The growth of Latvia’s gross domestic product (GDP) turned out unexpectedly strong in Q1 2022. GDP growth will be much lower in Q2, however. Generally the year will be difficult in Latvia, according to economists.
«The year started off promising for the economy because the national economy had time to enjoy post-pandemic restrictions effect, but Russia’s invasion of Ukraine had not yet reached its full effect on the economy,» Luminor Bank economist Pēteris Strautiņš comments the latest GDP results. He does add, however, that the year will be difficult, and not just for the economy. The bank’s economist suggests being patient.
«There are two major factors that have an effect on GDP in Q2 – lifted epidemiological restrictions and the war in Ukraine. Real world observations indicate the quarter has commenced with a significant upturn of consumption. Unrest around the world disrupts tourism. The restaurant sector, however, is doing better than it did in recent past. The public sector financing intended for massive investments has not gone anywhere even though transformation into physical assets will be a challenge due to increase of costs. The housing market continues developing – the drop in demand for mortgage loans lasted a couple of weeks due to the geopolitical crisis,» explains the economist.
Strautiņš adds that «the effect or recent events on the economy will be negative.
It is very possible GDP will decline in Q2. It may happen in Q3 as well. Direct losses from loss of exports to Russia are part of the problem.
Last year exports of Latvian goods and services to this country accounted for 1% of GDP. Exports to Russia may be lost entirely by mid-2022 due to sanctions and termination of transport and financial cooperation. There is also negative influence observed for exports of tourism services to the west. This is the first year since 2011 when purchasing power or real wages are decreasing.»
«There is also the risk of the European Union and, perhaps, the global economy entering a state of recession. This is why this year we expect the economy to grow 1.7% thanks to a good start of the year. But in some quarters GDP may turn out below the numbers of previous years. We expect a growth of more than 3% for next year, assuming, of course, the war in concluded by autumn 2022. That’s when the economy will benefit both from stronger export growth and energy price drop, which is very likely to lead to a general consumer price level reduction in the second half of the year,» stressed the bank’s expert.
«The year started off on a positive note for the economy. A very important contribution to such a good result were the measures imposed to reduce infection risks and less restrictive rules when compared to Q1 and Q4 of 2021. The GDP indexes exclude a price growth effect. If we look at GDP in actual prices, the increase observed over the course of the year becomes even more impressive and exceeds two-digit numbers,» BNN was told by Swedbank chief acting economist in Latvia Agnese Buceniece.
The biggest challenges for Latvia’s economy at the moment, according to her, are high prices and high level of uncertainty, including in regards to availability of imports of energy resources. Swedbank predicts economic growth will weaken significantly in the coming years. Quarter to quarter declines are expected in a couple of quarters. Generally the volumes produced in the economy this year will increase and will exceed last year’s level by 1.4%. Uncertainty and negative risks are high. This is why the economic development scenario may be even worse.
SEB Bank economist Dainis Gašpuitis told BNN that «the year started off strong for the economy, which benefited from optimism and normalisation after a whole winter spent under Covid restrictions. With restrictions lifted the service sector and consumption are slowly recovering. This is reflected in retail trade data and tax revenue. Growth continues in the processing industry, and high growth rate is observed in exports. The transit sector is doing unexpectedly well even though this sector’s perspectives are grim. On the other hand, growing import volumes are leaving a negative impact. We have to remember that strong growth is formed based on last year’s results, when GDP dropped -0.9%. In Q2 growth will be lower because of this reason.»
«Due to many complications positive flows have entered a transitional stage. The situation is expected to change drastically in the second half of the year, especially closer to the end. Conditions will remain favourable for growth of consumption in the coming months. Inflation growth, however, will gradually slow it down. This will become more apparent at the end of the year, when public utility bills are expected to grow significantly.
Consumption potential will be maintained by the savings made during Covid-19 pandemic. The growth of these savings has already slowed down. SEB Bank’s survey confirms residents’ ability to save money are running out and they have started using their savings to cover expenses.
Sharp consumption changes may affect entrepreneurs’ mood and investment plans. The mood of processing industry entrepreneurs shows no signs of any major changes in demand. A slight increase is observed for the growing financial difficulties and problems with raw materials. The most challenging task in the coming months will be looking for alternatives to raw materials previously supplied by Russia. The ability of the construction sector to avoid increase of costs and absorb EU finances will depend on this. Export expansion towards the west will continue nonetheless,» warns Gašpuitis.
Read also: Luminor: war in Ukraine has created more problems for construction than Covid-19 pandemic
According to him, «the high level of uncertainty for the second half of the year will consist of high spectrum risks, which increase the possibility of significant slowing of growth. This means the main enemies of growth will be the combined growth of food and energy costs, which is especially unpleasant for households, and this means a bigger drop of purchasing power of households, making them more cautious. The government’s future support mechanisms will play a major part. Focused benefits will allow for more effective use of budget resources. However, under certain conditions there comprehensive measures may be needed, including for entrepreneurs. Timely preparation will reduce the possible stress in society. Energy accessibility and prices will remain a topical problem. The state is working on it to avoid the risk of energy crisis. The epidemiological situation in Latvia and the rest of the world and the ability to avoid lockdowns will remain an important factor. Because the growing inflation has forced central banks to speed up conclusion of stimulating policies, it will be necessary to add corrections to their policies. Excessively aggressive restriction of inflation may result in even weaker economic activity. The strong start of the year will allow meeting a new wave of challenges from a good position. GDP outlook for the year is 1.8%. Considering the strong start of the year and the possibility of risks not materialising, this year’s success may turn out even better.»