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Rating Action:

Moody's affirms Latvia's A3 ratings, maintains stable outlook

31 May 2019

Frankfurt am Main, May 31, 2019 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Latvia's senior unsecured and long-term issuer ratings at A3. Concurrently, the Government of Latvia's senior unsecured medium-term note (MTN) programme ratings has been affirmed at (P)A3, and its short-term "foreign-currency" rating has been affirmed at (P)P-2. The outlook remains stable.

The affirmation of Latvia's A3 ratings balances the following key rating drivers:

(1) The strong growth performance of the Latvian economy through the economic cycle

(2) The Latvian government's low and declining levels of debt

(3) Latvia's moderate susceptibility to geopolitical risks

The stable outlook reflects Moody's expectation that the policies supporting the country's economic resilience and fiscal strength will be maintained, including on-going government efforts to reduce banking sector risks related to money laundering and the financing of terrorism. It is also based on the assumption that geopolitical risks will remain moderately prominent over the near to medium term.

Latvia's local currency and long-term foreign-currency bond and deposit ceilings are unchanged at Aaa. The short-term foreign currency bond and deposit ceilings remain unchanged at P-1.

RATINGS RATIONALE

RATIONALE FOR THE AFFIRMATION OF THE A3 RATINGS

FIRST DRIVER: THE CONTINUED STRONG GROWTH PERFORMANCE OF THE LATVIAN ECONOMY THROUGH THE ECONOMIC CYCLE

Latvia registered GDP growth of at 4.6% and 4.8% in 2017 and 2018, respectively, with the average GDP growth rate between 2014-2018 of 3.3% broadly in line with the A-rated median. While financial services exports have declined in recent years, owing to on-going regulatory efforts to reduce financial sector risks associated with money laundering and the financing of terrorism, Latvia's highly open economy has notably seen strong growth in sectors such as ICT and business services exports, alongside continued growth of traditional key goods exports sectors such as wood and wood products.

While the small and highly open nature of the Latvian economy leaves it potentially exposed to shifts and shocks in the external environment, Latvia has repeatedly proven itself to be able adjust and adapt to changing economic circumstances. For instance, previous changes in the economic relationship with Russia, such as the imposition of EU-Russia trade sanctions, have not left a marked and lasting negative impact on the economy. We expect GDP growth to slow from the cyclical peak of 2018 in coming years, but remain robust at 3.2% and 2.8% in 2019 and 2020 respectively. We expect private consumption to replace investment as the main driver of growth in coming years, as investment growth slows in part due to a stabilization of EU fund inflows.

Our expectations for growth in 2019 and 2020 are somewhat below estimates of the Latvian economy's current potential growth rate, with the current positive output gap expected to gradually close in coming years. However, Latvia faces medium to long term challenges to its growth potential, related to maintaining recent rapid productivity growth and a decline in the working age population owing to population ageing and emigration. Although net emigration figures have improved in recent years, they remain in negative territory, with Latvia's demographic challenges likely to become increasingly prominent over the coming decade.

Demographic pressures are also a contributing factor behind a continued, rapid increase in unit labour costs in recent years, which negatively affects Latvia's price competitiveness. That said, Latvia's export market share has moderately increased over the same period, and the Latvian economy has historically proven itself able to make substantial real adjustments to wage and price levels to regain competitiveness if needed, for instance in the wake of the global financial crisis which severely affected the Latvian economy.

SECOND DRIVER: THE LATVIAN GOVERNMENT'S LOW AND DECLINING LEVELS OF DEBT

Latvia's general government debt-to-GDP ratio has continued to improve in recent years, following a sharp increase in the wake of the financial crisis which saw debt increase from 8.0% of GDP in 2007 to 47.3% of GDP in 2010. The public finances have since been brought under control, amongst other things due to the introduction of a fiscal framework supported by a structural balance rule in 2013. Strong growth and sustained primary surpluses have placed the debt-to-GDP ratio on a gentle downward trajectory in recent years, with debt reaching 35.9% of GDP in 2018, slightly below the median for sovereigns in the A1-A3 rating category. While government debt figures can exhibit a degree of volatility due to a strategy of pre-financing up-coming debt redemptions, the underlying trend is of a continued and gradual decline of the government's debt load. We thus forecast debt-to-GDP to reach 32.5% by 2023.

