The past decade has been a turbulent period for the Latvian economy. From acquiring double digit growth figures before 2008, the country has first experienced a double digit drop in GDP before rebounding to a healthier economy and more focus on socioeconomic challenges.

Economic crisis and its aftermath

From 2008 to 2010 the Latvian economy took one of the sharpest downturns in the world, when the fall of GDP reached 21%. The financial assistance of the European Union, the IMF, and the World Bank supported the economic recovery program.

Latvia frontloaded austerity measures and implemented structural reforms while maintaining an exchange rate pegged to the euro. Overall, consolidation measures reached almost 17% of GDP during the time period from 2008 to 2012, including eight percent in 2009 – the first year of the adjustment program.

While implementing drastic cuts of expenditure it was agreed to cushion the hardship and to protect the poorest and most vulnerable people by strengthening the social safety net. So even in an atmosphere of major budget cuts, Latvia expanded and improved unemployment assistance and cash benefits to the poorest. Despite high unemployment and increased hardship the government measures have been meeting broad support.

The euro adoption has been viewed as important objective of the exit strategy from the international loan programme — still not a “magic wand” to make other policy challenges disappear. Latvia still needs to boost productivity and strengthen competitiveness by implementing reforms.

Latvia returned to growth in the latter half of 2010 as a result of economic stabilization measures, while maintaining a fixed exchange rate with the euro, which was accompanied by a favourable situation in external markets and increase in market confidence. At present, Latvia continues to show rapid and sustainable growth and has achieved considerable improvement in the fiscal position. Latvia still continues structural reforms towards improving competitiveness and productivity. The housing market bubble and credit crunch in 2008 had a severe impact on employment, as many companies have been able to operate only due to easy bank financing. Now that lesson has been learned and businesses are looking for prudent and sustainable foundation for further growth.

All major international rating agencies have upgraded Latvia’s credit rating by several notches since the beginning of 2012 crediting the country for recent improvements in economic and fiscal management, broad-based economic growth and the forthcoming accession to the euro. The latest upgrade came in June 2013 from S&P, when the long term rating on Latvia was raised one grade to BBB+, increasing by 4 notches since 2010 from the non-investment grade of BB.

Current economic situation and near-future forecast

The overall economic situation over the past year has been exceptional and much better than forecasted. Latvia's GDP in 2012 increased 5.0% – the fastest in the EU. Strong economic growth has been continuing in 2013, albeit at a slightly slower pace still among the fastest in the EU. In Q1, the annual growth rate was 3.8% and in Q2 it increased to 4.3%. The slight slowdown in 2013 can be attributed to the generally weak economic environment in the EU and a sharp decline in basic metal production, caused by the financial problems of the largest metal producer, Liepājas Metalurgs. Domestic demand has been the main contributor to growth in 2013.

During 2012 inflation gradually decreased, reflecting international food and energy prices and is among the EU's lowest in 2013 (inflation was 0% for the month of October 2013 compared to October 2012). There is still a very low contribution from core inflation, indicating that inflation is free from any domestic pressures. The annual y-o-y inflation in October 2013 decreased to 0.3%.

Unemployment has been gradually declining from the peak in Q1 of 2010. The jobseeker rate has declined from 21.3% in 1Q2010 to 11.4% in 2Q2013 (to the lowest since 4Q2008), while registered unemployment fell from 17.3% in March 2010 to 9.1% in September 2013. Further gradual decrease is expected to continue over the coming years.

The retail trade turnover maintains healthy growth, in September 2013 reaching 2.1% y-o-y. It is expected that retail trade will keep growing throughout the year at rates in line with improvements in employment and income.

Growth rates for manufacturing in 2013 have slowed down and turned negative in some months. Production volumes in September grew by 0.7% y-o-y and declining growth rates are mainly caused by falling metal production as well as reduction in electricity and gas supply.

Despite the unfavourable situation in external markets, particularly recession in the euro area, Latvian exports continued expanding in 2012 and in the first half of 2013. In the first 8 months of 2013, exports grew by strong 4.0% y-o-y, while the growth rate for imports has come down to 0.2%.

The Ministry of Finance revised its macroeconomic forecasts in June 2013, increasing the projected GDP growth in 2013 and 2014 to 4.2%. In the medium term, GDP is expected to maintain a 4% growth rate. The CPI growth forecast for 2013 is 0.4% and in middle term inflation is expected to remain moderate at around 2.5% per year, reflecting price convergence with the euro area.

In the last few months, the economic situation and outlook in the EU and euro area have improved. The EU and EA GDP returned to growth in the second quarter, while economic confidence indicators point to further improvements in the third quarter. Improvements in the EU economy are crucial for Latvia to sustain high growth in the medium term.