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Central & Eastern Europe Investment: Latvia: Bounceback economy adopts the euro

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Latvia is the eighteenth and newest member of the EU and was the fourth CEE state, after Slovenia, Slovakia and Estonia, to join the euro-zone.

“It’s a geopolitical success for Latvia,” says Dainis Gaspuitis, economist at SEB Bank in Riga. “We have emerged not only from the financial crisis, but from the post-Soviet era. It’s a step forward in converging with the Western world.”

When GDP fell by 17.7% and private consumption by 22.6% in 2009 – the steepest drops in the EU – speculation was rife that the lats, pegged to the euro, would devalue. This would have proved disastrous for the many borrowers, including mortgage holders, who took their loans out in lower interest rate euros during Latvia’s property boom in the mistaken belief that they had no currency risk. Instead, Latvia opted for a painful process of job and wage slashing, and government cutbacks to restore export competitiveness.

“Internal devaluation increased reform pressures,” explains Gaspuitis. “The crisis showed up imbalances: we had lost competitiveness in the private sector, while the public sector was inflated.”

Latvia’s unemployment rate came close to 20% in 2010, despite a high level of emigration that by late 2013 had depleted the population by 12% over the decade, to just over 2m. Yet by 2011, the economy had rebounded. In 2013, Latvia posted an average 4.1% annualised GDP growth in the first three quarters, driven by rising private consumption off the back of falling unemployment, rising wages and low inflation (although, some was certainly spurred by stocking up on durables in the belief that retailers would use the euro transition to hike prices).

On the supply side, problems at the Baltics’ only rolled steel producer, Liepājas Metalurgs – the company filed for bankruptcy in November 2013, with 1,500 workers laid off – will depress manufacturing and export growth, as well as adding to government costs through unemployment benefits and bank loans it had earlier guaranteed.

The economy has over the years reoriented towards services. Of the LVL7.8bn (€11.1bn) of FDI as of end-June 2013, financial services accounted for a good quarter, while real estate has been the fastest growing, at 16%, according to Bank of Latvia statistics. Sweden accounted for a massive 22%, followed some way behind by the Netherlands at 8%.

Latvia rebooted its real estate market in 2010 with a controversial immigrant investor visa scheme allowing non-European Economic Area members temporary residence – and the associated benefits such as travel within the Schengen zone – in exchange for investing in property and businesses. Real estate has benefited more than business, with many Russians buying up properties for rent in Riga and coastal resorts and the scheme has been blamed for recent rising prices.

Latvia has also changed its tax regime to make it attractive for foreign investors to register holding companies in the country, even if they are not resident. In 2013, for non-tax havens, capital gains on share transfers and dividends were abolished, as was withholding tax on dividends.

 

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