Latvia Navigates Economic Risks with Focus on Fiscal Discipline

Latvia’s economy demonstrated moderate growth in 2025, with the fiscal situation proving better than initially anticipated. But, the Fiscal Discipline Council (FDP) cautions that significant medium-term risks remain, stemming from increasing budget expenditures, challenges in tax revenues, inflationary pressures, and global economic uncertainty. Maintaining fiscal stability will require strengthening tax collection, curbing the shadow economy, enhancing competition, and improving the efficiency of public fund utilization.

Current Fiscal Standing and Future Projections

Jānis Priede, Chairman of the FDP, emphasizes that whereas Latvia’s fiscal situation is currently stable, proactive measures are crucial given heightened geopolitical uncertainty. The general government budget deficit for 2025 is estimated at 2.4% of gross domestic product (GDP), or approximately one billion euros – lower than the 2.9% stipulated in the budget law. Fiscal Structural Plan of Latvia 2025 Progress Report

The approved state budget for 2026 projects a deficit of 3.3% of GDP, with economic growth at 2.1% and inflation at 2.3%. However, recent estimates suggest a potential GDP growth of 2.6% in 2026, with inflation around 2.9%, potentially improving the year’s fiscal results.

Concerns Regarding Pension Savings and Energy Prices

The FDP advises against the premature withdrawal of second-pillar pension savings, a topic of political discussion. Such a move, they argue, would offer only short-term consumption boosts while increasing imports and potentially destabilizing the pension system under demographic pressures. Strengthening contributions at all pension levels, with withdrawals reserved for critical situations, is considered a more rational approach.

Escalating conflicts, such as in the Middle East, pose risks to energy prices and European inflation. European natural gas prices rose to around 55 EUR/MWh in the first week of March 2026, a 34% increase year-over-year. While Latvia’s gas storage is currently sufficient for the heating season, prolonged tension could lead to higher procurement costs as the pumping season approaches, impacting energy prices, inflation, and the cost of living. This could also reignite discussions about state support for households, challenging limited fiscal space.

Competition, Tax Revenues, and Public Debt

Insufficient competition in certain sectors contributes to inflation, with approximately 30% of the inflation increase attributable to “greedflation” – a result of low market competition. Strict enforcement against cartels is essential for improving competition.

Tax revenues in Latvia remain lower than the EU average. In 2025, revenues were 1.3% below plan, due to weaker private consumption and moderate economic growth. The shadow economy continues to limit the country’s fiscal capacity, necessitating improved curbing measures and regular evaluation of their effectiveness.

General government debt is expected to increase in the medium term, although Latvia’s debt level remains below EU fiscal criteria. Forecasts indicate a gradual rise to 51% of GDP in 2026 and 55% of GDP in 2027 and 2028. Public debt still relatively low in Latvia Interest payments are projected to reach €736 million in 2028.

Improving Public Expenditure Efficiency

The FDP advocates for a shift from mechanical budget cuts to an approach based on expenditure effectiveness and results. Evaluating the impact of public procurement system reforms and strengthening budget expenditure audits are crucial. Transitioning to results-based budget planning will promote long-term efficiency.

Global Fiscal Trends and Latvia’s Position

The FDP notes a broader trend of decreasing fiscal responsibility in developed countries since the Covid-19 crisis, with increased reliance on state support. This contributes to chronic deficits and rising national debts, potentially threatening global financial stability. Latvia must avoid adopting this “fiscal toxicity,” particularly during an election year.

Key Takeaways

• Latvia’s fiscal situation is currently stable but faces medium-term risks.
• Strengthening tax revenues, curbing the shadow economy, and improving competition are vital.
• Prudent fiscal policy is essential to avoid broader global trends of increasing debt.
• Monitoring energy prices and geopolitical events is crucial for managing inflation.