26. Latvia
In the run-up to the COVID-19 pandemic Latvia experienced stable economic growth, with growth rates exceeding the EU average. From 2011 to 2019, GDP grew by 3.3% per year on average. In 2019, the growth of the economy became more moderate. GDP grew by 2% in 2019. In 2020, the COVID-19 pandemic had a significant impact on the global and Latvian economies. In the 2nd quarter, GDP in Latvia decreased by 8.9% compared to the same period in 2019. However, this appears to be a comparatively mild decline, as in EU-27 GDP contracted by 13.9% over the same period. In Q3 and Q4 of 2020, the economic decline slightly slowed down. Overall, in 2020, GDP decreased by 3.6%, compared to 2019. The development of the economy in the medium term depends on the situation in the external environment and the pace of reform implementation. The further development of the Latvian economy will be closely related to export opportunities; therefore, the largest risk to Latvia's growth is related to the development of the global economy, especially the evolution of the COVID-19 pandemic. Also, the further development of the EU's common economic space is vitally important. Latvia's medium-term economic benefits will be mainly based on macro-economic stability (as a result of which Latvia's credit ratings have improved), the efficiency of the planned EU support programmes, and improvements in the business environment.
In Latvia, 99.8% of economically active merchants and commercial companies are SMEs, 92.1% of which are micro-enterprises.
SME loans dominate the banking sector’s lending to non-financial corporations (NFCs). As SMEs play an important role in the domestic economy, SME loans represented 73% of total loans to domestic NFCs in 2020. The outstanding amount of banking sector loans to SMEs decreased in 2020 by 7%; however the total banking's sector loan portfolio to NFCs decreased even further, by 8.5%. To a large extent, this is attributed to structural changes in the Latvian banking sector (for instance, the withdrawal of the credit institution's licence). Excluding one-off effects, the SMEs loan stock slightly declined (-3.2% year-on-year). In 2020, the new lending (flow) to SMEs was noticeably lower than in 2019 (by 20.5%), despite the increase of total new business lending to NFCs by 5.8%.
In 2019, venture and growth capital experienced a 33.7% y-o-y growth rate caused by the increase of finance allocated to equity. The high allocation to equity is explained by significant higher investment returns compared to the previous year. In light of the quantitative easing strategy, pursued by the European Central Bank (ECB), which took place in a low interest rate environment, market actors and investors have been searching for higher yields, including in riskier areas such as venture capital. The availability of cheap capital, low interest rates and the relative narrowing of classic investment opportunities increased investor tolerance above medium levels, thus stimulating alternative investment opportunities. However, in 2020 venture and growth capital decline by 6.29% year on year, reflecting the uncertainties and instabilities caused by the COVID-19 pandemic and its impact on the economy.
As a response to the COVID-19 crisis, the state promoted access to funding (through its micro-lending, start-up, and loans programme) for firms lacking the financial credibility (collateral, net worth, cash flow and credit history) that is necessary to access funding from commercial banks or private investors.
Currently, state support programmes are introduced via the JSC Development Finance Institution Altum (ALTUM), a state-owned development finance institution offering aid and financial tools to various target groups. ALTUM develops and implements state aid programmes to compensate for market shortcomings that cannot be resolved by private financial institutions. In response to the COVID-19 outbreak, in 2020, ALTUM introduced several support programmes through working capital loans, other loans and credit guarantees.
According to Eurostat data, in 2018, there were 112 728 economically active individual merchants and commercial companies in Latvia. 99.8% of these firms were SMEs and 91.1% of SMEs were micro-sized. Only 0.2% of firms in Latvia in 2018 were large firms (see Table 26.2)
In the Latvian ‘non-financial business economy’, SMEs account for 69.7% of value added and 78.5% of employment, significantly higher than the respective EU averages of 52.8% and 64.9%. The annual productivity of Latvian SMEs is slightly less than EUR 17 700 per person, less than half of the EU average of EUR 41 185. The majority of SMEs in Latvia are represented in wholesale and retail trade and manufacturing, with a combined contribution of 43% to total SME value added and 42% to SME employment.
In 2014-2018, the value added of Latvian SMEs rose by 35.4%, slightly less than the 38.4% growth of large businesses. SME value added growth accelerated in 2017-2018, with SMEs generating a two-digit increase of 19.4%, against the modest annual gains of 7.6% in 2015-2016 and 9.4% in 2016-2017. SME employment increased by 12.9 % in 2014-2018, largely thanks to micro firms, which created 26% more jobs, whereas small and medium firms reported an increase by 5.2% in employment in the same period.
