Economy of Latvia

Latvia's economy has had rapid GDP growth of more than 10% per year before it entered a severe recession in 2009 as a result of an unsustainable current account deficit, collapse of the real estate market, and large debt exposure amid the softening world economy. Triggered by the collapse of Parex Bank, the second largest bank, GDP decreased by almost 18% in 2009, and the European Union, the International Monetary Fund, and other international donors provided substantial financial assistance to Latvia as part of an agreement to defend the currency's peg to the euro in exchange for the government's commitment to stringent austerity measures. In 2011 Latvia achieved GDP growth by 5.5% and thus was again among the fastest growing economies in the European Union. The IMF/EU program successfully concluded in December 2011.

Privatization is mostly complete, except for some of the large state-owned utilities. Export growth contributed to the economic recovery, however, the bulk of the country's economic activity is in the services sector.

Economic history

For centuries under Hanseatic and German influence and then during its inter-war independence, Latvia used its geographic location as an important east–west commercial and trading centre. Industry served local markets, while timber, paper and agricultural products were Latvia's main exports.

Prior to World War I, Latvia was an advanced manufacturing hub within the Russian Empire, primarily serving the Russian market. After attaining independence in 1918, Latvia lost its status as an advanced manufacturing hub. Latvia sought in the interwar period to become an international exporter of food and to re-industrialize. Latvia experienced growth in GDP per capita during the interwar period, although some economic historians have argued that there was stagnation in the period of the authoritarian Karlis Ulmanis regime (1934–1940).

After reestablishing its independence, Latvia proceeded with market-oriented reforms, albeit at a measured pace. Its freely traded currency, the lat, was introduced in 1993 and held steady, or appreciated, against major world currencies. Inflation was reduced from 958.6% in 1992 to 25% by 1995 and 1.4% by 2002.

After contracting substantially between 1991 and 1995, the economy steadied in late 1994, led by a recovery in light industry and a boom in commerce and finance. This recovery was interrupted twice, first by a banking crisis and the bankruptcy of Banka Baltija, Latvia's largest bank, in 1995 and second by a severe crisis in the financial system of neighbouring Russia in 1998. After 2000, Latvian GDP grew by 6–8% a year for 4 consecutive years. Latvia's state budget was balanced in 1997 but the 1998 Russian financial crisis resulted in large deficits, which were reduced from 4% of GDP in 1999 to 1.8% in 2003. These deficits were smaller than in most of the other countries joining the European Union in 2004.

Until the middle of 2008, Latvia had the fastest developing economy in Europe. In 2003, GDP growth was 7.5% and inflation was 2.9%. The centrally planned system of the Soviet period was replaced with a structure based on free-market principles. In 2005, private sector share in GDP was 70%. Recovery in light industry and Riga's emergence as a regional financial and commercial centre offset shrinkage of the state-owned industrial sector and agriculture. The official unemployment figure was held steady in the 7%–10% range.

Economic contraction in 2008–2010

The 2008 financial crisis severely disrupted the Latvian economy, primarily as a result of the easy credit bubble that began building up during 2004. The bubble burst leading to a rapidly weakening economy, resulting in a budget, wage and unemployment crisis. Latvia had the worst economic performance in 2009, with annual growth rate averaging −18%.

The Latvian economy entered a phase of fiscal contraction during the second half of 2008 after an extended period of credit-based speculation and unrealistic inflation of real estate values. The national account deficit for 2007, for example, represented more than 22% of the GDP for the year while inflation was running at 10%. By 2009 unemployment rose to 23% and was the highest in the EU.

Paul Krugman, the Nobel Laureate in economics for 2008, wrote in his New York Times Op-Ed column for 15 December 2008:

"The acutest problems are on Europe's periphery, where many smaller economies are experiencing crises strongly reminiscent of past crises in Latin America and Asia: Latvia is the new Argentina".

By August 2009, Latvia's GDP had fallen by 20% year on year, with Standard & Poor's predicting a further 16% contraction to come. The International Monetary Fund suggested a devaluation of Latvia's currency, but the European Union objected to this, on the grounds that the majority of Latvia's debt was denominated in foreign currencies. Financial economist Michael Hudson has advocated for redenominating foreign currency liabilities in Latvian lats before devaluing.

However, by 2010 there were indications that Latvia's policy of internal devaluation was successful.

Economic recovery 2010–2012

The economic situation has since 2010 improved, and by 2012 Latvia was described as a success by IMF managing director Christine Lagarde showing strong growth forecasts. The Latvian economy grew by 5.5% in 2011 and by 5.6% in 2012 reaching the highest rate of growth in Europe. The GDP surpassed the pre-crisis level in 2018.

Economic issues 2022-23

The Russian invasion of Ukraine in February 2022 caused some economic problems in Latvia. Real GDP growth slowed to 2.8 percent in 2022 from 4.3 percent in 2021. Russia was a major trade partner and EU sanctions impacted this. Dramatic rises in the cost of energy, the need to seek alternative sources of gas and oil as well as logistics issues resulted in inflation averaging 17.2% in 2022 before falling back to single digits in 2023.