Research Update:

Latvia Long-Term Rating Raised To

'A-' On Strong Growth And Fiscal
Performance; Outlook Stable
Primary Credit Analyst:
Maxim Rybnikov, London (+44) 207 176 7125; maxim.rybnikov@standardandpoors.com
Secondary Contact:
Maria J Redondo, London (44) 20-7176-7094; maria.redondo@standardandpoors.com
Analytical Group Contact:
SovereignEurope; SovereignEurope@standardandpoors.com
Table Of Contents
Overview
Rating Action
Rationale
Outlook
Key Statistics
Related Criteria And Research
Ratings List
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Research Update:
Latvia Long-Term Rating Raised To 'A-' On Strong
Growth And Fiscal Performance; Outlook Stable
Overview
Latvia has continued to demonstrate robust economic growth, and external
performance exceeded our expectations in 2013.
We expect the fiscal position to remain strong with only moderate
government deficits and debt on a declining path.
We are therefore raising our long-term sovereign credit ratings on Latvia
to 'A-' from 'BBB+'.
The outlook is stable.
Rating Action
On May 30, 2014, Standard & Poor's Ratings Services raised to 'A-' from 'BBB+'
its long-term foreign- and local-currency sovereign credit ratings on the
Republic of Latvia. At the same time, we affirmed the 'A-2' short-term ratings
on Latvia. The outlook is stable.
Rationale
The upgrade reflects Latvia's strong economic performance, which we expect
will continue with output growing by 4% on average over 2014-2017. The upgrade
also reflects that the external performance has been better than we forecast,
as well as our expectation of continued prudent fiscal policies supporting a
modest decline in government debt as a percentage of GDP. The stable outlook
balances these strengths against some external risks, such as the high level
of nonresident deposits, as well as longer-term challenges, such as a
declining population.
The Latvian economy grew by 4.1% last year: the fastest growth rate in the EU.
Growth was mainly supported by robust consumption performance on the back of
falling unemployment. We expect growth to decelerate to 3.7% in 2014 before
picking up to average 4.3% over 2015-2017, buoyed by consumption but also
gradually recovering investments as the external environment improves. At the
same time, we expect that real GDP will only surpass the pre-crisis peak in
2016. Robust growth is helping to increase per capita income; we expect this
to reach $16,400 in 2014, up from $11,600 in 2010.
Latvia will continue to benefit from generally strong institutional and
governance effectiveness over the medium term. In recent years the government
has introduced a series of fiscal austerity measures to improve its fiscal
position and to satisfy the conditions of eurozone entry. The next general
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elections are scheduled for October 2014 and we currently do not foresee any
major shifts in policy direction. The upgrade is based on our assumption that
policymaking will remain focused on sustainable public finances, pro-market
reforms, and compliance with EU commitments.
Over the past four years, Latvia's fiscal deficits have narrowed
significantly. We estimate the general government deficit has decreased to
0.9% of GDP in 2013 from the recession-driven peak of 9% in 2009. The deficit
reduction was implemented through a combination of tax increases and
expenditure cuts, including sizable reductions in public wages. As a result,
we estimate general government debt, net of liquid assets, at about 32% of GDP
in 2013. We project that the ratio will decline to about 27% by 2017.
In our view, the fiscal framework has improved following the March 2013
introduction of the fiscal discipline law (FDL), which aimed to reduce the
pro-cyclicality of government expenditures. That said, the FDL focuses on the
government's structural balance, which is subject to uncertainty related to
estimating output gaps. We also anticipate some pressure on revenues from the
announced personal income tax rate cut by 1 percentage point to 23% in 2015
and to 22% in 2016. Overall, however, we do not foresee any major fiscal
slippages over the 2014-2017 forecast horizon.
General government interest expenditures are low: they accounted for just over
4% of revenues in 2010-2013. This partly reflected significant amounts of
official debt--primarily from a 4 billion support program from the IMF and
EU--but also the favorable terms that Latvia obtained in the capital markets
once it regained access in 2012. Over the forecast horizon, the remaining
official debt will be replaced by capital market borrowing. We do not expect
this to materially increase Latvia's interest expenditures.
