Published: 05.01.2023.
News Assessment

After two severe years of the Covid-19 pandemic, the year 2022 for Latvia began with hopes for the restoration of the usual course of life, which unfortunately was not destined to be fulfilled. Although Latvia had overcome the crisis caused by the pandemic much more successfully than initially predicted, after 24 February the situation in Latvia was completely determined by the war started by Russia in Ukraine, termination of trade relations with the aggressor countries, reception of refugees fleeing from the war in Ukraine and the rapid rise in the prices of energy resources, already merging with the energy crisis.

The year 2023 in Latvia will start with the technical or provisional budget. If the Annual State Budget Law has not come into effect at the beginning of the economic year, a provision or technical budget is approved, which provides for the implementation of the current policy without changing it. A provisional budget does not foresee any policy changes, new initiatives and new solutions, while proposals for policy changes and new measures will be put forward by the new government.

During the first half of the year, the economy continued to recover quite successfully from the time constraints imposed due to the pandemic, with service industries continuing to show high growth rates, but already from the second quarter, the effects of the war and the rise in energy resource prices were also felt. In the first quarter of the year the gross domestic product (GDP) had increased by 5.6% compared to the corresponding quarter of the previous year, while in the second quarter economic growth dropped to 2.9%, and in the third quarter, compared to the corresponding quarter of the previous year, a decline of 0.6% was already recorded. The decisive role in the decline of GDP was the reduction of the construction and wholesale sectors, where the construction sector was the first of the large sectors to be affected by the price increase, increasing construction costs and delaying the execution of works, while the wholesale sector was most directly affected by the termination of business with Russia.

The impact of the war was most directly manifested in the energy resources market, where the rapid rise in prices and the limited availability of resources raised the prices of both gas and electricity several times. In the second half of the year, when food prices also began to rise rapidly, inflation in Latvia reached unprecedented heights since the mid-1990s, reaching 22.2% in September and stabilising slightly below the 22% level in the following two months. The situation was similar throughout Europe, and Latvia, like other European countries, provided support to citizens and companies to mitigate the rapid rise in energy prices, allocating EUR 836 million for this purpose during the year, thereby significantly reducing payments for electricity and heating.

In order to curb the rapidly growing inflation, the central banks of the world countries started a cycle of interest rate hikes in 2022, and the US Federal Reserve was the first to do this on 16 March, followed by the European Central Bank on 21 July, making the first interest rate hike in the last 11 years. In the last months of the year, as the prices of energy resources fell on the world markets and the demand in the economy decreased, inflation began to stabilise both in the United States and in the eurozone, where in November it experienced the first drop since June 2021.

At the same time, the rising interest rates have started to increase the cost of borrowing and further slow down the growth of the global economy, the forecasts of which have been constantly reduced since the beginning of the war. The International Monetary Fund has cut its global economic growth forecast for 2022 to 3.2%, down from 4.4% in January, with a further slowdown to 2.7% in 2023. The US economic growth forecast for this year has been reduced from 4.0% to 1.6%, and for the next year – from 2.6% to 1.0%. The European Commission has made a similar reduction in forecasts for 27 European Union (EU) countries, lowering the growth forecast for 2022 from 4.0% in February to 3.3% in October and for 2023 – from 2.8% to 0.3%, respectively.

The Covid-19 pandemic already created unprecedented challenges for the economy of Latvia and the world, but now the war in Ukraine and the subsequent global energy crisis can have even more far-reaching consequences and create more comprehensive structural changes, taking into account Latvia’s direct borders, historical ties and the greater dependence on Russian energy resources. The decisive role here will be how successfully Latvia manages to reorganise the economy and especially the energy sector, completely abandoning Russian energy products and switching to new, including greener types of energy resources.

Similar to other countries of the world, Latvia’s short-term economic growth forecasts have also been reduced, taking into account the effects of the war and the rapid rise in energy prices. At the beginning of December, the Ministry of Finance updated the forecasts of macroeconomic indicators, predicting that Latvia’s economy will grow by 1.6% in 2022, while a 0.6% decline is expected in 2023. The high prices of energy resources, the increase in production costs and the weakening of demand in foreign markets have affected the Latvian economy in the second half of 2022, and the negative impact will remain in the beginning of 2023, but it is expected that economic growth will start to recover from the middle of the year, in 2024 and 2025 again showing positive dynamics and GDP growth reaching 3.0%.

The Law on Budget and Financial Management stipulates that in the Saeima election year, the draft of the state budget law (package of budget bills) must be submitted to the Saeima no later than four months after the newly elected Saeima has expressed its confidence in the Cabinet of Ministers. The year 2023 in Latvia will start with the technical or provisional budget.

If, at the beginning of the economic year, the Annual State Budget Law has not come into effect, the Minister for Finance shall approve the State budget expenditure, loan and borrowing limits necessary for the operation of the State, taking into account several conditions. The basis for the expenditure of each ministry shall be the amount of expenditure approved for the relevant year in the Medium-Term Budget Framework Law for the relevant ministry. It shall be adjusted to ensure the fulfilment of international liabilities, government debt interest payments, implementation of the projects co-financed by foreign financial assistance (including the EU funds), provision of the paid services of the budget institutions, as well as the performance of such payments, where the amount of expenditure depends upon the changes in the number of service recipients (for example: pensions, benefits).

