25. Latvia

Latvia had been experiencing stable economic growth rates exceeding the EU average until the COVID-19 pandemic. From 2013 to 2019, GDP grew by 2.9% per year on average.

The COVID-19 pandemic has had a significant impact on economic development for the global economy and Latvia was not the exception. In 2020, GDP shrank by 2.3%. Nonetheless, the extensive government and EU funds support measures, as well as the improvement of the epidemiological situation in 2021, contributed to the recovery of Latvia’s economy, and GDP grew by 4.3%.

The recovery of Latvia's economy from the COVID-19 pandemic crisis was interrupted by the large-scale aggression of Russia against Ukraine. On 24 February 2022, when Russia invaded Ukraine, the geopolitical situation and prospects for economic development deteriorated. Energy and food prices rose significantly, intensifying the inflation pressure at a time when the cost of living around the world had already skyrocketed as the world was recovering from the pandemic. The global economy was also affected by disruptions in raw material supply chains due to the war. In 2022, GDP grew by 2.8%, i.e., the lowest growth since 2017, excluding the drop of 2020 due to the COVID-19 pandemic. However, despite the war in Ukraine, the decline in GDP was better than predicted due to strong private consumption and export growth.

Further economic development in the medium term depends on the situation in the external environment and progress in reforms. The highest risk to the growth of Latvia is related to global economic development, in particular the geopolitical situation. Further development of the EU’s economic performance is equally important. In the medium term, economic advantages of Latvia are mainly based on the achieved macroeconomic stability, as a result of which Latvia’s credit ratings have improved, as well as on the efficiency of planned aid programmes of the EU funds and on the improvements in the business environment. Latvia owes its economic competitiveness to technological factors, improvements in production efficiency, increased innovation, and to a lesser extent cheap labour and low resource prices. In the medium term, Latvia’s growth rates may reach a 4-5% increase per year. If the war in Ukraine continue, the pace of economic recovery might be slower.

In Latvia, 99.8% of economically active merchants and commercial companies are SMEs, 91.1% of which are micro-enterprises.

In 2022, SMEs in Latvia continued their recovery, with SME value added growing by 7.9% and SME employment increasing by 1.7%. However, as value added growth is not adjusted for inflation, in the high-inflation environment of 2022, growth in real terms has been lower (SME value added growing by 6.7% and SME employment increasing by 0.7%).

As economic operators are experiencing the effects of the large-scale aggression of Russia against Ukraine, including supply chain disruptions, market shocks, uncertainty, and inflation, the government has developed solutions to overcome the crisis and stabilise the market by offering various financial instrument programmes.

Currently, state support programmes are introduced via the JSC Development Finance Institution Altum (henceforth – Altum), a state-owned development finance institution offering aid and financial tools to various target groups. Altum develops and implements state aid programmes to compensate for market shortcomings that cannot be resolved by private financial institutions.

On account of the actual data (including statistical data revisions), Latvia's GDP growth projections for 2022 have been revised downwards to 2.8% (3.0% in September). Nevertheless, the overall economic outlook has remained broadly unchanged, and the development in 2023 is similar to the previous forecasts, projecting a 0.3% contraction (a 0.2% fall in September).

In 2022, GDP growth reached 2.8% on the back of strong growth in private consumption and exports. Real private consumption growth started the year on a strong footing but surging inflation and slowing employment growth put a brake on it. Investment growth also slowed towards the end of the year, hampered by surging construction prices and delays in EU-funded programme implementation. Exports benefitted from the post COVID recovery in tourism in addition to high lumber and grain prices.

In 2023, GDP is forecasted to grow by 1.4%, hampered by high inflation weighing on private consumption and a delay in public investment programmes. Growth is expected to pick up by mid-year as inflation subsides and investment gains momentum. The economy is set to continue on this trajectory in 2024, with GDP growth reaching 2.8%. Inflation is expected to take some time to slow, staying close to double-digit levels in 2023. By 2024, a decline in energy prices and a broad-based slowdown in other price categories are set to bring inflation down to 1.7%. Unemployment is forecasted to decrease slightly in 2023 and then some more in 2024. The general government deficit is set to decrease to 3.8% of GDP in 2023 and to 2.7% in 2024.