The sovereign's external position remains a rating constraint, though it has
improved since 2009 on sharply reduced current account deficits and some
foreign bank loan write-downs. The current account deficit amounted to about
0.8% in 2013, narrowing from 2.5% in 2012. This compares to the peak of 23% in
2006. That said, we expect the deficits to widen gradually again as the trade
balance deteriorates on the back of strong consumption growth and recovering
investments, leading to an increase in imports.
With Latvia's eurozone accession in January 2014, Latvian banks obtained
access to the European Central Bank's (ECB's) liquidity facilities, which
helps to mitigate some external financing risks. Some vulnerabilities remain
from expected persistent current account deficits and a reliance on short-term
external financing, including nonresident deposits. Nonresident deposits grew
last year and could potentially generate risk management challenges for
resident banks. At the same time, we currently see limited leakage of external
funding from nonresident deposits into the domestic economy, with the deposits
generally invested in liquid foreign government securities or placed with
foreign financial institutions. The risks are also somewhat mitigated by the
stricter capital and liquidity requirements for banks focussed on nonresident
business.
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Research Update: Latvia Long-Term Rating Raised To 'A-' On Strong Growth And Fiscal Performance; Outlook
Stable
Close to 65% of banks operating in Latvia are subsidiaries and branches of
larger Nordic financial groups, which provided support during the 2008-2009
crisis. We expect the parent banks will continue to support their Latvian
subsidiaries, which limits the contingent fiscal liabilities from this source
to the sovereign.
With eurozone membership, Latvia now benefits from the highly developed
capital market of the monetary union as well as the credibility of ECB
monetary policy. However, we note that the ECB's monetary policy goals will
likely be aligned more closely with those of the larger eurozone members,
rather than the smaller economies such as Latvia. Challenges also remain from
declining depository corporation claims on the resident nongovernment sector,
which shrank by close to 5% in 2013. Credit is likely to recover only
gradually over the forecast horizon with potentially negative consequences for
domestic demand.
Outlook
The stable outlook balances Latvia's expected strong growth potential and
robust fiscal position against a number of external vulnerabilities, including
potential risks posed by high levels of nonresident deposits.
The outlook indicates that we see a less than one in three probability that we
will change our rating on Latvia in the next two years. Over a longer period,
an upgrade could come from Latvia's income levels converging closer to those
of other eurozone members or from a material improvement in its external
position.
We could lower the ratings if the government were to significantly relax its
fiscal policy. We could also consider a downgrade if we see a return of the
high current account deficits observed pre-crisis or escalating risks from
nonresident deposits.
Key Statistics
Table 1
Republic of Latvia - Selected Indicators
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Nominal
GDP (US$
bil)
29 34 26 24 28 28 31 33 34 37 40
GDP per
capita
(US$)
13,079 15,500 12,233 11,624 13,827 14,019 15,441 16,399 17,181 18,566 20,083
Real GDP
growth
(%)
10.0 (2.8) (17.7) (1.3) 5.3 5.2 4.1 3.7 4.2 4.4 4.4
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Research Update: Latvia Long-Term Rating Raised To 'A-' On Strong Growth And Fiscal Performance; Outlook
Stable
Table 1
Republic of Latvia - Selected Indicators (cont.)
Real GDP
per capita
growth
(%)
10.8 (1.5) (16.1) 0.9 6.8 6.3 5.1 4.2 4.6 4.7 4.7
Change in
general
government
debt/GDP
(%)
1.0 11.5 12.6 6.7 2.1 2.2 (0.6) 3.4 (3.8) 3.1 (0.3)
General
government
balance/GDP
(%)
(0.7) (4.4) (9.1) (8.1) (3.5) (1.4) (0.9) (1.0) (1.0) (0.8) (0.8)
General
government
debt/GDP
(%)
9.0 19.8 36.9 44.5 42.0 40.8 38.1 39.5 33.2 33.9 31.1
Net
general
government
debt/GDP
(%)
7.4 10.9 21.7 30.2 34.8 32.2 31.8 31.0 30.1 28.7 27.4
General
government
interest
expenditure/revenues
(%)
1.1 1.7 4.2 3.9 4.3 3.9 4.6 4.3 4.5 3.9 4.1
Oth dc
claims on
resident
non-govt.
