Economic growth will reach about 3.7% this year, according to the International Monetary Fund (IMF) estimates.
The overall impact of the contraction of the non-resident banking sector on the Latvian economy depends largely on how successful these banks will be in switching to other business models, as well as decisions taken by the responsible institutions in the fight against money laundering, said the IMF's Iva Petrova at the end of the annual review of the national economy known as an Article IV Consultation.
"Economic fundamentals are mostly sound, but risks have emerged. Fiscal and current account deficits and public debt remain at prudent levels, and private sector debt is on a declining path. However, the labor market has continued to tighten, and fiscal policy has become procyclical, as EU investment inflows have picked up and the upfront costs of the tax reform have dampened revenues," said the international lender.
"Real GDP growth is projected to reach 3.7 percent in 2018, supported by EU structural funds and rising wages, while external demand is projected to moderate. Over the medium term, growth should gradually converge to its potential rate of 3 percent, as EU investment funds level off and capacity constraints become increasingly binding," it added.
"Risks to the baseline are tilted to the downside. On the domestic front, more rapid labor market tightening and a deepening of fiscal pro-cyclicality could trigger an accumulation of imbalances and overheating pressures, and growth could be slower if structural reforms do not further advance. Financial sector stability could be at risk if enforcement of AML/CFT regulations falters or banks servicing foreign clients fail to refocus their business models, which could undermine confidence in the banking system. Externally, growing protectionism and weaker growth in advanced economies could become a drag on export growth, while an abrupt reversal of risk appetite in Europe and/or tighter global financial conditions could raise the cost of public debt financing," it warned.
"In our assessment, the impact of foreign customer-oriented banks on the economy is equivalent to a half percent to one percent of gross domestic product," Petrova told journalists at an end of mission briefing.
"This could be the potential impact of these banks on the economy over a given period of time. However, we are not sure how long it will take. Of course, the events of February [when ABLV was accused by the U.S. Treasury of institutionalized money laundering, which in turn prompted its collapse] also have certain consequences for the credibility and reputation of the banking sector," said Petrova.