In the second half of the year Latvia’s economy may become worse, and the coming years are promised to be challenging, according to bank economists.
Citadele Bank economist Mārtiņš Āboliņš stresses that the situation for Latvia’s economy remains positive despite Russia’s invasion of Ukraine. In Q1 2022 Latvia’s GPD grew by 6.7% when compared to Q1 2021.
Throughout the quarter Latvia’s GDP increased by 3.6%. Now Latvia’s economy is 4.6% bigger than it was before Covid-19 pandemic. Considering the price rise, in euros Latvia’s GDP is up to 20% larger than it was at the end of 2019. Āboliņš explained that this is a very rapid increase, and the good news is that in April and May the situation did not change significantly.
The economist notes that residents’ spending continue increasing. Covid-19 restrictions have been lifted in service sectors, foreign demand in industrial sectors is strong, households have savings and energy resource price growth remained compensated by the state by the end of April. At the same time, unemployment is down on the labour market, wages are on a rise and the negative effect from the war in Ukraine is not felt yet.
However, the risks for economic growth have increased considerably in recent months. The coming years will be challenging for Latvia’s economy, according to Āboliņš.
Although different Covid-19 restrictions remained in place in the first months of 2022, Latvia’s economy has not only become larger than it was before the pandemic but most sectors have also increased in Q1. Compared to Q1 2021, the accommodation and catering industry has increased by 87.2%, art and entertainment – by 26.8% and professional services – by 21.3%. At the same time, the processing industry has increased by 8.3% and the transport industry – by 8.2%.
Āboliņš explains that accommodation, entertainment and transport sectors’ growth is linked to relatively lower Covid-19 restrictions this year. Activity in these sectors remains behind 2019. In Q1 2022 construction and mining sector’s output went down when compared to the year before.
Read also: Latvia’s GDP up 6.7% in first quarter of 2022
«Unfortunately, the second half of the year may turn out less positive. Partly because of Russia’s invasion of Ukraine and the rapid price rise, the general mood of consumers has worsened significantly in March and April. On top of that, wage rise is behind price rise,» said Āboliņš.
He explained that foreign demand in the industrial sector remains strong and new industrial orders continue growing in Baltic States. However, finding suppliers of medals, chemical products and other raw materials will take time and will increase costs.
The slowing of the global economy is becoming more and more apparent and the decision to cut economic ties with Russia will start causing consequences in the second half of the year, predicts Āboliņš. According to him, the full effect of inflation will be felt in the second half of the year, when the heating season begins even though state aid is planned.
Finally the interest rate rise is starting to cool the US technologies sector. Since April the number of laid off employees has started growing.
However, Āboliņš believes there is currently no reason to worry about the IT sector in Latvia, as exports of this sector’s services have increased by more than 15% in the last 12 years. Nevertheless, global developments still affect Latvia at least partially. This is why the risk of recession in Baltic States is high for the next year or year and a half. According to Citadele Bank’s economist, Latvia’s GDP may increased by approximately 3% this year. GDP growth in 2023 is expected at only 1%.
Luminor Bank economist Pēteris Strautiņš says finally Latvia’s economic growth is ahead of Lithuania and Estonia. In Q1 Latvia’s GDP increased by 6.7% when compared to the start of 2021. In Estonia and Lithuania growth was 4.3% and 4.6% respectively. This is seasonally unadjusted data – in adjusted data Latvia’s neighbouring countries did slightly better (4.7% and 4.3% respectively). In Latvia the economy increased by 6.4% in comparison.
When compared to the previous period, the growth was 3.6%. Strautiņš said this is a very impressive index. This accomplishment was promoted by the curfew imposed in autumn 2021 and its effect on the result of Q4 of the same year. In Estonia growth by quarter has almost stopped (0.1%), whereas in Lithuania it was 1%. Strautiņš adds that the rapid growth in across quarters mainly came from increased taxes – VAT tax amounts, for example, increased by 0.7% when compared to the end of 2021.
The economist explains that the result of Q1 is mainly dictated by the major economic progress, not short-term fluctuations. This is reflected in the form of real export growth of 8.6%. The end consumer costs increased even more rapidly – by 11.2%. However, it is also necessary to take into account the base, which is very low for consumption and rather high for exports, because it had recovered relatively well from the first wave of the pandemic a year ago.
Strautiņš stresses that the increase of 83.3% for hotels and restaurants is a base effect and the situation remains complicated. The increase of processing industry was 8.3%, for information and communications industry it was 8.6%, for commercial services – 16.6%. This growth was the continuation of the story of success that remained mostly unaffected by the pandemic, said the economist.
