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Rating Action:

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

14 May 2021

Paris, May 14, 2021 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Latvia's A3 long-term issuer and senior unsecured ratings as well as its (P)A3 senior unsecured MTN program rating. The outlook remains stable.

The key drivers of the decision to affirm Latvia's ratings are:

1) The relative resilience of the Latvian economy to the pandemic shock as well as the economy's robust post-pandemic growth prospects;

2) The government's moderate debt burden and very strong debt affordability metrics;

3) The significant progress made by the Latvian authorities in tackling money laundering-related financial sector risks.

The stable outlook reflects Moody's expectation that the growth potential of the Latvian economy will not be materially and permanently negatively affected by the pandemic shock, and that the government debt burden will stabilize at a level broadly in line with rating peers in coming years. It also reflects Moody's expectation that the government will maintain its efforts to tackle money laundering-related financial sector risks, and that geopolitical risks will remain unchanged over the coming 12-18 months.

Latvia's local and foreign currency country ceilings remain unchanged at Aaa.

RATINGS RATIONALE

RATIONALE FOR THE AFFIRMATION OF THE A3 RATINGS

FIRST DRIVER: THE RELATIVE RESILIENCE OF THE LATVIAN ECONOMY TO THE PANDEMIC SHOCK AS WELL AS THE ECONOMY'S ROBUST POST-PANDEMIC GROWTH PROSPECTS

The outbreak of the coronavirus and the restrictions imposed to curb its spread caused the Latvian economy to contract by 3.6% of GDP in 2020. While this represents the economy's first contraction since the global financial crisis, the decline in GDP was significantly more moderate than the 6.1% recorded for the EU and 6.6% for the euro area as a whole. The relative resilience of the economy to the pandemic shock stems from a number of factors, such as the moderate contraction of Latvia's main Nordic-Baltic export partners, the low reliance on the sectors hardest hit by the pandemic such as tourism, and the economy's previously demonstrated ability to adjust and adapt to economic shocks.

Although the Latvian economy contracted in the first quarter of 2021, we expect it to return to full-year growth of 3.1% this year. While Latvia's vaccination drive is significantly lagging behind the European Union (Aaa stable) as a whole, it has recently picked up speed and we expect the roll-out to have progressed to a point where pandemic restrictions can be significantly eased in the second half of this year. The combination of base-level effects, an increase in consumption from pent-up consumer demand and a significant increase in investment fueled by the inflow of EU funds leads Moody's to forecast growth of 5.0% in 2022, before moderating to average annual growth of 3.25% in 2023-2024.

Latvia is set to receive a total of around 9% of 2018 GDP in grants under the EU's Next Generation EU post-pandemic recovery fund. Together with funding under the EU's regular 2021-2027 budget cycle, including those funds earmarked for the Rail Baltica railway project, this represents a significant boost to EU funded investment. The Latvian government's spending priorities and reforms under the recovery fund will focus on green and digital transitions, health care, reduction of inequality, economic transformation, and the rule of law.

SECOND DRIVER: THE GOVERNMENT'S STILL-MODERATE DEBT BURDEN AND VERY STRONG DEBT AFFORDABILITY METRICS

The outbreak of the coronavirus pandemic led to a significant increase in the government deficit and debt levels in 2020. However, relative to many peers, the 4.5% of GDP deficit and the 6.5 percentage point increase in the debt-to-GDP ratio in 2020 were relatively moderate. Compared to many peers, the fiscal support offered by the Latvian government to cushion the impact of the pandemic was relatively moderate, with total spending on emergency measures reaching 3.3% of GDP last year.

However, as the second wave of the pandemic hit Latvia with greater force towards the end of 2020, the government adopted a significantly more expansive fiscal stance, leading us to project a 2021 deficit of 8.0% of GDP and an increase in the debt burden to 47.5% of GDP in 2021 from a level of 43.5% in 2020. Although a significant increase from a pre-pandemic level of 37.0% in 2019, this remains lower than the single A-rated median of 51.7% in 2021.

Moreover, Latvia's debt affordability metrics remain very strong and largely unaffected by the pandemic. The ratio of government interest payments relative to revenue and GDP respectively stood at 1.7% and 0.7% at the end of 2020 - below the corresponding medians of single-A rated peers of 3.75% and 1.24%. The government's borrowing costs have remained very low since the beginning of the pandemic, supported by Latvia's ability to issue debt in a reserve currency and renewed ECB support programmes for the purchase of euro area government bonds. In March 2021, the government issued a €1.25 billion (4.1% of GDP) 10-year Eurobond with a zero coupon and yield of 0.105%.

