Washington, DC: Latvia’s economy has remained resilient despite a more challenging macroeconomic environment. Latvia faces a difficult policy tradeoff, as rising spending pressures from defense, aging (e.g., pensions and healthcare), and energy security coincide with weak productivity growth and slow income convergence to euro area levels. To preserve fiscal space and support long-run growth, policies should focus on a credible medium-term fiscal consolidation strategy that may require revenue mobilization and spending efficiency reforms. This should be accompanied by financial deepening and structural measures to boost productivity and investment. The authorities should continue to closely monitor the nonbank financial sector as consumer lending expands.
Outlook and Risks
GDP growth is projected to decline in 2026. Real GDP growth is projected to decline slightly to 1.8 percent in 2026, as the negative effects of the war in the Middle East are expected to be only partially offset by strong public investment, a recovery in consumption, strong credit growth spurred by the solidarity levy on banks, and momentum from stronger-than-expected growth at the end of 2025. Meanwhile, persistent supply disruptions in oil, gas, fertilizers, and petrochemicals are expected to increase inflationary pressures and cause headline inflation to reach 4 percent in 2026. The headline fiscal deficit is projected to increase to about 3 percent of GDP in 2026, driven by higher spending on defense, education, and social programs.
Risks to growth are tilted to the downside, while inflation risks are skewed to the upside. A prolonged war in the Middle East and heightened geopolitical and trade tensions could weigh on growth. Conversely, faster EU fund disbursement and accelerated structural reforms could contribute to higher-than-expected economic growth. Higher energy prices could raise inflation and wage pressures, while tighter global financial conditions could reduce inflation. Fiscal risks stem from higher defense and infrastructure spending, including Rail Baltica, as well as contingent liabilities from state-owned enterprises (SOEs), which could exceed the Fiscal Safety Reserve.
Managing Fiscal Pressures
Amid resilient demand and elevated inflation, a neutral fiscal stance in 2026 would have been preferable. If faced with additional disruptions in global energy markets, the authorities should allow automatic stabilizers to operate, while keeping the headline fiscal deficit on a declining path between 2027 and 2031. Any discretionary energy support measures should be limited, temporary, and targeted to vulnerable households to preserve fiscal space, maintain price signals, and contain price-wage pressures. Temporary support for viable firms facing high energy costs could also be considered, subject to strict eligibility criteria. Windfall taxes on energy companies should be avoided, as they could discourage investment in alternative energy sources.
Latvia should pursue a credible medium-term fiscal consolidation strategy to preserve fiscal space, address spending pressures, and keep public debt at a level that allows it to withstand large adverse shocks. In the medium term, fiscal pressures are increasing because of higher defense spending, the fiscal costs of an aging population (pensions and healthcare), investment needs related to energy security and climate, and the cost of reversing the diversion of pension contributions from the second (defined contribution) to the first (PAYG) pillar. Fiscal policy will also face tighter constraints once the EU national escape clause expires in 2028. Latvia should anchor public debt at 50 percent of GDP over the medium term. This anchor reflects Latvia’s exposure to external shocks as a small open economy, relatively high sovereign borrowing costs affected by geopolitical risks, rising spending pressures, and potential contingent liabilities from SOEs.
Meeting the medium-term debt anchor will require gradual fiscal consolidation supported by public sector reforms. The government should reallocate resources away from lower-priority spending and improve spending efficiency. Examples of improved spending efficiency include streamlining school and hospital networks. However, efficiency gains in these and other areas of current spending are unlikely to generate sufficient savings to address rising spending pressures. In healthcare in particular, efficiency gains should be complemented by additional resources over time, given Latvia’s relatively weak health outcomes.
Revenue mobilization should form an integral part of the fiscal consolidation strategy. Revenue measures should include raising property tax revenue, reducing income tax exemptions, improving VAT compliance, broadening corporate and personal income tax bases, and strengthening overall tax compliance. Together with the spending-efficiency measures discussed above, a combination of revenue reforms could generate about 0.5 percent of GDP per year over 2027-2031, with the greatest gains coming from reducing tax exemptions. The authorities should also restore the 1 percent of GDP contribution from the first to the second pension pillar by 2029 and strengthen the defined contribution pension pillars with measures to reduce costs, increase long-run returns, and raise contribution rates.
