These are interesting times for the Baltic country of Latvia. In the 12 years since it joined the EU in 2004 its economy grew rapidly then suffered a severe contraction. Its return to growth has coincided with its adoption of the euro, holding the EU presidency in 2015 and its capital, Riga, being designated European Capital of Culture for 2014.
Since 2011, Latvia’s economy has been one of the fastest growing in the EU. Jānis Reirs, the country’s minister of finance, says: “In 2011, GDP rose by 5% and in 2012 and 2013, by 4.8% and 4.2%, respectively [Latvia was the fastest growing economy in the EU in 2012 and 2013]. Cutting salaries during the crisis and the flexibility of Latvian entrepreneurs was the key to restoring our international competitiveness.”
Its citizens’ response to the need for flexibility and wage cuts may seem surprising. But as Dr Mārtiņš Kazāks, the chief economist at Swedbank Latvia, points out, many people who survived the boom and bust had survived the break-up of the Soviet Union. “There was a very rigid memory that things could be much worse,” he says. “Also, everyone had enjoyed the boom before the crash, but they’d started saying it wasn’t sustainable, so there was an acceptance that the period of good years had not been long and they hadn’t got used to it.”
Mr Reirs says: “Growth was initially based on an increase in exports, by 40% in actual prices between 2010 and 2012. This positively impacted employment and wage growth, and since 2012 it has been further stimulated by private consumption.”
Professor Morten Hansen, head of economics at Stockholm School of Economics, agrees with Mr Reirs. But he points out that Latvia's rate of growth has slowed and the economy continues to face pressure from challenges in the eurozone, the crisis in Russia – especially the recession and depreciation of the rouble – as well as the performance of some of the region’s other economies, such as Finland’s.
“We’re also waiting for credit to grow,” adds Mr Hansen. “Loans peaked in 2008 and then for seven years in a row they’ve been declining or flattening out as they have been in the past year and a half – so-called credit-less growth. There has been a lot of deleveraging here. But we also agree that there has been a very significant demand effect coming from people who got hammered in the financial crisis. Many claim it is the banks that are not willing to lend, but here we very much see that there is a demand effect, and we’re waiting for that to turn around to sustain any interesting growth rates. So there are the challenges of Russia, credit and neighbouring countries, but the mood is not bad – it's just not ‘happy days are here again’, so to speak.”
The country’s key export markets are Lithuania, followed by Estonia, with Russia and Germany vying for third place. “Latvia is highly integrated into the EU, but also highly integrated into the Baltic region and about 75% of exports from this country go to the rest of the EU,” says Mr Hansen.
The country’s return to growth and the introduction of the euro in 2014 has helped restore investors’ trust. “The best testimony of how trust has been recovered is Latvia’s return to the international bond markets driven by lower interest rates than those held by the European Commission and IMF,” says Mr Reirs. “Latvia’s credit rating has improved significantly from the speculative level in 2009 to the highest level of investment: AA-.”
Today the country is ranked 23rd in the World Bank’s Doing Business 2015 report, placing it ahead of countries such as Japan, the Netherlands, France and Belgium. “Access to credit, fiscal collection and business registration are Latvia’s key selling points, with the last only taking 24 hours on average,” says Mr Reirs.
With regards to further draws for investors, he adds: “Foreign investors choose Latvia for its highly qualified workforce, complemented by widespread foreign language skills. These two strengths have long created a workforce at competitively low costs in a convenient and central location.”
However, the country continues to battle against challenging demographics, such as a shrinking labour force caused by lower birth rates in the late 1980s as well as migration from the country in recent years. Experts say it is not easy to address this problem while the wage gap between Latvia and other EU countries remains large.
More positively, the country’s developed infrastructure has led to a burgeoning logistics sector. “In addition to three ice-free ports, Riga International Airport handles almost half of all Baltic airport passenger traffic and holds about 60% of the cargo market share in the Baltic region,” says Mr Reirs, adding: “An enhanced telecommunications infrastructure also means Latvia has one of the fastest internet connections in the world; one of the deciding factors for US specialist chemicals company Cabot to base its service centre here.”
Latvia’s corporate income tax rate is 15%. There are also labour and business incentives, such as four special economic zones (three of which are in the ice-free ports) where qualifying companies can take advantage of tax rebates of up to 80%. “For large-scale investment projects, tax rebates of 25% are available for investment ranging from approximately €10m to €49.8m, and 15% for entrepreneurs whose initial long-term investments exceed €49.8m,” says Mr Reirs.
With regards to exports, Mr Hansen says: “The export market is being driven by a combination of factors. Latvia is penetrating more markets – the same goods are being sold in more markets and there are also new goods, which is very consistent with the story of a catch-up economy. There are no macroeconomic imbalances, no problems with inflation, government deficit and employment, and no overheating.”
He adds out that the country is one of just eight economies in the EU that is neither in excessive deficit or macro imbalance procedures, saying: “The three Baltic countries are among those states, which is very different from the situation back in 2007, when there was a lot of overheating going on.”
Mr Kazāks is also optimistic. “We are seeing incomes going up. What companies have lost in Russia, they’ve been able to sell to other markets, so the economy is relatively agile,” he says.