The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Departmentby Dainis Stikuts and Mārtiņš Kazāks No. 1 • January 17, 2011Strong export-driven investment growth in 2011 • Most of GDP growth in 2011 came from investments into fixed assets; e.g., in 9 months of 2011, such investment grew by 24.6% year on year (YoY), contributing 5 percentage points to the GDP growth of 5.4%. The growth came from investments in equipment and machinery, which rose by 63% YoY in the first 9 months of 2011, making up 42% of all nonfinancial investments. Meanwhile, investments in buildings and infrastructure (40% of all nonfinancial investments) increased by only 9%. • The largest source of nonfinancial investments is companies’ own resources and loans. The rest is financed by EU structural funds. In 9 months of 2011, FDI inflow was about LVL 600 million, equivalent to about half of nonfinancial investments during that period. However, the largest part of foreign direct investment (FDI) was financial investment used to acquire existing real estate, and to strengthen banks’ balance sheets. Only 10% of FDI went into manufacturing. • Over the next few years, the Latvian economy will remain export driven. We expect single-digit growth in gross fixed capital formation during 2012. Growth of private sector investments depends on exports and, thus, the situation in the euro zone, whereas that of public sector investments depends on the state budget situation and access to EU funds.Kick-started by the 2008-2009 recession, the Contribution to annual GDP growth, ppeconomic structure has been shifting away fromdomestic consumption towards exports, and this 30process continued in 2011. The share of exports 20grew from 42.6% of GDP in 2007 to 56.1% in 9 10months 2011, and that of manufacturing (which 0exports about 60% of its output) from 10.7% to12.7%. The largest contribution to GDP growth in 9 -10months of 2011 came from investments (here, we -20limit analysis to gross fixed capital formation; -30inventories are not analysed due to data scarcity), -40which grew by 24.6% YoY, contributing 5percentage points to the total GDP growth of 5.4%. 2007 2008 2009 2010 2011Investments are still only about half of the pre-crisis Households Governmentlevel. This is largely due to the residential real Gross fixed capital form. Inventories Net exports GDP yoy grow th, %estate sector, which was overblown during theboom years and is still very inactive. Source: CSBL To grow output, develop products, and diversifyThe economic structure has become more markets, exporters need to invest. Capacitydependent on export demand. Hence, investment utilisation in manufacturing grew from 52% in theflows are very much driven by foreign trade activity. fourth quarter of 2009 to 66% in the fourth quarterFor example, manufacturing contributed 20%, and 2010 and continued to rise in 2011, reaching 68%transport and storage about 12% of all nonfinancial in the fourth quarter, which is close to the boom-investments in 9 months of 2011. The government years peak of 72%. The industries with the highestmade significant investments via EU structural capacity utilisation have been most active infunds – about 21% of all nonfinancial investments, investment, e.g., wood and metal manufacturing.mainly in infrastructure. Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000. E-mail: firstname.lastname@example.org 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. 1 • January 17, 2011Where were investments directed? What is the source of investments?Swift export growth explains the dynamics and the For the corporate sector, the major financing sourcestructure of nonfinancial investments. Investments of nonfinancial investments is own resources andin equipment and machinery increased by 63% YoY loans. Good cash flows and profit margins allowedin 9 months of 2011, amounting to 43% of all companies to build up deposits during 2010 (up bynonfinancial investments. Two-thirds of investments 36%) that had been depleted during the crisis. Byin machinery and equipment were done by major late 2010, deposit stock was already 6% above itsexporting sectors, such as manufacturing and pre-recession level. Despite still-good profittransport and storage. margins, deposits of resident nonfinancial corporations remained by and large flat in 2011. Thus, instead of increasing deposits, companiesNonfinancial investments, m LVL both invested in their capacity and reduced creditor Other f ixed assets 1000 120 exposures. For instance, by shifting their payment Equipment and machinery Buildings and inf rastructure dates for received deliveries from, say, the thirtieth 750 Long-term intangible assets 90 day to the first day after delivery, they obtain both Y oY growth, % (rs) discounts and liquidity buffer because, if necessary, 500 60 they could shift back to the payment on the thirtieth day and thus extend their liquidity without additional 250 30 borrowing. 