For the economy to grow and prosperity to increase, businesses need to continuously invest in new equipment, buildings, etc. If investments are made today, there is every reason to expect a return tomorrow. If investments are not made, this means less income over the next five to ten years.
In Latvia, a sharp decline in foreign direct investment took place after the start of the 2008 crisis. In the third quarter of 2008, the accumulated foreign direct investment amounted to €8.5 billion. With the onset of the crisis, foreign capital started to evacuate, and by mid-2009 accumulated FDI had fallen to €7.9 billion. The pre-crisis level was only reached in early 2011. In 2010-2012, a third of all investment in Latvia came from state and local government investments in the share capital of Latvian companies. If the state's capacity to invest in development is limited, it can force entrepreneurs to invest through political means. For example, it was only by threatening to impose a 20% tariff on cars made in Mexico that then US President Donald Trump forced Japanese carmakers to re-invest in the US in 2017. In 2021, private investment accounted for 18.8% of Latvia's total GDP, while public investment accounted for 4.8% (Latvia Macroeconomic Review, p. 10).
This year's Latvia Macroeconomic Review, prepared by the Ministry of Economics, stresses that "in the long term, private investment remains at a low level, largely due to weak lending, low demand and high uncertainty. The negative impact of these factors on investment was significantly exacerbated by the Covid-19 crisis." In turn, caution about taking on new risks has only increased following Russia's aggression against Ukraine (Financial Stability Report (29/06/2022), p. 12).
Given the caution of the domestic private sector, foreign direct investment has been an important driver of Latvia's economic development. However, caution is needed when analyzing foreign direct investment statistics produced by the Bank of Latvia. For example, during 2021, the amount of accumulated foreign direct investment increased by an incredible €4.2 billion. However, it should be borne in mind that three billion of the increase in the surplus balance relates to just one month (October 2021) and just one country (Sweden). As one of Latvia's largest foreign investors implemented a change of shareholder structure on October 1, 2021, when a single Swedish company became the holder of all shares, it is likely that this statistic also reflects a change in accounting treatment (the law prohibits the statistical authority from identifying statistics down to the level of a single company).
However, despite such exceptions, FDI is generally a good indicator of business sentiment. As the statistics on investment flows for early 2021 show, the Russian aggression in Ukraine did not cause a massive flight of foreign capital from Latvia.
In the first four months of this year, the balance of foreign direct investment was plus €420 million, and the balance was negative for only one month - in March 2021, when foreign direct investment balances fell by €31 million. As the Russian direct investment balance fell by €19 million in the first quarter of 2021, it can be concluded that the outflow of foreign capital this year was due to the change of ownership of Russian companies. However, Russian accumulated capital in Latvian companies remains very high at €1.8 billion.
In April this year, the stock of foreign direct investment increased by €93 million, suggesting that Russia's aggression against Ukraine has not provoked a rapid evacuation of foreign capital from Latvia.