The single largest expenditure item under the government's emergency measures in 2020 was a €250 million (0.9% of 2020 GDP) equity injection for the principally state-owned airline AirBaltic, which was severely impacted by the pandemic-induced drop in air travel. This was also accompanied by smaller direct support measures for Riga Airport and the state-owned Latvian railway company. Given that air travel will remain subdued at least for much of 2021 and that the rail freight sector is suffering from a structural decline in demand due to a permanent decrease in Russian transit shipments, we expect that the government will need to provide further material support to government-owned transport companies. That said, we do not expect the amounts involved to be significant enough to materially shift our assessment of Latvia's fiscal strength.

THIRD DRIVER: THE SIGNIFICANT PROGRESS MADE BY THE LATVIAN AUTHORITIES IN TACKLING MONEY LAUNDERING-RELATED FINANCIAL SECTOR RISKS

The Latvian financial sector was rocked in early 2018 by the sudden collapse of the country's third-biggest bank ABLV over money laundering-related issues, as well as the arrest of the then-governor of the country's central bank on charges of corruption tied to another commercial bank previously embroiled in money laundering scandals. We saw these events as highlighting significant shortcomings in the country's financial supervisory framework, and as a weakness of the overall strength of Latvia's institutions and governance.

However, over the course of the ensuing three years, the Latvian government has taken significant steps to tackle money laundering-related risks and restructure its financial system and supervisory framework. Most notably, the government in 2018 banned Latvian banks from making transactions with shell companies, and it has required banks that previously focused mainly on transactional banking for non-resident clients, which is highly exposed to money laundering risks, change to a more conventional business model. This has most notably resulted in the share of deposits held by non-residents falling from around 40% of total deposits at the end of 2017 to just over 17% in March 2021, much of which is held by EU clients.

These efforts most notably resulted in the decision in February 2020 of the intergovernmental Financial Action Task Force on Money Laundering (FATF) not to place Latvia on its so-called "grey list" of countries with strategic deficiencies in the field of money laundering supervision. This was based on an earlier assessment by the Council of Europe's anti money-laundering body MoneyVal that Latvia had made significant progress on improving its supervisory framework since MoneyVal's critical evaluation of Latvia in 2018. We expect the Latvian government to remain committed to stamping out money laundering-related problems and complete the transformation of its financial sector in coming years. More generally, we see the actions taken since 2018 as demonstrating the institutional ability to effectively and quickly correct major policy problems once they arise.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS

Latvia's ESG Credit Impact Score is neutral to low (CIS-2), reflecting low exposure to environmental risk and moderately negative exposure to social risks, as well as a very strong governance profile.

Latvia's overall E issuer profile score is neutral to low (E-2), reflecting low exposure to environmental risks across most categories.

We assess Latvia's S issuer profile score as moderately negative (S-3), reflecting low exposure to social risks across most categories, with the notable exception of demographics. The country's highly adverse demographic profile will continue to limit the labour supply and constrain the economy's potential growth rate over coming decades. That said, on current projections, increases in ageing-related fiscal costs are relatively contained.

Latvia receives a positive G issuer profile score of (G-1). Latvia's institutional environment continues to benefit from membership of the European Union and the euro area. Although money laundering-related scandals in the country's banking sector have raised questions about the quality of financial supervision, the government has made significant progress in tackling these issues over recent years.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects Moody's expectation that the Latvian economy will return to robust full-year growth in 2021 and beyond as pandemic restrictions are eased. It also reflects Moody's expectation that the government debt burden will remain moderate and broadly in line with single-A rated peers, and that fiscal risks tied to state-owned enterprises will remain manageable. Furthermore, the stable outlook reflects Moody's expectation that the government will maintain its efforts to stamp out issues around money laundering in the financial system, and that geopolitical risks tied to the country's tense relations with Russia will neither increase nor decrease over the next 12-18 months.

GDP per capita (PPP basis, US$): 32,076 (2019 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2% (2019 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.1% (2019 Actual)

Gen. Gov. Financial Balance/GDP: -0.6% (2019 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -0.6% (2019 Actual) (also known as External Balance)

External debt/GDP: [not available]

Economic resiliency: a1

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

On 11 May 2021, a rating committee was called to discuss the ratings of 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 institutions and governance strength have not materially increased. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. Other views raised included: The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

FACTORS THAT COULD LEAD TO AN UPGRADE

Upward pressure on the ratings would arise from an easing of longer term pressures on the economy's potential growth rate, stemming from population ageing and structural economic change, most likely supported by structural reforms. Faster-than-expected debt reduction in the wake of the pandemic 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.

FACTORS THAT COULD LEAD TO A DOWNGRADE

Downward rating pressure could develop in the event of a substantial weakening of the government's fiscal position relative to peers, 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 ratings.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, 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 further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1263068.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

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
Moody's France SAS
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JOURNALISTS: 44 20 7772 5456
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Alejandro Olivo
MD-Sovereign/Sub Sovereign
Sovereign
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
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JOURNALISTS: 44 20 7772 5456
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No Related Data.
© 2021 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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