Strengthening Financial Sector Resilience
Latvia’s financial sector is resilient but growing nonbank lending warrants close monitoring and strong oversight. Latvia’s banks are well capitalized and highly liquid, but nonbank lenders have increased in importance as a source of unsecured consumer loans for lower-credit-quality borrowers. The current neutral macroprudential stance is appropriate, as it contains the buildup of systemic risks but does not impede credit growth. Going forward, the authorities should extend the existing macroprudential framework to monitor and address risks arising from nonbank lenders.
Financial sector policies should continue to support financial stability by strengthening supervisory and regulatory frameworks. Staff supports the planned transfer of licensing and supervisory responsibilities for nonbank consumer lenders to the Bank of Latvia to strengthen oversight and safeguard financial stability. Staff reiterates that the solidarity contribution on banks should be phased out as planned in 2027, as it could distort future lending toward less productive uses. The implementation of the Capital Requirements Regulation 3 framework improved most banks’ capital adequacy ratios. Moreover, Latvia has continued to strengthen its AML/CFT framework, as confirmed by the MONEYVAL evaluation.
Boosting Investment and Productivity
Closing Latvia’s income gap with the rest of the euro area will require structural reforms that boost investment, innovation, and AI adoption. National and EU-level policies that strengthen the business environment and firm dynamics, deepen financial markets, improve labor market mobility and labor skills, and lower energy prices and energy price volatility will make investment more attractive and support innovation. Such reforms will directly address the drivers of Latvia’s income gap: low total factor productivity growth and limited capital accumulation.
Boosting productivity will require facilitating labor mobility, enhancing adaptability to technological change, increasing labor force participation, and strengthening workforce skills. Improving housing affordability and quality, particularly through renovations and energy-efficiency upgrades, would help reduce regional disparities and support labor mobility. Staff supports the government’s state-backed mortgage program to improve access to home financing in regional areas, provided it remains limited in scope and temporary.
AI creates opportunities for Latvia but limited digital skills among the workforce and low firm-level adoption limit potential productivity gains. The country has a capable digital infrastructure, but it needs to do more to increase the availability of digital and STEM skills. In particular, it needs to strengthen education, training, and reskilling programs, including by expanding and improving the quality of tertiary and vocational training, strengthening collaboration between schools and firms to better align skills with labor market needs, and increasing participation in STEM fields. Moreover, real sector reforms should facilitate labor reallocation toward higher value-added sectors and more productive firms to raise productivity.
The authorities should strengthen financial intermediation and deepen financial markets to better allow firms to scale up and invest. Latvia should build on recent IPO successes and pursue additional SOE listings while leveraging EU capital market integration under the savings and investment union to expand firms’ access to finance. Alternative lending models and targeted ALTUM support to SMEs that address clear market failures could further broaden financing for innovative firms, provided strong oversight safeguards financial stability.
Reducing administrative and regulatory burdens would improve the business environment, thereby boosting investment and productivity. Measures to increase government efficiency include simplifying regulations, expanding the digitalization of public services, and consolidating overlapping functions among line ministries. Streamlining spatial planning and construction regulations would support housing investment.
Further integration within the European single market could broaden market access and create new opportunities for Latvian firms to scale up. Latvia should therefore support lower barriers to cross-border trade in goods and services in the EU. It should also encourage greater participation by its firms in EU value chains through better transport infrastructure, logistics, and digital connectivity.
Strengthening energy security could increase business confidence and investment. Deeper integration with European power grids and continued investment in renewable energy to diversify the energy mix (including for heating) would strengthen Latvia’s resilience against energy supply disruptions. It would also reduce energy prices and their volatility, which would encourage investment.
An IMF team conducted meetings in Riga during July 6–17, 2026. The mission was led by Mr. Luis Brandao-Marques and included Bingjie Hu, Keyra Primus (all EUR), and Ha Nguyen (ICD). Carlos Acosta (LEG) participated virtually in meetings. Gundars Davidsons (OED) took part in the meetings. The mission would like to thank the authorities for their open collaboration, generous availability, and candid and constructive discussions.
read more: https://www.imf.org/en/news/articles/2026/07/17/mcs071726-republic-of-latvia-staff-concluding-statement-of-the-2026-article-iv-mission
