"The outlook is stable because we see Latvia's economy recovering over the next few years after a temporary recession this year triggered by the COVID-19 pandemic. The country reports one of the lowest debt-to-GDP ratios in the eurozone, which provides its authorities with ample fiscal flexibility to support the economy in the current circumstances. Moreover, the European Central Bank (ECB) will backstop these fiscal efforts. We expect fiscal deficits will narrow after the economy recovers in 2021, which will stabilize public debt at a moderate level," S&P said.
The agency also suggested Latvia might be in line for a future upgrade "if post-COVID-19 economic growth rates consistently exceed those of peers, while fiscal balances remain narrow, putting net public debt as a share of GDP on a firm downward trend."
There was also acknowledgment that so far, Latvia's response to the COVID-19 has been effective.
"The response to the pandemic will cause a significant economic contraction in Latvia this year, similar to all other EU economies. We note, however, that the domestic spread of the virus was quickly contained, and, in the absence of a local recurrence of the pandemic or a more protracted recovery of the country's main trading partners, we believe the Latvian economy will show a strong recovery over the next two years. In our base case, Latvia's economy will return to 2019 GDP levels around mid-2022," S&P said.
"The Latvian figures are low even compared with its Baltic peers Lithuania and Estonia, which were also effective in containing the spread of COVID-19. Due to this success, the three Baltic countries were able to establish a free-travel zone in mid-May, the first travel bubble within the EU and one of the first globally. Since the state of emergency was lifted in mid-June, most restrictions have also been lifted and the economy has opened up again."
Other rating supports include a track record of effective policymaking and the economy's sound external profile. Comparably low income levels and substantial long-term demographic challenges remain key rating constraints, it added, estimating that Latvia's economy will contract by about 7% this year due to the response to the pandemic.
The labor market will become a primary constraint to economic development in the medium term, the agency said, noting that Latvia has experienced one of the most pronounced population declines globally over the past 25 years.
"The working-age population is currently shrinking. In our view, it will be difficult for employment and population figures to rebound unless there is a substantial reversal in net emigration, which has dropped over the past few years, partly thanks to more Latvians repatriating," S&P predicted.
The current coalition can also take some comfort from a generally positive assessment of the political situation with the rating agency saying: "We have observed a high degree of cross-party consensus on the most important political items over the years, such as maintaining a business-friendly environment, delivering sound public finances, and retaining strong relations with EU and NATO partners."