(5)The General Escape Clause has been active since March 2020. In its Communication of 3 March 2021, the Commission set out its view that the decision on the deactivation or continued application of the general escape clause should be taken as an overall assessment of the state of the economy, with the level of economic activity in the EU or euro area compared to pre-crisis levels (end-2019) as a key quantitative criterion. Heightened uncertainty and strong downside risks to the economic outlook in the context of war in Europe, unprecedented energy price hikes and continued supply chain disturbances warrant the extension of the general escape clause of the Stability and Growth Pact through 2023.

(4)Taking account of the rapidly changing economic and geopolitical situation, the European Semester resumes its broad economic and employment policy coordination in 2022, while evolving in line with the implementation requirements of the Recovery and Resilience Facility, as outlined in the 2022 Annual Sustainable Growth Survey. The implementation of the adopted recovery and resilience plans is essential for the delivery of the policy priorities under the European Semester, as the plans address all or a significant subset of the relevant country-specific recommendations issued in the 2019 and 2020 Semester cycles. The 2019 and 2020 country-specific recommendations remain equally relevant also for recovery and resilience plans revised, updated, or amended in accordance with Articles 14, 18 and 21 of Regulation (EU) 2021/241, in addition to any country-specific recommendations issued up to the date of submission of the modified plan.

(3)Russia’s invasion of Ukraine, in the wake of the global pandemic, has significantly altered the geopolitical and economic context. The impact of the invasion on Member States’ economies has been felt for example through higher energy and food prices and weaker growth prospects. The higher energy prices weigh particularly on the most vulnerable households experiencing or at risk of energy poverty. The EU is also seeing an unprecedented inflow of people fleeing Ukraine. In this context, on 4 March 2022, the Temporary Protection Directive was triggered for the first time, granting displaced persons from Ukraine the right to legally stay in the EU, as well as access to education and training, the labour market, healthcare, housing and social welfare.

(2)On 24 November 2021, the Commission adopted the Annual Sustainable Growth Survey, marking the start of the 2022 European Semester for economic policy coordination. It took due account of the reaffirmed joint commitment of the Porto Social Summit of May 2021 to further implement the European Pillar of Social Rights, proclaimed by the European Parliament, the Council and the Commission on 17 November 2017. The European Council endorsed the priorities of the 2022 Annual Sustainable Growth Survey on 25 March 2022. On 24 November 2021, on the basis of Regulation (EU) No 1176/2011, the Commission also adopted the Alert Mechanism Report, which did not identify Latvia as one of the Member States for which an in-depth review would be needed. On the same date, the Commission also adopted a recommendation for a Council recommendation on the economic policy of the euro area, which was adopted on 5 April 2022 by the Council, as well as the proposal for the 2022 Joint Employment Report analysing the implementation of the Employment Guidelines and the principles of the European Pillar of Social Rights, which was adopted by the Council on 14 March 2022.

(1)Regulation (EU) 2021/241 of the European Parliament and of the Council , which established the Recovery and Resilience Facility, entered into force on 19 February 2021. The Recovery and Resilience Facility provides financial support for the implementation of reforms and investment, entailing a fiscal impulse financed by the Union. It contributes to the economic recovery and to the implementation of sustainable and growth-enhancing reforms and investment, in particular to promote the green and digital transition, while strengthening the resilience and potential growth of the Member States’ economies. It also helps strengthen sustainable public finances and boost growth and job creation in the medium and long term. The maximum financial contribution per Member State under the Recovery and Resilience Facility [was] updated on [XX] June 2022, in line with Article 11(2) of Regulation (EU) 2021/241.

(6)Following the approach in the Council opinion of 18 June 2021 on the 2021 Stability Programme, the fiscal stance is currently best measured as the change in primary expenditure (net of discretionary revenue measures), excluding COVID-19 crisis-related temporary emergency measures but including expenditure financed by non-repayable support (grants) from the Recovery and Resilience Facility and other EU funds, relative to medium-term potential growth. Going beyond the overall fiscal stance, in order to assess whether national fiscal policy is prudent and its composition is conducive to a sustainable recovery consistent with the green and digital transitions, attention is also paid to the evolution of nationally-financed primary current expenditure (net of discretionary revenue measures and excluding COVID-19 crisis-related temporary emergency measures) and investment.