The situation varies in sectors that are focused on domestic demand.
The biggest one – commerce – increased by 8%. The 8.4% drop of added value in construction was a disappointment but not a surprise, said Strautiņš, adding that there are large monetary investments, but their use is impeded by different organisational problems and growing material prices. In spite of increase of costs, construction in Estonia grew by 14%.
In Latvia investments in fixed assets increased by a mere 1.9% over the course of a year, Strautiņš said. The biggest drop – 12.7% – was in other construction, which mainly focuses on energy. Demand for heating was relatively low due to warm winter, whereas electricity production was impacted by high gas prices.
Strautiņš points out that data regarding the industry and GDP income side is particularly interesting this time around. The general wage fund increased by 13.2% in Q1 2022. He explains that even though average hourly rate has increased by 6.8% consumer prices increased by 9.22%.
The economist adds that this year’s successful reduction of PIT and increase of child benefits helped household’ income grow more rapidly. The component that contributes to the income of companies and self-employed persons – gross operating surplus – increased by 23.8%.
Companies face many problems, but the inability to increase prices is not one.
At the same time Strautiņš stresses that GDP result of Q1 2022 is much better than what is expected for the year. He predicts GDP growth will be around 2% this year, which, combined with the impressive accomplishment observed at the start of the year, allows for drop at the end of the year, when consumption will be pressured by growing prices, and export may be cut off by a very possible recession in Eurozone and slower growth in the US, where a recession is also possible.
Strautiņš notes that the good results are largely a result of previous slow growth rate in the Baltics. In Lithuania the government manages to stimulate consumption during the pandemic very successfully. In Estonia the government collected the fruits of the past labour put in to the industry’s development. There were also volatile success factors. This means this year’s results may be more modest. Strautiņš believes in the next couple of years it may be beneficial for Latvia that the housing markets of neighbouring countries have overheated slightly. In Latvia, on the other hand, the market’s development is just beginning.
Read also: Economy of Estonia expanded 4.3% on year
«We can and should use these short-term factors. However, to achieve convergence or equalisation of income with Baltic States, we have to do much more. We have to prevent defects of the economic policy by reducing political and administrative obstacles for added value generating activities for the construction of wind parks, factories and office buildings. It’s also necessary to create ambitious and realistic export specialisation strategy, which is something Lithuania succeeded in doing, becoming a financial technologies development centre,» said Strautiņš.
Swedbank acting chief economist Agnese Buceniece notes that GDP growth of 6.7% is a better result that what the flash estimate suggested a month ago. Reduced risk of the virus spreading and softer restrictions allowed economic activity to recover last year.
Buceniece explains that economic growth in Q1 benefited the most from household consumption, which increased by 15.1% over the course of the year. This index is in comparable prices, which excludes direct inflation influence. Residents spent more money on accommodation and catering, as well as leisure and culture events, which further contributed to the growth of these sectors. Tourism-related sectors, including passenger transports by air, commenced the years on a positive note. Growth of tourism, transport and other sectors helped develop exports of services.
The quarter was good for exporters and manufacturers of goods, said Buceniece.
Total export volumes, excluding the price effect, increased by 8.6%. With increased household expenditures there is also increased volume of imports – 15.6%. Investment activity is behind because increase was only 1.9%. Buceniece explained that this is related to the drop in the construction sector, which was slowed by both unfavourable weather and high construction costs, as well as shortage of different materials. Two of those factors were influenced by Russia’s invasion of Ukraine and the anti-Russian and anti-Belarusian sanctions.
Buceniece stresses that investments unrelated to construction increased at the start of the year, and this is good news. Government expenditures grew slower than investments. Government expenditures remained mostly on the level of 2021, increasing by a mere 0.3%. With risks of the pandemic down at least temporarily, certain positions of expenditures can be diverted towards support of the least protected residents to help them overcome the rapid price rise.
According to the Swedbank economist, the biggest challenges for Latvia’s economy are the growing prices and high uncertainty, including in regards to availability of imports of energy resources. She also admits that reorganisation of supply chains and exploration of new export markets will take time and money to replace Russian and Belarusian partners. Data for recent months indicate that economic activity will remain positive thanks to the ability to adapt acquired during the pandemic.
The economist reminds that improvements were observed on the labour market in spring months – unemployment is down, employment is up and the number of available jobs is high.