The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Departmentby Lija Strašuna No. 2 • March 2, 2012Economic growth continues, but Latvia is not immune toeuro zone problems In the fourth quarter of 2011, Latvia experienced the strongest economic growth in the European Union. Latvian GDP rose by 5% in annual terms, leaving behind both Lithuania and Estonia. Is the Latvian economy immune to euro zone problems? Of course, not... As expected, economic growth is slowing in Latvia. Still, confidence remains quite robust, and exporting sectors showed good results in the fourth quarter of 2011 despite a quarterly GDP fall in some of Latvias main trading partners. Economic sentiment indices and the collection of tax revenues in January-February 2012 suggest that economic activity has continued to rise, but most likely at a slower pace. Further developments will depend on how much demand for Latvian exports will weaken. Household consumption and investment dynamics will rely on the performance of exporting sectors (manufacturing, tourism, and transport). Under the baseline scenario, we expect economic growth in 2012-2013; however, uncertainty continues to be the name of the game. It is thus useful both for the public and private sectors to have action plans for several scenarios and to remain flexible. And it should also be borne in mind that, even if growth continues, it will not per se solve many of the existing problems in the economy, including inequality, too-slow job creation, skills and regional mismatches, and the diminishing and aging population.According to the flash estimate by the Central Real GDP growth, 2007=100 (sa)Statistical Bureau of Latvia (CSBL), Latvias GDProse by 0.8% in quarterly terms in the fourth quarter 110of 2011 (seasonally adjusted). This reveals anexpected slowdown in economic growth.Meanwhile, according to preliminary data, such 100important Latvian trading partners as Estonia,Germany, and Sweden experienced quarterlygrowth declines (-0.8%, -0.2%, and -1.1%, 90respectively). According to revised data, the EELithuanian economy grew by 1%, slower than in theprevious four quarters. 80 LV LTAnnual growth in Latvia was the strongest in the EUin the fourth quarter (5% vs. 4% in Estonia and 704.4% in Lithuania). However, the early phase of 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10 1Q 11recovery went more quickly in Estonia and Source: EurostatLithuania, partly owing to their larger export baseand differences in leverage levels. The Latvian Do the latest data suggest that the Latvianeconomy is still 16% below its pre-crisis peak in economy is immune to euro zone problems? Of2007, while Estonias and Lithuanias trail by 9% course, not… Growth is very likely to have beenand 8%, respectively. stronger if economic developments in the rest of Europe had been better. There are also differences in the length and depth of economic cycles in various countries (e.g., depending on the structure Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000. E-mail: email@example.com www.swedbank.com Legally responsible publisher: Cecilia Hermansson, +46 8 5859 7720. Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Dainis Stikuts, +371 6744 5844.
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 2 • 2 March 2012of their industries). Latvia might just lag other While confidence indices declined quite sharply inEuropean countries a quarter or two. Is Latvias the second half of last year, in the euro zone,GDP falling already in the first quarter of 2012? Sweden, Estonia, and Lithuania, they stayed surprisingly robust in Latvia.1 This applies both toGrowth is slowing, but optimism is still the consumer optimism that supported spending,surprisingly robust and to the manufacturers’ sentiment, backed up by exports. In January-February 2012 economicAlthough the last-quarter results were quite strong, sentiment in Latvia notably improved (similarly toLatvian economic growth has started to decelerate. that in Germany). The question is how long canDetailed data are to be published on March 9; such a “walk on water” continue.however, it is already known that both industry andretail trade decreased in quarterly terms in the Economic sentiment, points (sa)fourth quarter of 2011 (by 0.5% and 0.8%,respectively). This might be partly explained by 130one-off effects, e.g., a decline in heating productiondue to the unusually warm weather, and the brief 120turbulence in the banking sector kicked off byclosure of Latvijas Krājbanka. At the same time, 110warm weather without snow allowed construction 100output to continue increasing late last year (+4% inquarterly terms); freight transportation and tourism 90also expanded. 