Latvia

Recovery in growth tempered by conflict in the Middle East

2025 was marked by a rebound in economic activity driven by domestic demand. Recovery in growth slowed marginally in 2026 as a result of the conflict in the Middle East, but it is expected to resume its upward trajectory in 2027. Rising energy prices mechanically increased the cost of inputs and transportation. However, economic activity remains resilient and is driven by private consumption, which is projected to grow by 1.6% in 2026 and 1.9% in 2027. While supported by rising nominal wages, private consumption remains vulnerable to persistently high inflation. The latter began to accelerate as early as 2025. The rise in energy prices resulting from the blockade of the Strait of Hormuz kept inflation at a high level in 2026, and the stalemate in the geopolitical situation in 2027 will keep tensions running high. The impact remains moderate, however, as Latvia has an industrial sector with relatively low energy intensity and a diversified energy mix. Furthermore, to limit the loss of consumer purchasing power, the government has lowered the VAT on certain basic food items.

In 2025, investment surged by 9.8% after two years of contraction. It was driven mostly by private investment, as well as funding from the European Union, notably for the Rail Baltica project. Some 85%-funded by the European Union, this project aims to build a new high-speed rail line to integrate the Baltic countries into the European network and boost regional competitiveness. Originally scheduled for 2026, completion has been delayed until 2030 owing to the lack on Latvia’s part of the necessary budgetary resources, which are estimated at EUR 3.7 billion. Due to the combined effects of inflation and the uncertain geopolitical climate, the projected increase in investment for 2026 remains more moderate than in 2025, i.e., at around 3%. The country continues to face difficulties in financing innovation activities with fragmented aid programmes that are burdened by excessive red tape. However, in 2026, the European Investment Bank (EIB) committed EUR 20 million to green bonds issued by Latvenergo, the state-owned electricity company. The funding will support wind power projects, battery energy storage and the renovation of hydroelectric and photovoltaic facilities.

The economy is driven by the service sector, which accounts for 75% of GDP, including business services, ICT and transportation. Due to EU restrictions on Russian carriers, trade with Russia is increasingly taking place via Baltic states, through local companies. However, in July 2026, Russia suspended operations at its rail border crossings with Latvia. Despite the weakness of the Western European construction sector, the wood and furniture industry enjoys a competitive advantage thanks to abundant forest resources. As the country’s primary natural resource, wood is also used for residential heating and energy production in biomass power plants. The pharmaceutical industry is also a high-performing sector, with sales growth of 8.5% projected for 2026, driven largely by the pharma group Grindeks. The pharmaceutical leader has notably reduced its exports to Russia in favour of expanding into new markets, particularly in South America.

Rising budgetary pressures driven by increased defence spending

The budget deficit is expected to widen in 2026 and 2027. The widening deficit stems from an increase in the defence budget against a backdrop of persistent tensions with Russia. Latvia has therefore invoked the national exemption clause of the Stability and Growth Pact to finance these military expenditures, which are projected to amount to 4.1% and 5.5% of GDP in 2026 and 2027, respectively. In June 2026, Latvia signed a EUR 3.5 billion defense loan agreement under the European Union’s SAFE (Security Action for Europe) programme.

Controlling the deficit is important given the budgetary costs of an ageing population and the need to finance the healthcare system. The public debt-to-GDP ratio is projected to rise in the coming years. Revenues are struggling to keep pace with rising expenditure and tax revenue falls below the EU average. A tax reform took effect on 1 January 2026, which, among other things, will increase government revenue. The reform primarily involves reducing the tax burden on low- and middle-income earners and increasing it for others, as well as introducing a 3% surtax on all income exceeding EUR 200,000 per year, including wages, dividends, capital gains and other income.

The current account deficit is set to widen in 2026. As Latvia is a net importer of oil, the deficit is deteriorating due to rising global energy costs. Projected at around 0.7%, export growth has remained moderate in 2026, but is expected to recover in 2027 to around 2.7%, primarily on back of the competitive timber sector, as well as food and pharmaceutical products. The services balance, meanwhile, remains in surplus, driven mainly by the logistics, IT and transportation sectors.

New government amid tensions with Russia

Diplomatic relations with Russia are likely to remain tense through 2030. Several drones have been spotted in Latvian airspace in 2026. The increase in military spending is a response to an expected escalation of Russian hybrid attacks. Latvia has strengthened its security measures around a hydroelectric dam near Riga in response to the threat of Russian attacks against critical infrastructure in the region.

The Russian threat also affects domestic policy. On 10 May 2026, Prime Minister Evika Silina dismissed her defence minister after a drone crashed into a fuel storage facility. The head of government subsequently resigned after the minister left the party. On 28 May, Parliament approved the formation of a new government —still center-right and nationalist— led by the centrist Andris Kulbergs of the United List. On 3 October, the Prime Minister’s centre-right United List party emerged as the winner of the parliamentary elections. With 35.3% of the vote and 42 seats, Kulbergs’ party is well positioned to lead coalition negotiations. It could secure a parliamentary majority with either the nationalist National Alliance or the centrist New Unity party. These parties share a commitment to continue their support for Ukraine, reduce Russian cultural influence and align with NATO and European Union policies. Parliamentary election also saw gains for populist parties, boosted by support from the Russian-speaking minority (which accounts for one-third of the population and is largely excluded from the political process).

Last updated: September 2026