually unwound. This is broadly in line with the authorities' preliminary 2021 budget proposal, which foresees moderate wage increases for key public sector workers and a higher minimum wage.

The overall tax load has been reduced, the minimum wage has been increased to €500, medics and teachers will receive higher wages and the minimum pension and the guaranteed minimum income will be raised. Starting from July 1, 2021, minimum social insurance contributions will be introduced in Latvia. Revenue in the government basic budget is projected at €6.68bn and expenditure at €7.84bn. Revenue in the special budget is planned at €3.15bn and expenditure at €3.17bn.

Revenue in the consolidated 2021 budget will decline by €328mn, while expenditure will rise by €744mn, and the budget deficit is projected at 3.9% of GDP. 

A three-year revenue-neutral tax framework will also kick in in 2021 with the goal of improving the competitiveness of the labour market through more efficient taxes and expanding the social safety net. Overall, the five-party coalition government has been successful in implementing fiscal measures and agreeing on medium-term fiscal priorities with the objective of stabilising public finances according to Fitch. In the rating agency’s view this reinforces Latvia’s record of fiscal prudence, limiting downside risks to our deficit forecasts.

Under the budget bill, 75% of personal income tax revenue will go to local governments' budgets and 25% to the central government budget.

Starting from 2021, mandatory social insurance contributions will be cut by 1 percentage point to 34.09%. The tax paid by employees will be 10.5%, and the tax paid by employers will be 23.59%.

Also, there will be changes in the micro enterprise tax. Only the owner of the company will pay the micro enterprise tax, while the general tax regime will be applied to employees.

The minimum wage will be increased from €430 to €500. The income threshold up to which the differential non-taxable minimum is calculated has been raised from €1,200 to €1,800 per month. The maximum non-taxable minimum income will be increased from €250 to €300 a month. The non-taxable minimum income for pensioners will be increased from €300 to €330 a month.

The reduced value added tax (VAT) rate on Latvian fruit, berries and vegetables at 5% will be preserved until the end of 2023. Excise tax rate on tobacco will be increased by 5% a year in the coming three years.

 

5. REAL ECONOMY OUTLOOK 

The economy contracted by 5.2% y/y in 1H 2020, but data for 3Q 2020 pointed to a strong recovery across most sectors, including manufacturing and retail. However, 4Q has been damaging for the economy due to the COVID factor.

A report from Fitch warns that service sectors such as tourism and transport are likely to suffer permanent losses, although Latvia’s flexible labour market could eventually help limit the impact on those employed in the industry. 

Latvia’s Central Statistical Bureau announced on September 15 that in July 2020 the number of foreign and resident visitors comprised 298,900, which is 25.3% less than one year ago. The number of nights spent by visitors reduced by 30.5% y/y, and comprised 545,000 nights.

Like other airlines, the national airline airBaltic has been struggling during the pandemic. A July 2020 European Commission decision allows the Latvian state to invest €250mn in the capital of airBaltic. The decision provides for Latvia to recover the investment within five to seven years. 

Construction is set to perform particularly well due to growing demand for housing and large infrastructure plans, including Rail Baltica that has an estimated investment target of €2bn (7.3% of GDP) for Latvia starting in 2022. 

Rail Baltica is a greenfield rail transport infrastructure project with a goal to integrate the Baltic States in the European rail network. The project includes five European Union countries – Poland, Lithuania, Latvia, Estonia and indirectly also Finland. It will connect Helsinki, Tallinn, Parnu, Riga, Panevezys, Kaunas, Vilnius and Warsaw. The Baltic part of the Rail Baltica project is referred to as the Rail Baltica Global Project.

November 17, 2020 marked the first construction work on Rail Baltica at the Latvian capital Riga’s Central Railway Station. The first leg of Rail Baltica in Latvia will involve the construction of a new station complex and the adjacent infrastructure. The construction will take place in several rounds and will continue until 2025, demolishing and replacing the historic railway base and building a new railway bridge across the Daugava. The ambitious works costing €430bn will be carried out by Bererix, a general partnership company consisting of the Belgian Besix and the Latvian ReRe Group.

In the IT sector, Latvia has seen a flood of arrivals by companies from Belarus that want to relocate to Latvia after the mass unrest following Belarus’ August presidential election. Latvia has been encouraging the brightest minds of the high-tech sector in Belarus to move their businesses to Latvia in the wake of the crackdowns by the police throughout Belarus.

Meanwhile, for local startups the parliament adopted amendments to the framework of support for startups in September, allowing them to receive state aid more easily. 

 

6. MARKETS OUTLOOK 

The most tangible impact of the global COVID-19 health crisis on the NASDAQ Baltic stock exchanges was seen in 2020 as an increase in trading activity and a decrease of market prices. For 2019 the average daily share turnover was equal to €1.07mn, while during March 2020, when the pandemic was starting to spread through Baltics, the average daily share turnover increased to €3.5mn.

Since the Baltic states were among the ones closing their borders in spring, the companies that were affected the most were of course those whose business relied mainly upon tourism. 

Among the Latvian companies affected the most in terms of price decrease in the spring were Latvijas Balzams, Olainfarm, Rīgas Kuģu Būvētava, SAF Tehnika, Valmieras Stikla Šķiedra, and HansaMatrix. 

However, it is difficult to say how much of the price decrease of these companies was due to them being impacted by the COVID-19 pandemic, and how much can be attributed to the overall stressed market situation that was seen on the NASDAQ Baltic markets during mid-March of 2020.

Later, the specific COVID-19 vaccine impact was also difficult to distinguish from other factors that affect share price development and trading activity, the NASDAQ bourse said. Yet, if looking at the overall trading activity, during the middle of November, when the news about successful vaccine trials came out, there was a small increase in both turnover and the number of trades executed on the market.

But interestingly, although on NASDAQ Riga there are two international pharmaceutical companies listed, Grindeks and Olainfarm, there have been no significant trading activity changes visible for these companies. Moreover, only for Grindeks did the price slightly move upwards during mid-November 2020.

Although the news on COVID-19 vaccines is encouraging, the potential for new outbreaks in 2021 to cause potential prolonged lockdowns over the coming months could portend a bumpy economic road ahead. The backdrop will likely create above-average volatility next year, with downside protection coming in the form of fiscal and monetary policy support.

But with a vaccine on the way, hope will prevail as the Baltic states’ additional monetary stimulus revs up the monetary supply and stokes growth and inflation expectations.

It could be predicted that investor appetite in the Baltics in 2021 will continue to tilt toward stocks that favour diversification and both growth and value segments of the market, in a relatively low interest rate environment that favours equities, real assets and other asset classes over fixed income for intermediate and longer-term objectives.

But of all these factors, the COVID-19 vaccine rollout is arguably the most important in determining the trajectory of NASDAQ Baltics in 2021.