80 EZ LVReal GDP growth, % EE LT 70 DE SE 20 10 Quarterly, sa (rs) 60 Annual, nsa 2007 2008 2009 2010 2011 2012 10 5 Source: Ecowin In the fourth quarter of 2011, Latvian manufacturing continued to grow (1.9% in quarterly terms, 9% in 0 0 annual terms). At the same time, there was a quarterly fall in output of industrial sectors2 in Germany (-2.1%, for the first time since the third -10 -5 quarter of 2009) and Sweden (-1.2%). Many Latvian manufacturers are subcontractors to producers in these countries. The question thus arises whether -20 -10 the growth of Latvian manufacturing is sustainable. 2007 2008 2009 2010 2011 Source: CSBL If the confidence in, and output of, the manufacturing sectors of the Baltic Sea region andIndustry, retail trade, and construction, 2007=100 (sa) the euro zone improve in the first and/or second 120 quarter, most Latvian producers have a good chance of getting through the euro zone crisis without a fall in demanded production volumes from 100 those countries. It is not very likely, though, that they will get many new orders, due to both local 80 capacity constraints and a slowdown in demand growth in Europe. In such a case, manufacturing and export growth will weaken but remain positive, 60 and confidence will not worsen notably. 40 Industrial output Retail trade w/o motor vehicles Construction output 1 20 It is true, though, that Latvian confidence indices did 2007 2008 2009 2010 2011 2012 not grow as quickly in the second half of 2010 and the Source: CSBL first half of 2011 as in other countries. 2 Including mining, manufacturing, electricity, and gas supply. 2 (5)
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 2 • 2 March 2012Manufacturing output, 2007=100 (sa, 3M average) Annual growth of retail trade (excl. motor vehicles) and wage bill, consumer confidence 120 40 Food, % 0 110 Non-food (excl. fuel), % Real wage bill, % 20 Confidence, points (rs) -15 100 90 0 -30 80 EZ LV EE LT -20 -45 70 DE SE 60 2007 2008 2009 2010 2011 -40 -60 Source: Eurostat 2007 2008 2009 2010 2011 2012 Source: EurostatHowever, if demand for Latvian goods fromproducers in Baltic Sea region countries continues In 2011 (and also January 2012), retail trade wasto worsen, and they do not need to replenish their mostly driven by purchases of durable goods, owinginventories, orders for Latvian subcontractors will to rising optimism and lower prices, as well as theshrink as well. In such a case, the confidence and growth of incomes (both employment and wages).exports of Latvian manufacturers will be hampered Consumer confidence continued to grow in themuch more. If the negative scenario of deep beginning of 2012. Somewhat paradoxically though,recessions for Germany and Sweden materialises, an increase in consumer optimism in February wasLatvias export growth will be negative this year. mostly due to rising savings expectations.3 The expected financial situation of households over theIf the confidence of exporters deteriorates, they are next year did not rise much, thus indicating perhapslikely to postpone investments, especially given the that households are planning some precautionarycredit crunch in Europe. Available EU funds and savings. If the savings rate increases andalready started projects will weaken this negative consumers’ perceptions about the labour marketeffect, though. and the overall economy weaken, spending on durable goods could decline quite sharply.Since economic growth in Latvia is still very muchexport driven, developments in the exporting Consumer confidence, expectations over next 12sectors will definitely influence the confidence also months, points (sa)in other sectors of the Latvian economy. Therefore,depending on how strongly exporters are hit, 120 Financial sit.consumer optimism and private consumption will be General econ. sit.hindered accordingly. 80 Savings Unemploym. expect. 40 0 -40 -80 2008 2009 2010 2011 2012 Source: DG ECFIN 3 A larger share of respondents said that they are likely to save money during the next 12 months. 3 (5)
