Nov 13 - Fitch Ratings has upgraded Latvia's Long-term foreign currency
Issuer Default Rating (IDR) to 'BBB' from 'BBB-' and its Long-term local
currency IDR to 'BBB+' from 'BBB'. The Outlooks on the Long-term IDRs are
Positive. The agency has also raised the Country Ceiling to 'A' from 'BBB+',
increasing the Country Ceiling notching to three from two. Fitch has
simultaneously affirmed Latvia's Short-term foreign currency IDR at 'F3'.
The upgrade reflects Latvia's progress in achieving solid and broad-based
economic growth, further cutting its budget deficit, improving its terms of
market access and reducing its net external debt ratios.
Strong economic growth has continued in 2012, showing impressive resilience to
the recession in the eurozone. Fitch forecasts Latvian GDP growth at 5.0% y/y in
2012, up from 2.5% at the beginning of 2012, on the basis of GDP growth of 5.7%
on average in Q1-Q3. The continued recovery in 2012 has been driven by high
investment growth (through the strong absorption of EU funds) and a rebound in
private consumption, with net exports also less of a drag on growth.
Growth has become more broadly-based than in the pre-crisis period, with
tradable sectors contributing and despite a lack of private sector credit
growth. Fitch forecasts GDP growth to ease to 3.0% in 2013, though to remain
well above the EU average.
The rating upgrade also reflects the government's strong track record of fiscal
consolidation. Fitch forecasts the 2012 budget deficit at 1.9% of GDP, below the
target of 2.5% due to increasing tax revenue (particularly from VAT and personal
income tax) and lower government expenditure. The reduction in the deficit from
9.7% in 2009 is the sharpest adjustment over the period of any Fitch-rated
sovereign with the exception of major oil exporters. The agency believes the
government's targets to reduce the budget deficits to 1.4% in 2013 and 0.8% in
2014 are realistic.
Fitch expects Latvia to meet the Maastricht criteria in spring 2013, and to be
invited to join the euro in January 2014. However, there is a risk that Latvia
could miss the inflation criterion or its adoption could otherwise be delayed.
Fitch believes that euro adoption would be a net benefit to the small, open,
flexible and largely euro-ised Latvian economy, which already has a pegged
exchange rate to the euro. Latvia's economy is closely integrated with the EU
through trade and investment, and via the substantial integration of its
financial sector with that of the Nordic economies (83% of resident loans and
46% of bank deposits are denominated in euros). Euro adoption would virtually
eliminate exchange rate risk and could reduce vulnerabilities stemming from
currency mismatches and give Latvian banks access to ECB liquidity facilities.
These benefits should outweigh the cost of funding potential future euro area
However, weak external finances and banking sector risks will continue to weigh
on the rating in the medium-term. Whilst declining, external debt ratios remain
high compared to rating peers (net external debt is forecast at 53.3% of GDP at
In the banking sector, loan-to-deposit ratios remain high amongst residents
(total loan to deposit ratio is 105.4%, resident loan to deposit ratio is 192.9%
at September 2012) despite deleveraging by subsidiaries of foreign owned banks
and an increase in deposits since 2009. Similarly, concerns regarding asset
quality in the banking sector are diminishing but are nevertheless still
material: in September 2012 resident household non-performing loans were 15.9%
of the total, down from 19.6% in September 2011. Substantial increases in
non-resident deposits during 2012 could also render banks vulnerable to a
liquidity shock in the event of a sudden deposit outflow, despite regulatory
measures that impose higher capital and liquidity ratios on non-resident assets
Latvia faces a heavy repayment schedule in 2014 and 2015 as it will need to
repay loans to the EC and the private sector. In 2014 and 2015, repayments are
estimated at 1179mn LVL (7% of GDP) and 1100mn LVL (6.2% of GDP) respectively.
Given resilient international demand and Latvia's moderate level of public debt
(forecast at 41.5% of GDP at end 2012), Fitch expects the country will be able
to refinance official debt in the markets, assuming no material change in
investor's risk aversion.
Latvia's ratings are supported by underlying political and institutional
strengths and a per capita income level much higher than most rating peers
(Fitch forecasts income per capita at USD12,302 at end 2012).
The increase in the country ceiling by two notches to 'A' reflects Fitch's
assessment of a further reduction in the risk of the imposition of bank deposit
withdrawal restrictions or transfer and convertibility risks as the banking
sector position continues to improve and as Latvia moves closer to euro
RATING OUTLOOK - POSITIVE
The Positive Outlook reflects Fitch's baseline expectation that Latvia will
adopt the euro in January 2014 and that this will represent a net benefit to the
Latvian economy and sovereign creditworthiness.
Other factors that could lead to positive rating action include establishing a
track-record of strong, stable growth while preventing the re-occurrence of
macroeconomic imbalances and material reductions in external debt ratios over
Potential factors that could lead to a negative rating action include:
- a prolonged recession and increased risk aversion in the eurozone that
adversely affected Latvia's ability to issue international Eurobonds at
affordable rates, and achieve its ambitious refinancing schedule
- a shock that undermined the stability of the banking sector.
KEY ASSUMPTIONS AND SENSITIVITES
The ratings and Outlooks are sensitive to a number of assumptions. The upgrade
is premised on the assumption that Latvia will continue to build on its recent
track record of prudent macroeconomic policy-making. Fitch's fiscal projections
are based on the assumption that medium-term budget deficit outcomes are broadly
in line with Ministry of Finance targets, consistent with continued fiscal
Fitch assumes that the eurozone remains intact and that there is no
materialisation of severe tail risks to global financial stability that could
trigger a sudden increase in investor risk aversion and financial market stress.
Such a scenario would likely trigger a downgrade.
The ratings above were solicited by, or on behalf of, the issuer, and therefore,
Fitch has been compensated for the provision of the ratings.
Applicable Criteria and