Fitch Affirms Latvia at 'A-'; Outlook Stable
KEY RATING DRIVERS
The affirmation and Stable Outlook reflect the following factors:
Latvia's ratings are supported by its favourable fiscal position, as well as its credible institutional and policy framework which comes with eurozone membership. The macroeconomic imbalances that arose in the late 2000s are diminishing. However, the ratings are constrained by the country's low income per capita and high net external debt compared with peers.
Fitch estimates real GDP growth of 2.3% for 2015. This compares with the 'A' median growth rate of 2.9%. Economic growth has been weighed down by low export growth as a result of recession in Russia, Latvia's third-largest trading partner. However, resilience in the domestic sector has persisted, held up by strong household consumption. For 2016-2017, real GDP is forecast by Fitch to grow broadly at potential of 3%, bringing Latvia in line with the 'A' median. Economic activity will be mainly domestically driven, with net exports contributing negatively towards headline GDP.
Latvia's fiscal position remains a key support to the rating. Our latest projections point to a general government deficit of 1.5% of GDP and a government debt ratio of 36.7% of GDP for 2015; both ratios below the 'A' median fiscal deficit of 2.6% and debt ratio 44.4%. For 2016 and 2017, we forecast fiscal deficits 1.2% and 1.0% of GDP respectively. Prefinancing plans for a USD1bn Eurobond which matures in 2017 will lead to a slight increase in the debt ratio to around 39% in 2016, before falling back to 36% in 2017.
Latvia's ratings are also supported by a stable and improving banking sector. The sector is well capitalised (Tier 1 capital adequacy ratio at 18.4% 2Q15), and on-going private sector deleveraging has helped improve banks' balance sheets, with non-performing loans down to 6.8% (2Q15) from a peak of 19% in 2010. Fitch views positively the high level of foreign ownership in the banking sector, which reduces the risk of financial sector liabilities migrating onto the sovereign balance sheet. A risk factor to Latvia's banks is the large presence of non-resident deposits (NRDs), which stood at 52% (3Q15) of total deposits, with 17% (Sept 2015) directly from CIS economies. NRDs have stayed relatively stable in 2015, rising by 4% over the first nine months of 2015.
The low level of income per capita constrains Latvia's ratings. Structural rigidities in the economy (including high unemployment, low domestic savings) hamper the economy's growth potential and therefore the convergence in income levels with higher rated peers. There is a moderate risk that should wage growth continue above productivity growth, as it has since 2013, challenges to medium-term economic competiveness could eventually arise.
Latvia's net external debtor position stands out as a weakness against the median net creditor position (21.6% of GDP estimated) of its 'A' range peers. For 2015, Fitch is forecasting a net external debtor position of 24% of GDP, down from 28% in 2014. On-going private sector deleveraging, future reduction in sovereign debt and modest equity FDI inflows should help gradually bring down Latvia's external liabilities as a share of GDP.
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main factors that could, individually or collectively, trigger positive rating action include:
- A longer track record of strong and stable economic growth that fosters higher income per capita, without the re-emergence of macroeconomic imbalances.
- A sustainable improvement in external finances in conjunction with a reduction in external debt ratios.
The main risk factors that, individually or collectively, could trigger negative rating action are:
- Deterioration in Latvia's public debt dynamics, for example, from sustained fiscal slippage and/or economic underperformance.
- Deterioration in external finances, for example, associated with overheating of the domestic economy.
Fitch assumes Latvia's main economic partners in the eurozone will benefit from a gradual economic recovery. The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that the eurozone will avoid prolonged deflation. Nevertheless, deflation risks could re-intensify in case of adverse shocks.