sector/GDP
(%)
87.8 92.9 104.4 97.3 81.9 67.8 60.9 56.8 53.2 49.9 46.7
CPI
growth
(%)
10.1 15.4 3.5 (1.1) 4.4 2.3 0.0 1.3 2.2 3.0 3.0
Gross
external
financing
needs/CARs
+use. res
(%)
230.4 243.3 223.7 179.5 172.0 177.8 172.5 182.6 172.9 173.4 163.9
Current
account
balance/GDP
(%)
(22.4) (13.1) 8.6 2.9 (2.2) (2.5) (0.8) (1.2) (1.8) (2.0) (2.2)
Current
account
balance/CARs
(%)
(41.7) (24.4) 15.4 4.6 (3.1) (3.5) (1.2) (1.7) (2.6) (2.8) (3.0)
Narrow
net
external
debt/CARs
(%)
125.6 126.3 143.5 120.1 85.5 81.1 77.6 72.5 68.2 61.1 53.4
Net
external
liabilities/CARs
(%)
149.5 138.0 151.6 126.8 98.0 96.8 97.3 91.9 87.7 80.5 73.7
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Research Update: Latvia Long-Term Rating Raised To 'A-' On Strong Growth And Fiscal Performance; Outlook
Stable
Table 1
Republic of Latvia - Selected Indicators (cont.)
Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition
of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year
plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as
the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid
assets held by nonresidents minus financial sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net
external lending. CARs--Current account receipts.
The data and ratios above result from S&Ps own calculations, drawing on national as well as international sources, reflecting S&Ps independent
view on the timeliness, coverage, accuracy, credibility, and usability of available information.
Related Criteria And Research
Related Criteria
Sovereign Government Rating Methodology And Assumptions, June 24, 2013
Methodology For Linking Short-Term And Long-Term Ratings For Corporate,
Insurance, And Sovereign Issuers, May 7, 2013
Criteria For Determining Transfer And Convertibility Assessments, May 18,
2009
Related Research
Sovereign Defaults And Rating Transition Data, 2013 Update, April 18,
2014
Latvia Outlook Revised To Positive On Debt Reduction Prospects;
'BBB+/A-2' Ratings Affirmed, Dec. 13, 2013
Supplementary Analysis: Latvia (Republic of), Aug. 16, 2013
Outlooks: The Sovereign Credit Weathervane, Year-End 2013 Update, Feb. 4,
2014
In accordance with our relevant policies and procedures, the Rating Committee
was composed of analysts that are qualified to vote in the committee, with
sufficient experience to convey the appropriate level of knowledge and
understanding of the methodology applicable (see 'Related Criteria And
Research'). At the onset of the committee, the chair confirmed that the
information provided to the Rating Committee by the primary analyst had been
distributed in a timely manner and was sufficient for Committee members to
make an informed decision.
After the primary analyst gave opening remarks and explained the
recommendation, the Committee discussed key rating factors and critical issues
in accordance with the relevant criteria. Qualitative and quantitative risk
factors were considered and discussed, looking at track-record and forecasts.
The chair ensured every voting member was given the opportunity to articulate
his/her opinion. The chair or designee reviewed the draft report to ensure
consistency with the Committee decision. The views and the decision of the
rating committee are summarized in the above rationale and outlook.
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Research Update: Latvia Long-Term Rating Raised To 'A-' On Strong Growth And Fiscal Performance; Outlook
Stable
Ratings List
Upgraded; CreditWatch/Outlook Action; Ratings Affirmed
To From
Latvia (Republic of)
Sovereign Credit Rating A-/Stable/A-2 BBB+/Positive/A-2
Ratings Affirmed
Latvia (Republic of)
Transfer & Convertibility Assessment
Local Currency AAA
Latvia (Republic of)
Short-Term Debt A-2
Upgraded
To From
Latvia (Republic of)
Senior Unsecured A- BBB+
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Research Update: Latvia Long-Term Rating Raised To 'A-' On Strong Growth And Fiscal Performance; Outlook
Stable
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