According to the viewpoints of investors, Latvia’s investment climate in 2019 was still seen as average, reaching 2.6 points out of five, which is an improvement by only 0.1 point in comparison with 2018, as concluded in the “Sentiment Index 2019” research by the Foreign Investors’ Council in Latvia (FICIL) and Stockholm School of Economics in Riga (SSE Riga).
“Under the current circumstances, foreign investors in Latvia feel relatively well, and the share of companies planning to increase investment has risen from 55% in 2018 to 64% in 2019. However, entrepreneurs emphasise a number of unresolved problems hindering Latvia’s competitiveness in attracting new investment, such as lack of workforce, worsening of the demographic situation, quality of education and the high share of shadow economy. In addition, labour costs continue to rise sharply, which may lead to a situation in the coming years where some companies look for other locations for functions that generate lower added value. Latvia’s challenge is to improve the competitiveness so that we are prepared for a situation where the outflow of investments with lower added-value will have to be replaced with new, high added-value investments”, says Dr. Arnis Sauka, professor of SSE Riga.
The 2019 study focussed on four topics that, according to investors, are currently crucial for Latvia’s ability to compete for foreign investment, namely, the stability and development of the financial sector, tax system, the quality of higher education and productivity of workforce.
Investors have evaluated the progress achieved during the previous year in effectiveness combating economic and financial crime with 3.2 points on a five-point scale. The year 2019 in the financial sector was the year of an “overhaul”, and while investors commend the activities carried out, only in February we will have more clarity on whether Latvia is able to avoid the grey list. At the same time, new requirements from the banking industry have created difficulties and additional burden for businesses. Banks are placing high demands on their customers and not all companies have the necessary knowledge and tools to fulfil them.
Foreign investors also assessed the 2018 tax reform with3.1 points out of five, which is slightly above average. Investors emphasised the need to simplify the tax system. Most investors mentioned the introduction of the zero-tax rate for reinvested profits as a very positive improvement, and in some cases, investors also commended the introduction of the progressive income tax rate. However, before launching a discussion on the content of upcoming tax reform in 2021, majority of the investors indicate that a comprehensive analysis of the results of the previous reform should be carried out.
The quality of education and science in Latvia was evaluated with 2.7 points which is a relatively significant decrease compared to the situation a year before -3 points out of 5. As a country with a declining population, it is particularly important for Latvia to ensure competitive higher education. Otherwise, it will be impossible to sustain long-term economic growth. Investors urge to continue the ongoing changes to modernise the governance model in higher education institutions, as well as to address the insufficient level of funding.
Index for the productivity of workforce, compared to the previous four years, has reached its highest point so far – 3.4 out of 5. However, investors point out that productivity remains a challenge both in the private sector and in public administration. Investors believe that public administration has many opportunities to reduce bureaucracy, streamline processes and develop e-services. In many cases, investors also expressed the view that the municipal reform could have a positive impact on the efficiency of the public sector.
Investors also highlighted imminent challenges, requiring immediate attention from policy-makers. These are issues of availability of workforce, situation regarding demography and healthcare sector, predictability of the business environment, as well as fair competition, reducing shadow economy and setting a clear vision for Latvia’s future. Labour force shortage is at a critical point, unemployment rate is low, however no new mechanisms have been created to deal with the problem of availability of workforce. Although entrepreneurs are actively investing in improving productivity, it addresses the problem only partially. Investors also point out that the lack of a clear vision prevents Latvia from becoming more competitive.
Investors’ assessment of the performance of policy makers has improved over the past year from 2.9 to 3.1, which is a positive assessment of the work and initiatives undertaken by the Prime Minister and the new State President.
About the research
FICIL Sentiment Index was first launched in 2015 by FICIL in cooperation with SSE Riga. The key aim of the Index is to foster evidence-based policy decisions and promote a favourable investment climate in Latvia. This is the fifth consecutive report, which is based on a survey: mini case studies of foreign investors. From September to early November 2019, we interviewed 47 senior executives representing key investors in Latvia, which contribute significantly to Latvia’s economy with almost fourth (23%) of taxes paid by companies, 9% of the total profits and employing more than a tenth (11%) of the total workforce in all companies with an annual turnover above 145 000 EUR and 50% foreign capital.
FICIL Sentiment Index 2019 is supported by the Norwegian Embassy in Riga and the US Embassy in Latvia. The full research is available here: https://www.ficil.lv/research/