(7)On 2 March 2022, the Commission adopted a Communication providing broad guidance for fiscal policy in 2023, aiming at supporting the preparation of Member States’ Stability and Convergence Programmes and thereby strengthening policy coordination. The Commission noted that, based on the macroeconomic outlook of the 2022 winter forecast, transitioning from an aggregate supportive fiscal stance in 2020-2022 to a broadly neutral aggregate fiscal stance would appear appropriate in 2023, while standing ready to react to the evolving economic situation. The Commission announced that the fiscal recommendations for 2023 should continue to differentiate across Member States and take into account possible cross-country spillovers. The Commission invited the Member States to reflect the guidance in their Stability and Convergence Programmes. The Commission committed to closely monitor the economic developments and adjust its policy guidance as needed and at the latest in its Semester spring package of late May 2022.

(8)With respect to the fiscal guidance provided on 2 March 2022, the fiscal recommendations for 2023 take into account the worsened economic outlook, the heightened uncertainty and further downside risks, and the higher inflation compared to the winter forecast. Against these considerations, the fiscal response has to expand public investment for the green and digital transition and energy security, and sustain the purchasing power of the most vulnerable households so as to cushion the impact of the energy price hike and help limit inflationary pressures from second round effects via targeted and temporary measures; fiscal policy has to remain agile so as to adjust to the rapidly evolving circumstances, and be differentiated across countries depending on their fiscal and economic situation, including as regards the exposure to the crisis and the inflow of displaced persons from Ukraine.

(9)On 30 April 2021, Latvia submitted its national recovery and resilience plan to the Commission, in accordance with Article 18(1) of Regulation (EU) 2021/241. Pursuant to Article 19 of Regulation (EU) 2021/241, the Commission assessed the relevance, effectiveness, efficiency and coherence of the recovery and resilience plan, in accordance with the assessment guidelines of Annex V to that Regulation. On 13 July 2021, the Council adopted its Decision on the approval of the assessment of the recovery and resilience plan for Latvia. The release of instalments is conditional on a decision by the Commission, taken in accordance with Article 24(5) of Regulation (EU) 2021/241, that Latvia has satisfactorily fulfilled the relevant milestones and targets set out in the Council Implementing Decision. Satisfactory fulfilment presupposes that the achievement of preceding milestones and targets has not been reversed.

(10)On 22 April 2022, Latvia submitted its 2022 National Reform Programme and, on 26 April 2022, its 2022 Stability Programme, in line with the deadline established in Article 4 of Regulation (EC) No 1466/97. To take account of their interlinkages, the two programmes have been assessed together. In accordance with Article 27 of Regulation (EU) 2021/241, the 2022 National Reform Programme also reflects Latvia’s bi-annual reporting on the progress made in achieving its recovery and resilience plan.

(11)The Commission published the 2022 country report for Latvia on 23 May 2022. It assessed Latvia’s progress in addressing the relevant country-specific recommendations adopted by the Council in 2019, 2020 and 2021, and took stock of Latvia’ s implementation of the recovery and resilience plan, building on the Recovery and Resilience Scoreboard. Based on this analysis, the country report identified gaps with respect to those challenges that are not addressed or only partially addressed by the recovery and resilience plan, as well as new and emerging challenges, including those emerging from Russia’s invasion of Ukraine. It also assessed Latvia’s progress on implementing the European Pillar of Social Rights and on achieving the EU headline targets on employment, skills and poverty reduction, as well as progress in achieving the UN’s Sustainable Development Goals.

(12)On 23 May 2022, the Commission issued a report under Article 126(3) TFEU. This report discussed the budgetary situation of Latvia, as its general government deficit in 2021 exceeded the 3% of GDP Treaty reference value. The report concluded that the deficit criterion was not fulfilled. In line with the Communication of 2 March 2022, the Commission did not propose to open new excessive deficit procedures in spring 2022 and it will reassess the relevance of proposing to open excessive deficit procedures in autumn 2022.