Growth is expected to be slower at the start of 2023, as real disposable income growth remains negative and households grapple with high heating bills. However, slowing inflation is set to provide a relief to households’ purchasing power lending a boost to consumption growth. Additionally, EU-funded investments, including those financed by the RRF, are projected to pick up in the second half of 2023. Export growth is expected to slow down due to weakening foreign demand, construction activity in particular.

In 2024, growth is forecast to pick up to 2.8%. A marked slowdown in inflation is set to foster private consumption. A further increase in EU-funded investments and a decline in prices of construction materials are expected to boost investment. Export growth is projected to pick up as the inflation slowdown elsewhere in the EU boosts foreign demand.

According to Eurostat data, in 2022, there were 111 153 economically active individual merchants and commercial companies in Latvia. 99.8% of these firms were SMEs and 91.1% of SMEs were micro-sized. Only 0.2% of firms in Latvia in 2020 were large firms (see Table 25.2)

In 2022, there were approximately 105 527 SMEs operating in Latvia, with the vast majority of these (95 383) being micro-sized enterprises that employed between zero and nine people. Additionally, there were around 8 694 small businesses, which had between 10 and 49 employees, and 1 450 medium-sized businesses.

In 2022, there were approximately 484 738 people employed by SMEs in Latvia. Micro-sized enterprises that employed between zero and nine people employed 172 307 people in this year, small-sized businesses (10-49 employees) employed 170 763 people, while medium ones (50-249 employees) employed around 141 668 people.

In the Latvian ‘non-financial business economy’, SMEs account for 70.5% of value-added and 78.1% of employment, significantly higher than the respective EU averages of 51.8% and 64.4%.

The tourism sector partially recovered from the downturn in 2021 in terms of SME employment. While SME employment in the industrial sector declined by 4.2% in 2021, it increased by 1.2% in 2022. SME value-added in this particular sector increased significantly in both 2021 and 2022, by 18.1% and 8.4%, respectively.

In 2022, 8 826 new companies were registered in Latvia - 401 less than in 2021. This is the lowest figure since 2004. If 14 157 companies were liquidated in 2021, then in 2022 – 10 959, which is 22.6% less.

Latvia ranks 22nd in the EIF SME Access to Finance Index (Despite increasing its position in the EIF Access to Finance Index from 26th place in 2020 to 23rd in 2021). Although it improved its score in 2022, the percentage of SMEs feeling that there are no financing obstacles decreased by 4.1%. Latvia’s improved score can be attributed to an increase in the percentage of SMEs applying for loans and a more than twofold increase in the percentage of SMEs using grants or subsidised bank loans. Nevertheless, Latvia ranks third in the share of finance-constrained firms in the EU, and has the highest percentage of firms in the EU (30%) who report that they have invested too little over the past three years. Factors that explain Latvia’s poor access to finance include persistently high interest rates, high collateral costs and the corporate credit gap, which has contracted by 20% over the past six years. Over the last 13 years, the corporate lending dynamics saw a short-lived growth during some periods affected by certain very sizable transactions; however, until mid-2022, the overall dynamics remained strongly negative (back in June, the annual rate of change in loans stood at –1.1%). In turn, in the second half of the year, corporate lending was rather active, and the annual growth in corporate loans already reached 10.4% in November 2022.

The dynamics of lending to non-financial corporation (NFCs)_ are still driven by the interaction between supply and demand factors. Lending policies of the largest credit institutions are still conservative concerning NFCs. Weak competition in the market of lending to SMEs is one of the factors that affect lending conditions (e.g. loan maturities, prices, collateral requirements). According to a bank lending survey, the credit standards remained stable in 2021 and at the beginning of 2022, and the number of rejected applications remained the same.

The Government of Latvia continues work on the creation of an initial public offering fund for Baltic SMEs. The fund will provide financing for the initial listing and inclusion of SMEs in the securities market of the Baltic countries, primarily in the stock market (both in the regulated market and in the alternative market of the Multilateral Trading System (MTF) in the Nasdaq Baltic Exchange). At the same time, BaltCap Growth Fund is available to Latvian SMEs, which provides risk capital to SMEs. Of course Business Angels as the solvation of SME financing problems.

