- IMF Tells Latvia to Tighten Fiscal Policy as War-Driven Energy Costs Push Inflation Higher
Latvia faces a difficult combination of slower economic growth, rising inflation and mounting public spending pressures, prompting the International Monetary Fund to call for a credible medium-term fiscal consolidation strategy that protects the country’s ability to absorb future shocks.
The IMF expects real GDP growth to slow to 1.80% in 2026 from 2.10% in 2025, while period-average inflation is projected to rise to 4.00% as disruptions to oil, gas and petrochemical supplies feed into domestic prices.
The Fund said Latvia’s challenge is being intensified by higher defence expenditure, an ageing population, healthcare demands, energy-security investment and the green transition.
The assessment, released after the IMF Executive Board concluded Latvia’s 2026 Article IV consultation, paints an economy that has recovered from stagnation but remains structurally constrained.
Real GDP was flat in 2024 before rebounding by 2.10% in 2025, supported by private investment and public consumption, while 2026 growth is expected to weaken despite strong public investment, recovering consumption and credit expansion.
“Latvia faces structural challenges, with weak productivity and slow income convergence with the rest of the euro area,” the IMF said, pointing particularly to weak total factor productivity and limited capital deepening.
Energy has become one of the most immediate macroeconomic risks. The IMF said headline inflation has remained elevated in recent months because of higher energy prices linked to the war in the Middle East, while persistent supply disruptions in oil, gas, fertilisers and petrochemicals could keep price pressures higher for longer.
The Fund warned that a prolonged conflict and heightened geopolitical and trade tensions represent downside risks to growth, while further increases in energy and food prices could intensify inflation and wage pressures.
The Fund’s recommendation is that fiscal policy should move towards neutrality rather than attempt to offset every energy shock through broad government support.
It said any new energy assistance should be “limited, temporary, and targeted at vulnerable households”, while viable firms facing exceptionally high energy costs could receive temporary help under strict eligibility rules.
The IMF also advised against windfall taxes on energy companies, arguing that such measures could weaken incentives for investment in alternative energy and undermine longer-term energy security.
The larger fiscal challenge extends beyond the current energy shock. Latvia is facing increasing expenditure on defence, pensions and healthcare alongside investment requirements for energy security and climate transition, while the temporary diversion of pension contributions from the second to the first pillar is also adding to future costs.
The IMF wants Latvia to anchor public debt around 50.00% of GDP over the medium term, citing the economy’s exposure to geopolitical risk, volatile growth, higher sovereign borrowing costs and potential liabilities from state-owned enterprises.
Government debt is currently below that proposed ceiling but moving gradually higher. IMF projections put gross public debt at 47.10% of GDP in 2026, compared with 46.90% in 2025, before rising to 48.80% in 2027, while the ESA fiscal deficit is expected to widen from 3.00% of GDP this year to 4.20% next year.
The Fund said fiscal constraints could become more demanding once the European Union’s national escape clause expires in 2028, increasing the importance of beginning adjustment before those pressures intensify.
Spending cuts alone, however, are unlikely to close the gap. The IMF called for greater efficiency in areas such as school and hospital networks but acknowledged that Latvia’s comparatively weak health outcomes mean healthcare spending may actually need to increase rather than fall.
It therefore argued that “revenue mobilization should form an integral part of the fiscal consolidation strategy”, recommending higher property-tax revenue, fewer income-tax exemptions and stronger value-added tax compliance.
Pension reform is another element of the proposed adjustment. The IMF wants Latvia to restore one percentage point of social contributions from the first pension pillar to the second by 2029 and strengthen its defined-contribution arrangements, potentially through higher contribution rates.
The recommendations reflect the longer-term fiscal pressures created by population ageing and the need to preserve retirement income without allowing pension obligations to place progressively larger demands on the state budget.
Financial conditions, by contrast, remain relatively resilient. The IMF said Latvian banks have ample capital and liquidity and noted that implementation of the CRR3 regulatory framework improved capital adequacy at most institutions, although it again urged authorities to phase out the solidarity contribution on banks as planned in 2027.
The Fund warned that retaining the levy could distort lending decisions, while growing nonbank credit particularly lending to lower-quality borrowers requires closer supervision and stronger macroprudential oversight.
Private-sector credit growth has accelerated markedly, providing some support to domestic demand. IMF data show credit to the private sector rising 13.50% in 2025, compared with 3.00% in 2024, reinforcing the Fund’s assessment that credit growth will help support consumption and investment in 2026 even as external shocks weigh on activity.
The authorities plan to transfer licensing and supervision of nonbank consumer lenders to the Bank of Latvia in 2027, a move the IMF supports as part of efforts to contain financial-stability risks.
The more persistent weakness lies in productivity. Latvia’s income convergence with richer euro-area economies has slowed because productivity growth has weakened, investment has been insufficient and skill mismatches continue to constrain labour-market efficiency.
The IMF said reforms should encourage labour mobility, raise participation among older workers, link retirement ages to future increases in life expectancy and improve housing affordability to make it easier for workers to move towards areas with stronger employment opportunities.
Technology and capital-market development are also central to the Fund’s proposed growth strategy. Latvia possesses comparatively capable digital infrastructure, but the IMF said limited digital skills and weak adoption of artificial intelligence at company level are constraining potential productivity gains, particularly among smaller businesses.
It called for expanded STEM participation, stronger training and reskilling, deeper capital markets, fintech development and reduced administrative burdens to improve access to finance and create more profitable investment opportunities.
Latvia therefore enters the next phase of its economic recovery with limited room for complacency.
Growth has returned and the banking system remains well capitalised, but inflation, geopolitical exposure and rising public obligations are narrowing fiscal flexibility while productivity remains insufficient to close the income gap with the rest of the euro area.
The IMF’s message is that Latvia needs to use the current period of resilience to strengthen its fiscal position, deepen investment and raise productivity before defence, ageing and energy-security costs make the adjustment significantly more difficult.