0 0 Demand for new loans has increased too – they rose throughout 2011, and the total resident -250 -30 corporate loan stock has been growing month on month since summer. The rest of financing (about -500 -60 one-fifth of all nonfinancial investment) is EU 2008 2009 2010 2011 funding. Although not the largest source of Source: CSBL financing, EU funds have been instrumental in keeping up corporate investment activity as theyInvestments in buildings and infrastructure grew by significantly reduce the cost of private investment.9% in 9 months of 2011, accounting for about 40%of all nonfinancial investments. In contrast to the Loans to resident nonfinancial corporations,boom years, when activity was dominated by m LVLprivate sector housing developments, two-thirds ofinvestments in buildings and infrastructure in 2011 120 6000came from public administration, i.e., state andmunicipalities, as well as the energy and water 90 5750supply sector, where state-owned companiesdominate. Such projects are heavily supported byEU funds and have been used to provide stimulus 60 5500to recovering economic activity.During the recent years, the quality of investments 30 5250has changed. For instance, manufacturers now lookmore for high quality investments to improvecompetitive advantage or to develop niche products 0 5000instead of straight forward production volume Jan.11 Apr.11 Jul.11 Oct.11boosting. They try to buy the most modern and, in New loans issued Loans stock (rs)some cases, unique technology. Yet, to a large Source: FCMCdegree it is still buying foreign made technology and In 9 months of 2011, FDI inflow was about LVL 600machinery rather than developing their own. We million, equivalent to about half of nonfinancialhave not seen so far much of increase in investments during that period. Of course, not allexpenditures for research and development (R&D), FDI ended up as nonfinancial investment to boostwhich were 0.22% of GDP in 2010. These the economy’s gross fixed capital – 20% of FDIexceeded the pre-crisis level but still were just went into real estate (mainly the takeover of existingabout one-third of EU average. As most of Latvian real estate rather than new developments) and 32%companies are small to create their own research into financial intermediation (to strengthen thecentres, cooperation and government support is banks’ balance sheets). Manufacturing got onlyneeded to boost R&D and innovations. 10% and domestic trade 14% of FDI, most of which 2 (3)
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 1 • January 17, 2011was probably invested in fixed assets; however, FDI risk of suddenly weaker business confidence andof these two sectors represent only 12% of all investment activity in Latvia if the euro zonenonfinancial investments. situation continues to weaken.FDI inflow to Latvia in during 9 months of 2011 Confidence and nonfinancial investments 20 80 10 60 Real estate Domestic 0 40 20% trade -10 20 14% Manufac- -20 0 Financial turing -30 -20 intermed. 10% 32% -40 -40 Other -50 -60 24% Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 Jan.11 Latvias manufacturing confidence Euro zones manufacturing confidence Source: Source: LaB Non financial investments, YoY grow th (rs) Eurostat Other factors that will weigh on investments in 2012Outlook are (i) shrinking profit margins and less own resources due to the forecast recession in the euroInvestments depend on the situation in Europe zone; (ii) higher risk premiums for loans owing tosince growth in the Latvian economy in the coming more stringent banking regulatory requirementsyears will remain export driven (i.e. household (e.g., Basel III requirements and higher paymentsincomes are expected to remain rather weak). In into the deposit insurance fund after the bankruptcyother words, investments depend on confidence on of Latvijas Krājbanka late last year); and (iii) a likelywhat will be the demand for Latvian exports, which temporary slowdown by exporters in investments,is largely determined by the depth and length of the which were considerable during 2011.sovereign debt crisis in the euro zone. Under the base scenario, we expect single-digitAs for 2012, we see the following factors driving growth in gross fixed capital formation during 2012;investment activity. Investments will be supported however, small negative quarterly growth in one orby (i) the large projects (e.g., in the energy sector, two quarters is very likely.infrastructure) that started in 2011 and will continuethis year; (ii) inflow of EU funds, which is expectedto be similar to that of 2011; and (iii) robust and stillrather high business confidence in the beginning of Dainis Stikuts2012. Mārtiņš KazāksThroughout 2011, manufacturing confidence inLatvia was surprisingly stable compared with that inthe euro zone and other major trade partners. Thismight suggest some nonlinearity in response tochanges in the external environment, i.e., there is aSwedbankEconomic Research DepartmentSwedbank 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 inLegally responsible publisher this publication. However, we cannot guarantee the accuracy or completeness of the reportCecilia 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.Dainis Stikuts, +371 6744 5844Lija Strašuna, +371 6744 5875 3 (3)