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Fitch Affirms Latvia at 'A-'; Outlook Stable
April 28, 2017 / 8:06 PM / 8 months ago

Fitch Affirms Latvia at 'A-'; Outlook Stable

(The following statement was released by the rating agency) LONDON, April 28 (Fitch) Fitch Ratings has affirmed Latvia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A-' with Stable Outlooks. The issue ratings on Latvia's senior unsecured foreign and local currency bonds have also been affirmed at 'A-'. The Country Ceiling has been affirmed at 'AAA'. The Short-Term Foreign- and Local-Currency IDRs have been affirmed at 'F1'. KEY RATING DRIVERS Latvia's ratings are supported by the sovereign's institutional strengths and a credible policy framework aided by eurozone membership, as well as a more favourable fiscal position relative to 'A' rated peers. However, the country's lower per capita income, weaker external finances, smaller and more open economy, and weaker demographics compared with its 'A' peers constrain the ratings. Latvia's economy grew 2.0% in 2016, below the 'A' median of 2.7% but slightly above the eurozone average (1.8%), after growing 2.7% in 2015. For 2017, Fitch forecasts growth to rise to 2.6% due to a rebound in investment stemming from a recovery in use of EU funds after a double-digit slump in 2016, caused by the EU funding cycle. The high import intensity of capital goods means a negative contribution from net exports is projected to weigh on 2017 GDP. Private consumption will support growth, but at a lower rate than last year due to higher inflation, which Fitch forecasts to average 2.7% in 2017 from 0.1% in 2016. Risks to Fitch's GDP forecast are tilted to the downside, dependent on the absorption of EU funds and economic developments in Latvia's largest trading partners. After a fiscal deficit of 1.3% of GDP in 2015, Latvia achieved a balanced fiscal position in 2016 - a significant improvement from the government and Fitch's forecast for a deficit 1.0% of GDP at the time of our November 2016 review. Savings were made through a 30% contraction in public capital spending, which offset increases in defence, social welfare and salary spending. Tax receipts exceeded budget plans, despite weaker than budgeted growth, suggesting some progress in increasing tax compliance. Fitch forecasts a fiscal deficit of 0.5% of GDP in 2017, reflecting already planned government revenue-raising measures of 0.4% of GDP against expenditures of 0.54% of GDP, higher absorption of EU funds and the fading out of one-off revenue effects. Fitch's deficit forecast does not take into account any accounting impact arising from the winding-down of bad bank Reverta by end-2017. Higher economic growth and an improvement in tax collection efficiency are upside fiscal risks. Government debt and debt service metrics are better than the peer medians. The debt/GDP ratio increased to 40.1% in 2016 (A median 51.7%) from 36.5% in 2015, accounting largely for pre-financing February 2017's USD1 billion Eurobond redemption. Fitch forecasts government debt/GDP to fall to 39.7% by 2018. Latvia's banking sector benefits from being part of the ECB's Single Supervisory Mechanism. The sector is well-capitalised (Tier 1 capital adequacy ratio at 17.1% in 2016), and deleveraging has improved banks' balance sheets. The high level of foreign ownership in the banking sector reduces the risk of financial sector liabilities migrating onto the sovereign balance sheet. Non-resident deposits (NRDs) are large, but had fallen to 44% of total deposits at end-2016, compared with 55% a year earlier. Recession in Russia and the clampdown by Latvia's Financial and Capital Market Commission on money laundering among NRD serving banks are key drivers of the declining stock of NRDs. Fitch expects this trend to continue in 2017, but at a slower pace and primarily led by withdrawals by individuals and corporates (24% of NRDs are funding from Nordic parent banks to Latvian subsidiaries, which are considered more stable). Fitch does not expect falling NRDs to impact credit supply or the real economy. Latvia's ratings remain constrained by the sovereign's weaker external finances compared with 'A' peers. Since peaking in 2009 (at 58.4% of GDP), net external debt has stayed on a downward trend (33.4% of GDP estimated for 2016). However, this compares unfavourably with the median net external creditor position of its rated peers (12.4%). On-going deleveraging by the financial and non-financial private sector will keep net external debt on a downward trajectory, but at a more modest pace than previous years. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Latvia a score equivalent to a rating of 'A-' on the Long-Term Foreign-Currency IDR scale. In accordance with its rating criteria, Fitch's sovereign rating committee decided not to adopt the score indicated by the SRM as the starting point for its analysis because the SRM output has migrated from 'A' to 'A-', but in our view this is potentially a temporary deterioration. Assuming an SRM output of 'A', Fitch's sovereign rating committee adjusted the output to arrive at the final Long-Term IDR by applying its QO, relative to rated peers, as follows: -External Finances: -1 notch, to reflect that although Latvia benefits from the euro's "reserve currency flexibility", Fitch believes that this status would likely offer Latvia only limited protection in case of a global or domestic financial crisis. In addition, Latvia's small and open economy exposes it to external vulnerabilities, and net external debt is high relative to peers. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable or not fully reflected in the SRM. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main factors that could, individually or collectively, trigger positive rating action include: - Persistent strong and stable economic growth that fosters higher income per capita, without the re-emergence of macroeconomic imbalances. - A sustainable improvement in external debt ratios. The main risk factors that could, individually or collectively, trigger negative rating action are: - Deterioration in Latvia's public debt dynamics, for example, from sustained fiscal slippage or economic underperformance. - Deterioration in external finances, for example, associated with overheating of the domestic economy. KEY ASSUMPTIONS The global economy performs in line with Fitch's Global Economic Outlook. Contact: Primary Analyst Kit Ling Yeung Associate Director +44 20 3530 1527 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Arnaud Louis Director +33 144 299 142 Committee Chairperson Paul Gamble Senior Director +44 20 3530 1623 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on Applicable Criteria Country Ceilings (pub. 16 Aug 2016) here Sovereign Rating Criteria (pub. 18 Jul 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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