On the policy side, substantial progress has been made to facilitate SME access to finance. In 2014, Altum was established. It is a one-stop-shop national development finance institution where SMEs can apply for European, national and local aid in the form of financial instruments (loans, guarantees, equity instruments, etc.). Latvia has been very active in using available EU Structural Funds to prevent market failures in the financial sector and ensure that SMEs get the required investments so they can grow. A variety of financial instruments have been created to facilitate the availability of financial resources in all stages of business development, especially for starting a business.

The financial instruments implemented by the Altum (directly and indirectly):

  • Equity instruments: pre-seed, seed and start-up capital, venture capital, and expansion capital;

  • Quasi-equity instruments: mezzanine loans;

  • Debt instruments: guarantees (loan guarantees, short-term export credit guarantees), start-up loans, microloans, SME loans, FRS loans, loans for rural development/farmers.

Credit guarantees serve as collateral for obtaining loans from commercial banks. While there are no formal restrictions pertaining to SMEs, credit limits and maturity periods vary between SMEs and large firms and within large firms as well. Guarantees are limited to 80% of financial services for both large companies and SMEs. Certain activity restrictions (e.g. financial and insurance activities, alcohol trade, etc.) as well as sectoral restrictions, per EU regulation, apply as well in terms of credit guarantees (average amount of guarantees issued EUR 40 – EUR 45 million per year). The programme has been functioning since June 2016, and by 30 September 2022, 980 guarantees amounting to EUR 245.9 million were issued, guaranteeing financial services for at least EUR 400 million. This is evidence of constantly high demand for such financial instruments.

Portfolio guarantees were developed in 2017 to improve the availability of financial resources for SMEs in Latvia. They were intended to contribute to the creation of new companies, expand existing activities and increase lending rates (average amount of guarantees issued EUR 6 to EUR 10 million per year). Since the start of the programme from 2018 to 31 December 2022, 855 guarantees in the amount of EUR 35.57 million have been issued within the framework, providing financial services to companies in the amount of EUR 44.47 million.

The main target of export credit guarantees is to reduce political and commercial risks related to export transactions. Due to the uncertain economic conditions from April 2020 to December 2022 export credit guarantees are available for export transactions independently of the country of the debtor (with a deferred period until 2 years).

From the beginning of the current export credit guarantee programme in 2017 until 31 December 2022, export credit guarantees have been issued in the amount of EUR 35.8 million (declared export amount – around EUR 163 million), and 159 companies have been supported.

Since 2019, intensive work has been and continues to improve the supervision of risk capital funds, paying particular attention to the fulfilment of the requirements defined in the state aid regulation.

  • Acceleration Funds: the aim of the measure is to promote the development and competitiveness of economic operators by providing acceleration (i.e., promotion, stimulation, development) services and financing for business projects that involve technological or industrial risks of failure (in 2022, 24 companies made investments in the acceleration fund for a total of EUR 1.6 million)

  • Support for early-stage and growth capital funds: the aim of the measure is to promote the establishment, development and competitiveness of merchants and agricultural service cooperative societies by providing seed and growth capital for the implementation of business projects (In 2022, they made investments in the funds for a total amount of EUR 9 million)

SME Growth Loans are loans for investment and working capital. The programme provides reduced requirements for collateral and options to receive interest rate subsidies or a guarantee for a loan. The maximum amount of an investment loan is EUR 2.85 million and not more than 90% of the total project costs. The maximum amount of working capital is EUR 1 million. The maturity of the investment loan is from 2 to 15 years. The maturity for the working capital loan is from 2 to 5 years (average amount of loans issued EUR 20-25 million per year). By 31 December 2022, 15 loans in the amount of EUR 12.8 million have been issued.

Parallel loans refer to a top-up loan that serves as co-financing for a bank loan in the event that the bank’s terms and conditions are too onerous for the entrepreneur. Available only in addition to bank funding, the loan can be issued to economic operators registered in the Republic of Latvia, subject to restrictions regarding the business sector and financial situation. The loan is available for long-term investments (average amount of loans issued EUR 1 million per year). The programme has been functioning since July 2016, and 21 parallel loans for EUR 11.4 million have been issued by 31 December 2022.

