Summary:KEY ISSUES Context. Latvia has made remarkable economic progress since the crisis: the output gap is now largely closed, the current account deficit has been reduced to sustainable levels, and unemployment continues to fall. However, the economy has recently slowed considerably in the face of a deteriorating external environment, weak investment, and persistently shrinking bank credit. Challenges. Subdued economic growth is expected to continue in 2015 due to continued weakness in trade partners, particularly Russia. An escalation of geo-political tensions or protracted low growth in the Euro Area poses further downside risks. Rapid productivity growth will be needed over the medium term if per capita income is to converge to core Euro Area levels. Staff views. ? The continued contraction of bank credit is likely to constrain investment going forward. Recent efforts to catalyze SME lending and improve the implementation of insolvency procedures are welcome. ? Over the medium term efforts are needed to increase the revenue envelope to ensure that necessary capital and social expenditures can be accommodated. ? Although geopolitical tensions do not appear to have significantly affected the inflow of non-resident deposits (NRDs) to date, continued vigilant supervision and regulation of the NRD banking sector is needed. ? Structural reforms are needed in several areas—such as education, infrastructure, labor markets and the judicial system—to maintain competitiveness over time in the Euro Area currency union. Authorities’ views. The authorities were in broad agreement with staff recommendations, notwithstanding some differences on tax and benefit policies. They agreed to explore ways to build fiscal space over the medium-term to accommodate essential expenditures. They also concurred with the need for higher prudential standards and intensive monitoring of risks associated with NRD banking sector.