It should be noted that the financing of the measures commenced in the previous economic year shall continue; however, the services not provided for in the previous economic year (payment orders) shall not be paid for, and investments not implemented in the previous economic year shall not be made. It is necessary to ensure the enforcement of existing laws and regulations in the field of pensions, benefits and compensation, as well as to ensure the making of such mandatory payments as expenses for the fulfilment of state debt obligations in accordance with the provisions of existing agreements and state contributions to the EU budget. At the same time, the fulfilment of the budgetary policies and conditions prescribed by the State Budget Law for the previous economic year shall continue at a constant level, except for the fixed-term measures expected to be completed in 2022.

To ensure stable financing necessary for the performance of functions of local governments, the allocation of the funding for earmarked grants and grants, loan and borrowing limits shall be approved. Thereby the use thereof shall be ensured for the implementation of the projects co-financed by the EU and other foreign financial assistance.

In recent years, Latvia’s economy had to recover from the Covid-19 crisis, provide extensive state support to businesses affected by restrictions, to residents who lost their income directly, and to less well-off groups in society. Once the economy began to adapt to the situation of the epidemiological crisis, the next wave came – the armed conflict in Ukraine caused by the Russian Federation. In order to deal with crisis situations, legal regulations were adopted as a matter of urgency, and the state implemented new policies that provided for support for businesses affected by restrictions, less well-off groups in society, Ukrainian civilians, as well as other support measures in order to recover and promote the growth of Latvia’s national economy. These time-bound crisis management measures must be incorporated and continued within the framework of the provisional budget as financing of the measures started in the previous financial year in accordance with the current regulatory enactments.

On 20 December 2022, the government approved an updated draft order on the schedule for the preparation of the Draft State Budget Law for 2023 and the budget framework for 2023, 2024 and 2025. According to it, the budget is expected to be submitted to the Saeima on 9 February 2023.

In general, the tax burden (the ratio of tax revenues to GDP) in Latvia is one of the lowest in the EU. According to Eurostat data, in 2021 the share of tax revenues in GDP in Latvia was 30.8% (in 2020 – 31.2%), while on average in the EU it was 41.7%. Only Bulgaria (30.7%), Romania (27.3%) and Ireland (21.9%) had an even lower tax burden in 2021.

For several years, one of the government’s priorities was reducing labour taxes for lower income earners.

The tax burden of labour is characterised by an indicator such as the tax wedge. It reflects the difference between the worker’s net income and what this labour costs the employer. It is calculated as the percentage ratio of employment taxes (personal income tax (PIT) and the employee’s and employer’s mandatory state social insurance contributions (MSSIC)) to the salary before the payment of all taxes and the amount of the employer’s MSSIC. According to Eurostat data, as a result of the changes made, the labour tax burden on working persons without dependents, who receive 67% of the average wage in Latvia, decreased from 41.3% in 2017 to 37.9% in 2021. Since 2020, Latvia’s indicator has been lower than the EU average (in 2021 in EU-27 it was 39.2%), but still remains higher than in the other Baltic countries: 34.4% in Lithuania and 33.9% in Estonia.

It should be noted that in the second year of the Covid-19 pandemic, the opposite trend was observed in most of the countries of the Organisation for Economic Cooperation and Development (OECD) – the burden of labour taxes on working persons without dependents in 2021 increased on average in 2/3 of the OECD countries. Latvia was just one of the few OECD countries that also reduced the labour tax burden in 2021 (a reduction of 1.93 percentage points in 2021, compared to 2019).

Also in 2022, the reduction of the labour tax burden continued, improving regional competitiveness. In order to provide greater support to low and medium wage earners, from 1 January to 30 June 2022, the maximum differentiated non-taxable minimum (including the non-taxable minimum for a pensioner) was EUR 350 per month, while from 1 July – EUR 500 per month.

According to the International Tax Competitiveness Index 2020, Latvia has the second most competitive taxation system among OECD member states (the index was created by the US think tank “Tax Foundation”).

In 2022, Latvia’s Economic Freedom Index was 74.8, thus Latvia’s economy is in 18th place in the 2022 index. Latvia ranks 13th among 45 countries in the European region, and its overall score is above the regional and world averages.

It is predicted that in 2022, compared to last year, tax revenues in the general budget will increase by EUR 1 894.2 million or 19.6%. In 2023, the tax revenue of the general budget is forecast at EUR 12 244.2 million, or with a 5.7% increase compared to 2022.

In 2023, together with social and cooperation partners, work will be ongoing on medium-term tax policy guidelines aimed at strengthening the country’s competitiveness by implementing a stable, simple, understandable for tax-payers and flexible tax policy, which ensures the achievement of the country’s fiscal needs and strategic development goals.