(13)On 20 July 2020, the Council recommended Latvia to take in 2020 and 2021 all necessary measures, in line with the general escape clause, to effectively address the pandemic, sustain the economy and support the ensuing recovery. It also recommended Latvia to pursue, when economic conditions allow, fiscal policies aimed at achieving prudent medium-term fiscal positions and ensuring debt sustainability, while enhancing investment. In 2021, based on data validated by Eurostat, Latvia’s general government deficit increased from 4.5% of GDP in 2020 to 7.3% in 2021. The fiscal policy response by Latvia supported the economic recovery in 2021, while temporary emergency support measures increased from 2.8% of GDP in 2020 to 5.2% in 2021. The measures taken by Latvia in 2021 have been in line with the Council Recommendation of 20 July 2020. The discretionary budgetary measures adopted by the government in 2020 and 2021 were mostly temporary or matched by offsetting measures. At the same time, some of the discretionary measures adopted by the government over the period 2020 to 2021 were not temporary or matched by offsetting measures, mainly consisting of a reduction of the social security contribution rate, an increase in the threshold for personal income tax allowance, an increase in wages for medical personnel and teachers as well as an increase of minimum social benefits. Based on data validated by Eurostat, general government debt stood at 44.8% of GDP in 2021.

(14)The macroeconomic scenario underpinning the budgetary projections in the 2022 Stability Programme is realistic in 2022 and cautious thereafter. The government projects real GDP to grow by 2.1% in 2022 and 2.5% in 2023. By comparison, the Commission’s 2022 spring forecast projects a similar real GDP growth of 2.0% in 2022 and a slightly higher growth of 2.9% in 2023, mainly due to a more positive outlook for private consumption and exports. In its 2022 Stability Programme, the government expects that the headline deficit will decrease to 6.5 % of GDP in 2022 and to 2.8 % in 2023. The large deficit in 2022 mainly reflects measures included in the 2022 budget, namely an in increase in income tax allowance, a sizeable investment package and an increase in wages for healthcare, interior and education sector employees. Moreover, broad government support to households and companies to mitigate the rise in energy prices, as well as projected slower growth of tax revenue due to the negative impact on the economy from the Russian invasion of Ukraine, will keep the deficit elevated, despite COVID-19 support to the economy being significantly lower in 2022 than in 2021. According to the Programme, the general government debt-to-GDP ratio is expected to increase to 45.7% in 2022, and to decline to 45.2 in 2023. Based on policy measures known at the cut-off date of the forecast, the Commission 2022 spring forecast projects a government deficit for 2022 and 2023 of 7.2% of GDP and 3.0% respectively. This is higher than the deficit projected in the 2022 Stability Programme, mainly due to additional policy measures included in the Commission forecast, namely the creation of national energy supply security reserves according to recent amendments to the Energy Law (estimated fiscal impact of 0.6% of GDP in 2022). The creation of the reserves has been credibly announced, but was not known at the time of the preparation of the Stability programme. The Commission 2022 spring forecast projects general government debt-to-GDP ratio of 47.0% in 2022 and 46.5% in 2023, above the Stability programme projection. The difference is due to a higher deficit projection and a lower forecast of nominal GDP.

Based on the Commission spring 2022 forecast, the medium-term (10-year average) potential output growth is estimated at 2.3 %. However, this estimate does not include the impact of the reforms that are part of the Recovery and Resilience Plan and can boost Latvia’s potential growth.

(15)In 2022, the government phased out the majority of measures taken in response to the COVID-19 crisis, such that the temporary emergency support measures are projected to decline from 5.2% of GDP in 2021 to 0.8% in 2022. The government deficit is impacted by measures adopted to counter the economic and social impact of the increase in energy prices, which in the Commission spring 2022 forecast are estimated at 0.9% of GDP in 2022 and are expected to be phased out in in 2023. These measures mainly consist of price caps on energy prices to households and entrepreneurs, full-coverage of certain sub-components of electricity tariff by the state, as well as support to particular social groups and poorer households. These measures have been announced as temporary. However, in case energy prices remain elevated also in 2023, some of these measures could be continued. Some of these measures are not targeted, notably the general price caps on energy prices. The government deficit is also impacted by the costs to offer temporary protection to displaced persons from Ukraine, which in the Commission 2022 spring forecast are projected at 0.3% of GDP in 2022 and 0.5% of GDP in 2023, as well as the increased cost of defence expenditure by 0.1 % of GDP in 2022 and 0.3 % of GDP in 2023.