Loans are available for businesses to improve the energy efficiency of equipment and introduction of renewable energy projects. Through the loan, it is possible to finance:

  • Energy efficiency - replacement of equipment, lighting, ventilation, drying, heating, cooling, steam manufacturing equipment (<5% energy savings)

  • Sustainable transport - mobility, electric vehicles, biogas or transport

  • Renewable energy - decentralized power supply equipment, solar panels, cogeneration equipment, wind turbines

  • Green buildings- Construction (energy efficiency for heating <40 kWh/m2) or renovation (energy efficiency <25%) of non-residential buildings

It is of special relevance for companies with significant energy consumption where costs exceed EUR 20 thousand annually (e.g. supermarkets and sports centres, warehouses, hotels, office buildings, food producers, woodworking, metalworking companies or large companies and large energy consumers affected by the Energy Efficiency Law). By investing in energy efficiency measures, the companies can reduce their energy consumption by up to 50% (average amount of loans issued EUR 5 million per year).

Commercial banks are reluctant to finance start-ups due to their high business risks and lack of financial records as well as the prevalence of information asymmetries between start-ups and banks and the high administrative costs of servicing loans to smaller firms. As a result, Altum provide support for microloans of up to EUR 25 000, while start-up loans of up to EUR 150 000, including high-risk innovative entrepreneurs with high growth potential and viable business project investments and current assets (average amount of loans issued EUR 10 million per year).

The objective of the Investment Fund is to stimulate an influx of new investments to expand entrepreneurship by stimulating business owners to make new investments, thus creating a value-added chain throughout the economy. The application for the new support programme for large investment projects started in 2022. The programme is planned for development projects of large and medium-sized enterprises in Latvia from EUR 10 million. When achieving the objectives of the project and fulfilling certain criteria, a company can qualify for a loan with a capital discount of 30% or repayment of the portion of the loan granted by Altum. In the first selection round of the loan programme, the Investment and Development Agency of Latvia has approved 14 large investment projects, while in the closed round, 7 projects have been approved for further evaluation of the request for funding from Altum.

The large-scale aggression of Russia against Ukraine has caused significant economic and financial turmoil, particularly in commodity markets, where oil, gas, wheat, fertilizer, and seed prices have skyrocketed. The scope of the economic impact of the aggression is very unclear and will depend on the duration of the war and political reactions. However, there is no doubt that global growth will be significantly hampered, and inflationary pressures will rise. To mitigate the impact of war and the resulting consequences on market reorientation, access to raw materials, and on the creation of new supply chains, the Investment and Development Agency of Latvia is carrying out important work in advising entrepreneurs on current crisis solutions and potential support tools. The Investment and Development Agency of Latvia acts as a single point of contact for market reorientation, also looking for options to replace exports and imports.

As economic operators are experiencing the effects of the large-scale aggression of Russia against Ukraine including, supply chain disruptions, market shock, uncertainty, inflation, etc., the MoE has developed solutions to overcome the crisis and stabilise the market by offering various financial instrument programmes:

  • At the CM meeting of 14 June 2022, a loan programme with financing of EUR 21.5 million was approved to reduce the economic consequences of the war. The beneficiaries are small- (micro), medium-sized and large enterprises which are able to demonstrate that they need the loan to mitigate the negative impact on their economic activity and that they are economically viable;

  • At the CM meeting of 21 June 2022, a guarantee programme with a financing of EUR 12.5 million was approved to reduce the economic consequences of the war. The beneficiaries are small (micro), medium-sized and large enterprises capable of demonstrating that they need the guarantee to mitigate the negative impact on their economic activity and that they are economically viable;

  • At the meeting of 11 October 2022, the CM approved a programme providing compensation to manufacturing businesses for the increase in electricity and natural gas costs, due to the consequences of the war during the period from 1 February 2022 to 31 December 2022. The total planned support funding is EUR 50 million.

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