- IMF Urges Latvia to Tighten Fiscal Path as Defence and Ageing Costs Rise
The International Monetary Fund has urged Latvia to adopt a credible medium-term fiscal consolidation strategy, warning that rising defence, ageing and energy-security costs are colliding with weak productivity growth and slowing income convergence with the rest of the euro area.
In its concluding statement at the end of the 2026 Article IV mission, IMF staff said Latvia’s economy has remained resilient despite a more difficult macroeconomic environment, but now faces a challenging policy trade-off between supporting growth, preserving fiscal space and managing mounting spending pressures.
The Fund projects Latvia’s real GDP growth to ease to 1.80% in 2026, as the negative impact of the war in the Middle East is only partly offset by strong public investment, recovering consumption, credit growth and stronger-than-expected momentum at the end of 2025. Headline inflation is expected to rise to 4.00% in 2026, driven by persistent supply disruptions in oil, gas, fertilisers and petrochemicals.
The IMF also expects Latvia’s headline fiscal deficit to widen to about 3.00% of GDP in 2026, reflecting higher spending on defence, education and social programmes. It said risks to growth are tilted to the downside, while inflation risks are skewed upward, particularly if the war in the Middle East persists or broader geopolitical and trade tensions intensify.
For Latvia, the Fund’s warning is not only about the 2026 shock. It is about the longer-term fiscal burden facing a small, open economy exposed to external volatility, higher sovereign borrowing costs, ageing-related spending, energy transition demands and possible contingent liabilities from state-owned enterprises.
The IMF said a neutral fiscal stance in 2026 would have been preferable given resilient demand and elevated inflation. It advised the authorities to allow automatic stabilisers to work if global energy markets face further disruption, but keep the headline fiscal deficit on a declining path from 2027 to 2031. Any discretionary support, especially for energy, should be temporary, targeted and limited to vulnerable households, with support for viable firms facing high energy costs subject to strict eligibility criteria.
The Fund cautioned against windfall taxes on energy companies, arguing that such measures could discourage investment in alternative energy sources at a time when Latvia needs to strengthen energy security and reduce exposure to price volatility.
The IMF recommended that Latvia anchor public debt at 50.00% of GDP over the medium term. It said achieving that anchor would require gradual fiscal consolidation supported by public-sector reforms, spending efficiency and revenue mobilisation.
Revenue mobilisation, the Fund argued, should form an integral part of Latvia’s consolidation strategy. Recommended measures include raising property tax revenue, reducing income tax exemptions, improving VAT compliance, broadening corporate and personal income tax bases and strengthening overall tax compliance. Combined with spending-efficiency reforms, these measures could generate about 0.50% of GDP per year between 2027 and 2031.
On spending, the IMF pointed to school and hospital network reforms as examples of areas where efficiency gains could be made. But it warned that such gains are unlikely to be sufficient on their own, particularly in healthcare, where Latvia’s relatively weak health outcomes suggest that efficiency reforms should be complemented by additional resources over time.
The pension system also features prominently in the Fund’s recommendations. IMF staff said Latvia should restore the 1.00% of GDP contribution from the first pension pillar to the second pension pillar by 2029 and strengthen defined contribution pillars by reducing costs, increasing long-term returns and raising contribution rates.
The financial sector was assessed as resilient, with banks described as well capitalised and highly liquid. However, the IMF said the rapid expansion of nonbank lending warrants close monitoring, particularly because nonbank lenders have become increasingly important providers of unsecured consumer loans to lower-credit-quality borrowers.
The Fund supported the planned transfer of licensing and supervisory responsibilities for nonbank consumer lenders to the Bank of Latvia, saying this would strengthen oversight and safeguard financial stability. It also reiterated that the solidarity contribution on banks should be phased out as planned in 2027 because it could distort lending towards less productive uses.
Beyond fiscal and financial-sector issues, the IMF said Latvia must accelerate structural reforms to close its income gap with the euro area. It identified low total factor productivity growth and limited capital accumulation as the core drivers of the convergence challenge.
The Fund said reforms should focus on strengthening the business environment, deepening financial markets, improving labour mobility and skills, lowering energy costs and supporting innovation and artificial intelligence adoption. It noted that Latvia has capable digital infrastructure but limited digital skills and low firm-level AI adoption, which constrain potential productivity gains.
The IMF also encouraged Latvia to improve housing affordability and quality, especially through renovations and energy-efficiency upgrades, to reduce regional disparities and support labour mobility. It backed the government’s state-supported mortgage programme for regional areas, provided it remains limited and temporary.
The Fund further urged Latvia to deepen financial intermediation and capital markets by building on recent IPO successes, pursuing additional state-owned enterprise listings and using EU capital market integration to expand firms’ access to finance.
Energy security remains a central policy priority. The IMF said deeper integration with European power grids and continued investment in renewable energy would strengthen resilience against supply disruptions, reduce energy prices and volatility, and support business confidence and investment.
The broader message from the IMF is that Latvia’s economy has proved resilient, but resilience alone will not be enough. The country must now create fiscal room, lift productivity and strengthen financial oversight while managing higher defence, ageing and energy costs.
For a small open economy exposed to external shocks, the policy margin is narrowing. Latvia’s challenge will be to consolidate gradually without weakening growth, mobilise revenue without damaging competitiveness, and accelerate reforms fast enough to sustain income convergence with the euro area.