(16)On 18 June 2021, the Council recommended that in 2022 Latvia maintains a supportive fiscal stance, including from the impulse provided by the Recovery and Resilience Facility, and preserves nationally-financed investment. The Council also recommended Latvia to keep the growth of nationally-financed current expenditure under control. It also recommended Latvia to pursue, when economic conditions allow, a fiscal policy aimed at achieving prudent medium-term fiscal positions and ensuring fiscal sustainability in the medium term, and at the same time, to enhance investment to boost growth potential.

(17)In 2022, based on the Commission’s 2022 spring forecast and including the information incorporated in Latvia’s 2022 Stability Programme, the fiscal stance is projected to be supportive at -3.3% of GDP, as recommended by the Council. Latvia plans to provide continued support to the recovery by making use of the Recovery and Resilience Facility to finance additional investment as recommended by the Council. The positive contribution to economic activity of expenditure financed by Recovery and Resilience Facility grants and other EU funds is projected to increase by 0.8% of GDP compared to 2021. Nationally-financed investment is projected to provide an expansionary contribution to the fiscal stance of 0.3 percentage points in 2022. Therefore, Latvia plans to preserve nationally financed investment, as recommended by the Council. At the same time, the growth in nationally-financed primary current expenditure (net of new revenue measures) in 2022 is projected to provide an expansionary contribution of 1.5 percentage points to the overall fiscal stance. This significant expansionary contribution includes the additional impact of the measures to address the economic and social impact of the increase in energy prices (0.8 % of GDP) as well as the costs to offer temporary protection to displaced persons from Ukraine (0.3 % of GDP). Latvia broadly keeps under control the growth of nationally-financed current expenditure in 2022, as the significant expansionary contribution of nationally-financed current expenditure in 2022 is mainly due to the measures to address the economic and social impact of the increase in energy prices as well as the costs to offer temporary protection to displaced persons from Ukraine.

(18)In 2023, the fiscal stance is projected in the Commission 2022 spring forecast at +3.2% of GDP on a no-policy change assumption. Latvia is projected to continue using the grants from the Recovery and Resilience Facility in 2023 to finance additional investment in support of the recovery. The positive contribution to economic activity of expenditure financed by Recovery and Resilience Facility grants and other EU funds is projected to increase by 0.9 percentage points of GDP compared to 2022. Nationally-financed investment is projected to provide a contractionary contribution to the fiscal stance of 0.8 percentage points in 2023. At the same time, the growth in nationally-financed primary current expenditure (net of new revenue measures) in 2023 is projected to provide a contractionary contribution of 2.7 percentage points to the overall fiscal stance. This includes the impact from the phasing out of the measures addressing the increased energy prices (0.9 % of GDP) and additional costs to offer temporary protection to displaced persons from Ukraine (0.1% of GDP).

(19)In the 2022 Stability Programme, the general government deficit is expected to gradually decline to 2.3% of GDP in 2024 and to 1.7% by 2025. Therefore, the general government deficit is planned to remain below 3% of GDP over the programme horizon. These projections assume phasing out of support programmes and solid growth of tax revenue. According to the Programme, the general government debt-to-GDP ratio is expected to decrease by 2025, specifically with a decrease to 44.5% in 2024 and to 43.4% in 2025. Based on the Commission’s analysis, debt sustainability risks appear low over the medium term.

(20)Latvia’s tax revenue as a share of GDP is significantly below the EU average, limiting the funding to public services. Latvia collects the lowest revenue from corporate income taxes in the EU (0.7 % of GDP in 2020), while revenue from property taxes is 1.0 % of GDP compared with the EU average of 2.3 % of GDP. Moreover, while the tax wedge on an average earner is around the EU average, the implicit tax rate on labour is among the lowest in the EU, pointing to considerable scope for increasing the revenue from labour taxation through better collection and higher progressivity. Latvia’s public expenditure on healthcare and social protection are particularly low compared to the EU average, hampering timely and equal access to healthcare and adequate social assistance. As a result, Latvia has some of the highest income inequality, lowest poverty reduction impact of social transfers and worst health outcomes in the EU. Despite recent increases, the minimum income, minimum pensions and disability benefits fall below the poverty line. Limited access to and quality of social assistance and services for vulnerable groups further hinder social inclusion. The long-term care system is underdeveloped, with a limited supply of home care and community-based services. Social housing is scarce and often does not provide adequate living conditions. Furthermore, social assistance varies across municipalities and is often not targeted enough. Higher taxation of property and capital and more progressivity of income taxation offer the best potential for increasing tax revenue as these sources remain underutilised compared to the EU average. Moreover, efforts to reduce the shadow economy should continue beyond the measures planned in the recovery and resilience plan.