In total, 8 939 new companies were registered in 2020 (Lursoft), the lowest number since 2004 and 14.4% lower than in 2019. The number of liquidations (de-registrations) decreased by half in 2020, totalling 11 685 companies, a net loss of 2 746 firms. The steep decline in liquidations in 2020 can be explained by a large increase in liquidations in 2017-2019 partially due to the removal of inactive companies by the country’s Register of Enterprises in recent tax and law reforms.
In 2018, 1,035 companies in the “business economy” with at least 10 employees could be classified as high-growth firms. This represented 11.2% of all firms in Latvia (EU average - 11.6%).
Loans to SMEs dominate in the banking sector’s lending to non-financial corporations (NFCs).As SMEs play an important role in the domestic economy of Latvia – loans to SMEs comprised 73% (at the end of 2020) of total loans to domestic NFCs. The outstanding amount of banking sector loans to SMEs decreased in 2020 by 7%, however the total banking's sector loan portfolio to NFCs decreased by 8.5%. To a large extent, this is attributed to structural changes in the Latvian banking sector (for instance, the withdrawal of the credit institution's licence). Excluding one-off effects, the SMEs loan stock slightly declined (-3.2% year-on-year). In 2020, the new lending (flow) to SMEs was noticeably lower than in 2019 (by 20.5%), despite the increase of total new business lending to NFCs by 5.8%.
In 2020, the spread between interest rates on small and large loans increased (by 0.4 percentage point) as the interest rate on small-size loans to enterprises increased to 4.4%, while interest rate on large-size loans increased slightly (2.9%). According to the Bank Lending Survey (BLS), credit standards and terms, including interest rates, tightened in the first half of 2020 on account of the uncertainty caused by the Covid-19 pandemic. As fiscal and monetary policy measures positively influenced bank asset quality, the credit standards and terms, including interest rates, were eased afterwards. Due to their inherently higher credit risk, credit standards and terms for SMEs are typically stricter than those for large corporates. For instance, the lender may require a personal guarantee from the owner of an SME.
On the policy side, substantial progress has been made to facilitate SME access to finance. In 2014, the Development Financial Institution ALTUM (hereinafter “Altum”) was established. It is a one-stop-shop national development finance institution where SMEs can apply for European, national and local aid in the form of financial instruments (loans, guarantees, equity instruments, etc.). Latvia has been very active in using available EU Structural Funds to prevent market failures in the financial sector and ensure that SMEs get the required investments so they can grow. A variety of financial instruments have been created to facilitate the availability of financial resources in all stages of business development, especially for starting a business.
The financial instruments implemented by the Altum (directly and indirectly):
Equity instruments: pre-seed, seed and start-up capital, venture capital, expansion capital;
Debt instruments: guarantees (loan guarantees, short term export credit guarantees), start-up loans, microloans, SME loans, FRS loans, loans for rural development/farmers.
Credit guarantees
Credit guarantees serve as collateral for obtaining loans from commercial banks. While there are no formal restrictions pertaining to SMEs, credit limits and maturity periods vary between SMEs and large firms, and within large firms as well. Guarantees are limited to 80% of financial services for both large companies and SMEs. Certain activity restrictions (e.g. financial and insurance activities, alcohol trade, etc.) as well as sectoral restrictions, per EU regulation, apply as well in terms of credit guarantees (average amount of guarantees issued EUR 40 – EUR 45 million. per year).
Portfolio guarantees were developed in 2017 to improve the availability of financial resources for small, medium and micro enterprises in Latvia. They were intended to contribute to the creation of new companies, expansion of existing activities and increase of lending rates (average amount of guarantees issued EUR 6 toEUR 10 million. EUR per ).
Export credit guarantees
The main target is to reduce political and commercial risks related to export transactions. Due to the uncertain economic conditions from April 2020 till December 2021 export credit guarantees are available for export transactions independently of the country of the debtor (with deferred period until 2 years) (EUR 44.2 million exports declared).
Acceleration and capital funds
Acceleration Funds - the aim of the measure is to promote the development and competitiveness of economic operators by providing acceleration (i.e., promotion, stimulation, development, acceleration) services and financing for business projects that involve technological or industrial risks of failure (EUR 3.06 million. allocated);
Support for early stage and growth capital funds - the aim of the measure is to promote the establishment, development and competitiveness of merchants and agricultural service cooperative societies by providing seed and growth capital for the implementation of business projects (EUR 6.07 million. allocated).
