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
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
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
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%
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%
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.
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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.
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