(21)In accordance with Article 19(3), point (b) of Regulation (EU) 2021/241 and Annex V, criterion 2.2, the recovery and resilience plan includes an extensive set of mutually reinforcing reforms and investments to be implemented by 2026. These help address all or a significant subset of the economic and social challenges outlined in the country-specific recommendations addressed to Latvia by the Council in the European Semester in 2019 and 2020, in addition to any country-specific recommendations issued up to the date of adoption of a plan. In particular, Latvia’s plan includes measures addressing, to a varying extent, all six broad challenges – fiscal, human capital, public administration, productivity and the digital and green transitions. The plan includes reforms related to the governance and financing of higher education institutions, the implementation of a comprehensive human resources strategy in healthcare and the introduction of indexation for minimum income benefits. Sizeable investments include the greening of the Riga transport area by acquiring clean public vehicles and the energy renovation of both private and public buildings and businesses. Significant investment is also planned to promote regional development: building schools, industrial parks and affordable housing and modernising hospitals. These measures are expected to boost the growth potential of the economy in a sustainable manner.

(22)The implementation of the recovery and resilience plan of Latvia is expected to contribute to making further progress on the green and digital transition. Measures supporting the climate objectives in Latvia account for 37.6% of the plan’s total allocation, while measures supporting digital objectives account for 21% of the plan’s total allocation. The fully-fledged implementation of the recovery and resilience plan, in line with the relevant milestones and targets, will help Latvia swiftly recover from the fallout of the COVID-19 crisis, while strengthening its resilience. The systematic involvement of social partners and other relevant stakeholders remains important for the successful implementation of the recovery and resilience plan, as well as other economic and employment policies going beyond the plan, to ensure broad ownership of the overall policy agenda.

(23)Latvia has not yet formally submitted the Partnership Agreement and the other cohesion policy programming documents. In line with Regulation (EU) 2021/1060 of the European Parliament and of the Council of 24 June 2021, Latvia shall take into account the relevant country-specific recommendations in the programming of the 2021-2027 cohesion policy funds. This is a prerequisite for improving the effectiveness and maximising the added value of the financial support to be received from cohesion policy funds, while promoting the coordination, complementarity and coherence between these funds and other Union instruments and funds. The successful implementation of the Recovery and Resilience Facility and cohesion policy programmes also depends on the removal of bottlenecks to investment to support the green and digital transition and balanced territorial development.

(24)Beyond the economic and social challenges addressed by the recovery and resilience plan, Latvia faces a number of additional challenges including access to bank credit. Credit flow to the private sector has been negative for most of the last decade. It turned positive in 2016 but the growth rate of credit remained below the growth rate of GDP. In 2020, private sector debt stood at 66.5% of GDP compared with 78.3% of GDP 5 years earlier. Small and medium-sized enterprises have found it particularly difficult to get credit, partially due to their higher credit risk, but they also face a relatively high cost of credit and burdensome paperwork. Furthermore, poor liquidity of the assets offered for collateral, make it particularly hard to get credit outside of the Riga region. This presents a significant barrier both for mortgage lending and lending to businesses. Moreover, financing for consumer green technologies could be made more affordable through cheaper and longer-term credit products. Policy efforts have mainly focused on supporting lending by combining it with public grants. However, this comes with a significant cost to the government budget and is therefore not a sustainable way of boosting lending. Easing the credit supply constraints requires general improvements in transparency and trust in the business environment, including a reduction of the shadow economy. Furthermore, there is room for increasing the loan recovery rates, which would reduce the banks’ costs associated with non-performing loans and which could be facilitated by a more efficient legal system. Targeted loan and guarantee schemes could help lower the liquidity risks faced by the banks when accepting collateral in relatively illiquid markets. Public lending schemes for strategically important investments, like the green transition and regional development, could increase effective competition in the banking market or fill a market gap where bank financing is either too expensive or not available. Moreover, public guarantee and lending schemes offer a significantly more cost-efficient way of supporting private borrowing than grant schemes. Besides the barriers to bank financing, the Latvian market for alternative sources of finance is underdeveloped and holds potential for improving firms’ access to finance.