In order to implement the measures related to the reform of the EU Recovery Fund Plan, i.e., strengthening analytics and developing data management in the field of tax administration and customs , significant changes in the legal framework of tax administration have been introduced in 2022 by envisaging, as from 2024, a publicly available overall assessment of the rating of taxpayers by the State Revenue Service (SRS), as well as by consolidating several types of tax administration inspections into one type of inspection with the aim of ensuring the more targeted and efficient use thereof.

At the same time, in 2022, changes in the legal framework of agreement have also been developed to ensure the opportunity for the taxpayer to agree on the settlement of administrative and legal relations with the SRS within the framework of the tax administration inspection, as well as changes have been made in the legal framework of the extension of the tax payment deadline in order to ensure the fast and high-quality provision of tax services to the payer by granting an extension of the payment term by a decision prepared in the SRS information systems, based only on automatic data processing.

In order to increase the level of well-being in the country through the performance of public benefit organisations, which would simultaneously allow the achievement of the NAP2027 vision of Latvia as a country where society is involved, every person feels good and people care and support each other, a concept for improving the public benefit system has been developed. The changes will reduce the administrative burden on the parties involved, will provide for the appropriate balance of privileges and supervision for public benefit organisations, and will set clear conditions for the opportunities of public benefit organisations to perform economic activity.

In the ten months of 2022, initiatives led by state-owned capital companies have been carefully evaluated and support has been expressed for making gifts (donations) to non-governmental organisations in the amount of EUR 520 thousand in areas important to society, such as education and science, sports and the improvement of the social welfare of society and the promotion of social assistance.

In 2022, the Gambling and Lottery Policy Guidelines 2022-2027 have been approved with the aim of promoting the protection of public interests, reducing the risks associated with gambling and lotteries, ensuring a controlled, transparent, legal, socially responsible and addiction risk-free environment for the organisation of gambling and lotteries. The Guidelines provide for 47 measures to achieve the relevant goal.

Limiting the shadow economy is an important task in order to ensure the level of public welfare and promote the development of the national economy. Based on the proposals provided by experts of the sectoral ministries and national economy sectoral associations, the Shadow Economy Restriction Plan 2021-2022 has been developed and approved by an order of the Cabinet of Ministers. The plan provides for five directions of action and defines reducing the circulation of obtaining illegal funds and limiting the payment of “envelope wages” as priority measures. It is expected that the Shadow Economy Restriction Plan 2023-2025 will set as a priority the reduction of the shadow economy in specific sectors of the national economy with a high risk of the shadow economy.

During the EU funds programming period 2014-2020 until 30 November 2022, EUR 4.6 billion of co-financing from EU funds, or 99.8% of the EUR 4.64 billion of financing available to Latvia, has been attracted (also thanks to the assumed State budget over-commitments in the amount of EUR 165.4 million of EU funds’ co-financing).

In 2022, significant steps were taken to attract the financing of the EU funds programming period 2021-2027 – almost two years of intensive work has resulted in the European Commission’s positive decision at the end of 2022 on the approval of the EU Cohesion Policy Funds Programme for 2021-2027. The Cohesion Policy Programme stipulates that in the following years Latvia will receive a total of approximately EUR 4.3 billion of EU financing in the form of grants or support, which Latvia will not have to repay (in addition to that, EUR 0.7 billion of national co-financing). The programme also provides for financing for Latvia from the Just Transition Fund in the amount of EUR 191 million with the aim of providing support to regions and industries that will be particularly affected by the phasing-out of the use of fossil resources. 

As regards investments in the programming period 2014-2020, the European Commission with two decisions (of 30 June 2021 and 22 July 2022) approved amendments to the EU funds operational programme “Growth and Employment” administered by the Ministry of Finance, providing for an additional allocation of approximately EUR 222.4 million within the framework of the REACT-EU initiative. In general, Latvia has received EUR 230.3 million within the framework of the REACT-EU initiative, which is part of the European Commission’s proposal in the European recovery Plan (EUR 7.93 million from the REACT-EU funds has been allocated to the operational programme “Providing food and basic material assistance to the most deprived in the programming period 2014-2020”, administered by the Ministry of Welfare, within the framework of the Fund for European Aid to the Most Deprived).

As part of the implementation of the Latvian Recovery Fund Plan with funding of EUR 1.82 billion, on 7 October 2022, EUR 201 million has been received from the European Commission to the State budget for the first nine achieved targets for 2021; by the end of November 2022, 12 of the 49 indicators set for 2022 have been met, for which a payment request of EUR 438 million must be submitted to the European Commission in 2023. So far, the Cabinet of Ministers has approved 34 Cabinet regulations or informative reports on the implementation of 43 investments and reforms of the Recovery Fund Plan for a total financing of EUR 976 million, or ~53% of the total financing of the Recovery Fund Plan.

In 2023, Latvia plans to make amendments to the Recovery Fund Plan. Also, on 8 March 2022, the European Commission came up with a proposal for an additional allocation to the energy sector, or the RePowerEU initiative, within the framework of which Latvia could receive an additional EUR 123.98 million, for which amendments to the Recovery Fund Plan are planned accordingly.