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The Latvian Economy, 2010, May

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Swedbank was founded in 1820, as Sweden’s first savings bank was established. Today, our heritage is visible in that we truly are a bank for each and every one and in that we still strive to …

Swedbank was founded in 1820, as Sweden’s first savings bank was established. Today, our heritage is visible in that we truly are a bank for each and every one and in that we still strive to contribute to a sustainable development of society and our environment. We are strongly committed to society as a whole and keen to help bring about a sustainable form of societal development. Our Swedish operations hold an ISO 14001 environmental certification, and environmental work is an integral part of our business activities.

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  • 1. Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department by Lija Strašuna No. 1 • 13 May 2010 Stabilisation in labour market, but is deflationary pressure easing? • Unemployment seems to have reached its peak, bringing stabilisation to the labour market, but the unemployment rate will be high for years to come. Job creation is and will be slow, as exporting sectors are not able to absorb a large part of the current unemployed. To lessen the negative consequences of long- term unemployment, job creation should be supported, and one of the ways to do it is by changing tax policy. • Monthly inflation resumed in early 2010 as upward price pressure came from abroad due to recovering demand and rising commodity prices in the world; meanwhile, local deflationary pressure is still present. Although global price growth is expected to slow in the 2nd half of the year due to gradual fiscal tightening, stronger-than-expected price pressures from abroad might shorten the envisaged deflation period in Latvia. • Unless labour cost cuts are replaced by structural reforms, there is a risk of very low medium-term growth. For the scenario of low inflation together with low economic growth not to come true, productivity gains through increasing production volumes are necessary, supported by activities from the government side to improve the business environment, tax system, education system, etc. Unemployment seems to have peaked… Unemployment rate, % 25 25 After two years of falling economic activity, seasonally adjusted GDP increased by 0.3% qoq in 20 20 the 1st quarter of 2010. With recession being over, it seems that the unemployment rate has reached its 15 15 peak. Registered unemployment rate started to decrease in the first weeks of April, falling to about 10 10 16.7% by the end of the month (about 190,000 unemployed). In addition, the number of newly 5 5 registered unemployed continues to diminish – from about 21,800 persons per month in the autumn of 0 0 2009, it is down to 16,300 in March 2010 (in 2004- Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 2007 it was on average 8,000 per month). Newly registered unemployed, thsd people (rs) According to the State Employment Agency, the Registered unemployment rate number of job vacancies is also increasing for the Job-seekers' rate, nsa fourth consecutive month, albeit very slowly and Source: State Employment Agency, Eurostat from very low levels (2111 positions for the end of April). The development of confidence indices also supports signs of stabilisation in the labour market. The unemployment expectations of consumers diminished notably during the 1st quarter of 2010. However, the improvement has been observed in exporting sectors, while companies operating in the local market are still coping with weak demand. For instance, employment expectations of businesses in manufacturing and services are improving, especially Economic Research Department. Swedbank AS. www.swedbank.lv Mārtiņš Kazāks +371 6744 5859, Lija Strašuna +371 6744 5875, Dainis Stikuts +371 6744 5844 Legally responsible publisher: Cecilia Hermansson. +46 8 5859 1588
  • 2. Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 1 • 13 May 2010 in such exporting sectors as wood, chemicals, … but the labour market will remain weak in machinery and equipment, and base metal the upcoming years industries, as well as in travel, tourism, computers, and research and development-related activities. Overall, there is some stabilisation in the labour market, but, as historical experience shows, the Business confidence, employment unemployment rate will be high for years to come. 1 expectations With low employment, no wage growth, and conti- 80 nuing fiscal consolidation, there is still little hope of the revival of consumer spending needed to sustain a meaningful recovery. 40 We see that job creation is and will be slow, as 0 exporting sectors are unable to absorb a large part of the current unemployed. There are about 230,000 job seekers in Latvia, which is nearly as -40 many as the exporting sectors currently employ. 2 With private consumption and investment starting to -80 recover in 2011, job creation will pick up somewhat, Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 but it is clear that part of the current unemployment Retail trade Manufacturing is a long-term one, as domestic demand sectors will Services not need as many employees as in the boom Source: DG ECFIN years. This situation is encouraging people to Unemployment emigrate, leading to structural problems in the long 200 100 term by diminishing the size and quality of the labour force. 160 80 To lessen the negative consequences of long-term 120 60 unemployment, job creation should be supported. 80 40 One of the ways to do this is by changing tax policy. For instance, targeted and temporary tax dedu- 40 20 ctions might be considered to encourage first employment among younger people and long-term 0 0 3 unemployed. This initiative should be included -40 -20 already in the 2011 budget. Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 Is the deflation story dead? Unemployment expectations over next 12M (rs) Registered unemployment, thsd people Monthly consumer price inflation in the 1st quarter Source: State Employment Agency, DG ECFIN of 2010 was caused by more expensive imported goods and seasonal increases in food prices. At the Job-seekers’ data for the 1st quarter of 2010 will be same time, prices of local goods and services available in late May, but currently it seems that our continued to decline. While the total consumer price earlier forecast of this rate peaking at about 23% in index (CPI) fell by just 0.2% qoq, core CPI (i.e., the spring of 2010 holds. We will see the turning excluding fuel, nonprocessed food, and admi- point in job-seekers’ rate only in August, when nistratively regulated prices) declined by 1.4% qoq Labour Force Survey results for the 2nd quarter will in the 1st quarter of 2010. Monthly increases in be published. However, the dynamics of this rate producer prices at the beginning of the year were will most likely be similar to registered unemploy- mostly driven by more expensive exported ment dynamics (although the latter might decrease production. On a quarter-on-quarter basis, the faster due to weaker motivation to register when unemployment benefits end). Even with a possibility 1 See, e.g., IMF, World Economic Outlook (April 2010), of unemployment rate to increase again in autumn “Chapter 3, Unemployment dynamics during recessions and due to seasonal factors, unless recovery in the euro recoveries: Okun’s law and beyond”. zone is substantially slower than expected due to 2 Swedbank estimations. For instance, there are about 130,000 Greece problems, the unemployment rate reached employed in manufacturing, which is about 14% of total this spring will still be the maximum. employment. In the service sectors, there might be up to 100,000 people working for exports (about 10% of total employment). 3 For more details, see IMF, World Economic Outlook (2010). 2 (4)
  • 3. Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 1 • 13 May 2010 producer price index (PPI) of production realised in changes might influence price developments the local market declined by 0.2%, while that of substantially, though (especially direct taxes, such exported production rose by 3.2% in the 1st quarter as VAT or excise). Therefore, when planning tax of 2010. changes, the authorities should consider not only the fiscal effect and the effect on incomes but also Core inflation and total CPI, yoy, % the influence on prices. Timing is particularly 20 4 important, taking into account the euro adoption target in 2014. 15 3 Although low inflation might make the further 10 2 process of competitiveness adjustment slower than 5 1 it would be in the deflation case, it would somewhat ease the deleveraging process, as well as increase 0 0 budget revenues (e.g., tax revenues would rise due to growing turnover) and diminish the budget deficit. -5 -1 CPI growth (yoy), % -10 -2 Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 20 Core inflation, mom Total inflation, mom Core inflation, yoy Total inflation, yoy 15 Source: CSBL, LaB 10 Overall, it can be seen that upward price pressure is coming from abroad, due to recovering demand 5 and rising commodity prices in the world. In addition, the weakening euro exchange rate against 0 US dollar is beneficial for Latvian exporters (outside the euro zone), although it makes imported energy -5 resources more expensive. Jan.08 Jul.08 Jan.09 Jul.09 Jan.10 Eurozone SE UK Producer price inflation, yoy RU EE LT LV Source: Reuters 25 20 15 Competitiveness still improving 10 It should be emphasized that deflation is not a 5 necessary condition for improving competitiveness. 0 What matters is Latvia’s development relative to its trading partners. In the 1st quarter of 2010, -5 competitiveness continued to improve due to a -10 bigger price growth in trading partner countries, as -15 well as to favourable exchange rate developments. -20 For instance, the CPI-based real effective exchange Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 rate (REER) of the lats has already declined by 9% Total Local market Exported from its peak in February 2009 – an amount that is nearly 1/3 of its appreciation since 2006. A similar Source: CSBL trend can also be observed in the PPI-based REER. Although global price growth is expected to slow in So far, the competitiveness adjustment has been the 2nd half of the year due to a gradual fiscal achieved through labour cost cuts, which cannot be tightening, stronger-than-expected price pressures continued forever, while productivity improvement from abroad might shorten the envisaged deflation 4 has been weak. Unit labour costs were also period in Latvia. Nevertheless, local deflationary reduced in the 1st quarter of 2010 – unemployment pressure will still be present, as the labour market will be weak and deleveraging will proceed. This pressure, together with low global inflation, implies 4 For more details see our recent Swedbank Analysis „Competitiveness that, even if inflation in Latvia resumes, it will be adjustment in Latvia – no pain, no gain?”, available at subtle (excluding the effect of tax changes). Tax http://www.swedbank.lv/eng/docs/materiali.php?nmid=0&naid =3 3 (4)
  • 4. Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 1 • 13 May 2010 rose, and, according to our forecast, wage cuts Risks to future growth continued. However, it seems that most of the Unless labour cost cuts are replaced by structural potential to improve competitiveness through labour reforms, there is a risk of very low medium-term cost cuts and weak labour market driven deflation growth. In our opinion, the risk of stagflation (i.e., has been used by now. At the same time, with the high inflation and no growth) is very small, but the labour market remaining weak, there are no strong scenario of low inflation together with low economic inflationary pressures. Further adjustment through growth is more likely. In case of low global inflation, the labour market would be extremely painful, this would make the process of improving squeezing domestic demand further and competitiveness slower and longer than it could be undermining the recovery. The competitiveness with local deflation, and export-driven growth would adjustment is not yet over, but, in our opinion, also decelerate. For this scenario not to come true, further gains should be obtained via productivity- productivity gains by increasing production volumes enhancing structural reforms. are necessary, supported by activities from the Effective exchange rates of the lats, government side to improve the business 2005=100 environment, tax system, education system, etc. 140 130 Lija Strašuna 120 110 100 90 Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 NEER REER_CPI REER_PPI Source: Bank of Latvia Swedbank Economic Research Department Swedbank’s monthly newsletter is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported in Balasta dambis 1a, Riga, LV 1048, Latvia this publication. However, we cannot guarantee the accuracy or completeness of the report www.swedbank.lv and cannot be held responsible for any error or omission in the underlying material or its Martiņš Kazāks, +371 6744 5859 use. Readers are encouraged to base any (investment) decisions on other material as well. Dainis Stikuts, +371 6744 5844 Neither Swedbank nor its employees may be held responsible for losses or damages, Lija Strašuna, +371 6744 5875 direct or indirect, owing to any errors or omissions in Swedbank’s monthly newsletter. Legally responsible publisher Cecilia Hermansson, +46 88 5859 1588 4 (4)