Furthermore, debt affordability is correspondingly strong, and has improved significantly in recent years owing to Latvia's ability to refinance maturing debt at lower interest rates, with interest payments to revenue standing at 1.9% in 2018, compared with the single A rated median of 3.9% in 2018.

The Latvian government has seen widening headline deficits in recent years, after it recorded a 0.1% of GDP fiscal surplus in 2016. The headline deficit reached 0.6% and 1.0% of GDP in 2017 and 2018 respectively, in part as a result of a comprehensive reform of income and corporate taxation and rapid expenditure growth. Against the backdrop of strong economic growth in 2017 and 2018, the government's fiscal stance has come under criticism from the European Commission amongst others for being pro-cyclical.

Following parliamentary elections in October 2018, a new five-party coalition government took office in January 2019. The 2019 budget adopted by parliament in April this year is based on a no policy change scenario. The government's full fiscal plans for 2020 and beyond are not expected to become known until the presentation of next year's budget in the autumn, meaning that there is currently a degree of uncertainty about the medium term fiscal trajectory. While the government is likely to face pressure notably on increasing public sector wages, the government has committed to keep its fiscal plans in line with the country's fiscal framework and the recommendations by the fiscal council, leading us to expect that deficits will be maintained at moderate levels of 0.6 to 0.7% of GDP in coming years.

THIRD DRIVER: LATVIA'S MODERATE SUSCEPTIBILITY TO GEOPOLITICAL RISKS

We expect that a moderate level of geopolitical risk, stemming from geopolitical tensions with Russia, will remain a negative feature of Latvia's rating profile - as it is for the Government of Estonia (A1, stable) and the Government of Lithuania (A3, stable). While tensions in relations with Russia increased with the outbreak of armed conflict in Ukraine in 2014 and have remained at a more elevated level since then, geopolitical tensions have also exhibited a degree of stability over recent years.

We believe that the risk of military intervention by Russia in the Baltics is a highly unlikely event, given that Latvia and its Baltic neighbours are NATO members with multinational battalions also being stationed in all three countries since 2017. However, it is also an event with a potentially very high impact. Moreover, geopolitical risks could materialise in forms other than outright military conflict such as cyber warfare attacks or attempts by Russia to foment unrest among Latvia's substantial ethnic Russian population.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook on the rating reflects the resilience and flexibility of the Latvian economy as well as Latvia's solid track record of effective and prudent economic and fiscal policy making, which leads us to expect that the government appointed earlier this year will maintain a prudent fiscal policy stance and remain committed to limiting money laundering-related risks in the country's financial system. Furthermore, we see no reason to assume that geopolitical risks will materially decrease (or increase) over the near to medium term.

WHAT COULD MOVE THE RATING UP

Upward pressure on the rating would arise from an easing of negative medium to long term pressures on the economy's potential growth rate, most likely through competitiveness-enhancing structural economic reforms. A faster-than-expected debt reduction along with a broadening of the country's tax base would also be credit positive, as would an easing of geopolitical risk in the region.

WHAT COULD MOVE THE RATING DOWN

Conversely, downward rating pressure could develop in the event of a substantial weakening of the government's fiscal position, a structural deterioration in the country's economic performance or a weakening of efforts to curb money laundering-related risks associated with the country's financial system. An escalation of tensions with Russia that would be detrimental to the country's growth and fiscal performance would also lead to downward pressures on the rating.

GDP per capita (PPP basis, US$): 27,685 (2017 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 4.6% (2017 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.2% (2017 Actual)

Gen. Gov. Financial Balance/GDP: -0.6% (2017 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.7% (2017 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 28 May 2019, a rating committee was called to discuss the rating of the Latvia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Petter Bryman
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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