SME Growth Loans
Loan for investment and working capital with reduced requirements for collateral and an option to receive interest rate subsidies or guarantee for a loan. The maximum amount of an investment loan is EUR 2,850,000 and not more than 90% of the total project costs. The maximum amount of working capital is EUR 1,000,000. Maturity of investment loan is from 2 to 15 years. Maturity for working capital loan is from 2 to 5 years (average amount of loans issued EUR 20-25 million. per year).
A loan for the company's energy efficiency
Loans are available for businesses in order to improve energy efficiency of equipment and introduction of renewable energy projects. Through the loan, it is possible to finance:
Energy efficiency - replacement of equipment, lighting, ventilation, drying, heating, cooling, steam manufacturing equipment (<5% energy savings)
Sustainable transport - mobility, electric vehicles, biogas or transport
Renewable energy - decentralized power supply equipment, solar panels, cogeneration equipment, wind turbines
Green buildings- Construction (energy efficiency for heating <40 kWh/m2) or renovation (energy efficiency <25%) of non-residential buildings
It is of special relevance for companies with significant energy consumption where costs exceeds EUR 20 thousand annually, for example: supermarkets and sports centres, warehouses, hotels, office buildings, food producers, woodworking and metalworking companies or large companies and large energy consumers affected by the Energy Efficiency Law. By investing in energy efficiency measures, the companies can reduce their energy consumption up to 50% (average amount of loans issued EUR 5 million. peryear).
Start-up and micro loans, loans for micro companies
Commercial banks are reluctant to finance start-ups due to their high business risks, lack of financial records, the prevalence of information asymmetries between start-ups and banks, and high administrative costs of servicing loans to smaller firms. As a result, Altum provide support for microloans of up to EUR 25 000, while start-up loans up to EUR 150 000, including high-risk innovative entrepreneurs with high growth potential and viable business project investments and current assets (average amount of loans issued EUR 10 million peryear).
Parallel loans
Paraller loans refer to a top-up loan that serves as co-financing for a bank loan in the event that the bank’s terms and conditions are too onerous for the entrepreneur. Available only in addition to bank funding, the loan can be issued to economic operators registered in the Republic of Latvia, subject to restrictions regarding the business sector and financial situation. The loan is available for long-term investments (average amount of loans issued EUR 1 million per year).
Covid-19 support financial instruments
In 2020 Altum launched a number of programmes in response to the COVID-19 pandemic under the Temporary Framework for State aid measures to support the economy during the crisis:
Credit guarantees and portfolio guarantees. SME’s that have experienced objective difficulties in making loan payments to banks due to the spread of COVID-19,have access to a guarantee that allows a commercial bank to defer payment of the principal amount (total state budget financing available EUR 50 million.);
Working capital loans - up to EUR 1 million with a term of up to 3 years. Support is available for SMEs and large businesses. Collateral requirements have been reduced and a reduced interest rate has been applied to receive support (total state budget financing available EUR 60 million. + EUR 99 million.Altum co-funding);
Guarantees for large companies –As a response to the spread of COVID-19, the guarantees aim to support viable companies whose activities require financing in order to restore, maintain and promote their competitiveness, as well as increase turnover, including exports (total state budget financing available EUR 20million);
Recapitalization Fund The fund with a total size of EUR 100 million was established. The State contribution amounted to EUR 48.91 million, whereas the private pension funds contributed with EUR 51.09 million. The fund is managed by Altum on a commercial basis and by using the best industry practices, including guidelines developed by the European Venture Capital Association. The Fund can support -medium and large economic operators whose operations were adversely affected by COVID-19, as well as those large companies that are ready to transform their current business model or adapt to the new realities of life and business. The maximum investment amount is EUR 10 million per beneficiary, and it can be used to finance both investment projects and working capital. The instruments used by the Fund include a) equity investments alone or together with another investor, credit institution or equity fund, by acquiring companies’ shares; b) quasi-equity investments, in the form of subordinated loans, ensuring the right to acquire at least 51% of all shares of the company in case of a default event by converting the loan into equity; and c) investments in corporate bonds, including convertible bonds, to be purchased on the primary market provided that they are listed on the Nasdaq Riga regulated market or in a multilateral trading system;
Loans and interest rate subsidies to undertakings to promote competitivenessIn order to ensure access to finance for large and medium sized undertakings with limited flow of investments s, interest rate subsidies and other appropriate terms are implemented from the financial market participants (commercial banks, private investors) as a response to the impacts caused by the slowdown of economy. Available only in addition to bank funding (total state budget financing available EUR 50million).
Source: See Table 26.3.