November 13, 2012 / 7:16 PM / in 5 years

TEXT-Fitch raises Latvia rating to 'BBB', outlook is positive

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'.

RATING RATIONALE

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 
bailouts. 

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 
end 2012). 

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 
and liabilities. 

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 
adoption.

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 
the medium-term.

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 
consolidation. 

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
0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below