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 2 • 2 March 2012Tax revenues: so far, so good Economic sentiment and real GDP growthAlthough it currently looks like Latvias economic 120 20%growth will continue to slow, so far it remains quite ESI, points 15%robust. Annual GDP growth (rs) 110 10%Annual growth of tax revenues (3M average) and 5%nominal GDP, % 100 0% 40 -5% VAT 90 Total tax revenues -10% 20 Nominal GDP 80 -15% -20% 70 -25% 0 2006 2007 2008 2009 2010 2011 2012 Source: CSBL, DG ECFIN-20 The authorities should thus continue closely monitoring the budget and confidence data in order to be able to react if the economic situation-40 worsens. Unfortunately, the government still does 2008 2009 2010 2011 2012 not have (or at least has not communicated) a “plan Source: State Treasury B” and keeps saying that their forecasts areTax revenue performance in January was still good conservative enough. So far, the budget plan does(16% growth in annual terms, 10% above the plan). look feasible and has some safety margin, but theFor comparison, tax revenues grew by 12% in 2011 uncertainty surrounding the euro zone debt andoverall. Therefore, the government budget is not financial crisis and its influence on the Latvianunder pressure, at least not yet. Although it is very economy is still high.likely that a part of tax revenues relates to the fourthquarter of 2011, this performance indicates that It is also useful to have action plans for severaleconomic activity has continued to rise in the scenarios in the private sector. Businesses seem tobeginning of this year. be a bit more cautious and flexible in their behaviour that the government sector – althoughEconomic sentiment also remains healthy so far. they are still quite optimistic about future prospects,Retail trade volumes rocketed in January 2012 by most of them are prepared also for tougher6.4% in monthly terms (seasonally adjusted), developments (they have accumulated reservesreaching 16.6% annual growth (see also the graph and can adjust their behaviour quite quickly ifon the previous page). There was a pickup in necessary).registered unemployment rate in January-February The households’ position is probably the weakest –(to 11.8% from 11.5% in December 2011); their leverage has been reduced and incomes havehowever, this is seen as a seasonal phenomenon. risen, but rapid spending growth is a bit worrisomeUnless the rate continues to increase in March, since the level of savings is still quite low andthere are no reasons to worry about this rise. unemployment high.But uncertainty is still the name of the game. Dataare coming with a delay and may bring unpleasant Will growth cure all the problems?surprises. A quarter of negative quarterly economic Even if negative scenarios do not materialise andgrowth is very likely this year, and, given the fourth- growth continues (under the base scenario, wequarter data for Latvias main trading partners, this forecast 2% economic growth in 2012, down frommight turn out to be the first quarter of 2012. 5.2% in 2011),4 there are still many issues to be solved. The currently forecast slow growth will neither cure labour market problems, nor address demographic 4 For a more explicit description of possible scenarios and more detailed forecasts, see Swedbank Economic Outlook, January 2012 4 (5)
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 2 • 2 March 2012challenges in general. With the existing economicpolicy in place, job creation will be too sluggish tosignificantly reduce unemployment and incomeinequality, or to raise living standards to lessenemigration.The latest IMF report on Latvia5 highlighted theissue of increased poverty and argued that thecurrent social safety net and tax policy should beadjusted to improve incentives for the poor to workand for businesses to create new jobs. Although thediscussion on social policy changes and thereduction of labour taxes has started, it is far fromover, and no decisions have been made yet. Thedeclining and aging population requires anadjustment in the pension system. The governmenthas just agreed on a gradual increase in the retiringage beginning in 2014 (not 2016, as plannedbefore), so that it reaches 65 in 2020 (currently 62).This will help, but it does not address issues of jobcreation, productivity, and income growth, which arefundamental to pension system sustainability. Skillsand regional mismatches in the labour marketrequire reforms in education, especially higher andvocational education. Lija Strašuna 5 http://www.imf.org/external/pubs/cat/longres.aspx?sk= 25709.0 Swedbank Economic Research Department Swedbank AB. SE-105 34 Stockholm. 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 Legally responsible publisher this publication. However, we cannot guarantee the accuracy or completeness of the report Cecilia Hermansson, +46 8 5859 7720 and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, Martiņš Kazāks, +371 6744 5859 direct or indirect, owing to any errors or omissions in Swedbank’s monthly newsletter.5 Dainis Stikuts, +371 6744 5844 http://www.imf.org/external/pubs/cat/longres.aspx?sk= Lija Strašuna, +371 6744 587525709.0 5 (5)