The document provides an overview and forecasts of macroeconomics in the Baltic states. It finds that the Baltic economies have converged towards EU income levels faster than other countries. While the structure of the economies is similar, manufacturing and trade make up relatively larger shares in Lithuania. Post-crisis growth has surpassed pre-crisis levels, though Latvia experienced a deeper crisis and longer recovery. Strong growth is broad-based but volatile construction growth stands out. Tight labor markets and rising wages are putting inflationary pressures, while open economies make the Baltics dependent on global trade growth. Medium-long term growth depends on productive investment and efficient resource use.

1. MACROECONOMICS IN THE BALTICS:
OVERVIEW AND FORECASTS
Liva Zorgenfreija
Latvijas Banka
XVII starptautiskā konference „Apdrošināšana un Pārapdrošināšana Baltijā 2018”
28.09.2018

2. THE BALTICS ARE CATCHING UP WITH THE EU. FASTER CONVERGENCE TO EU
LEVELS FOR ESTONIA AND LITHUANIA
GDP per capita, 2017
(PPP, % of EU average)
GDP per capita, 1995-2017
(PPP, % of EU average)
Source: Eurostat
0
50
100
150
200
250
Bulgaria
Croatia
Romania
Latvia
Greece
Hungary
Poland
Slovakia
Portugal
Estonia
Lithuania
Cyprus
Slovenia
CzechRepublic
Spain
Italy
Malta
France
UnitedKingdom
Finland
Belgium
Germany
Denmark
Austria
Netherlands
Ireland
Luxembourg
EU AVERAGE
0
20
40
60
80
100
120
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
EU Estonia Latvia Lithuania

3. Agri
3% Manufacturi
ng
15%
Other
industry
5%
Construction
7%
Trade
12%
Transport
7%
Tourism
2%
IT
6%
Financial &
insur.
4%
Real estate
10%
Prof. and
admin. serv.
10%
Public
admin.,
educ., health
16%
Arts&entert
ain.
3%
3
Source: Eurostat
Value added in 2017 by sector (%)
Agri
4% Manufacturin
g
12%
Other
industry
4%
Construction
6%
Trade
15%
Transport
9%
Tourism
2%
IT
5%
Financial &
insur.
4%
Real estate
12%
Prof. and
admin. serv.
8%
Public
admin.,
educ., health
16%
Arts&enterta
in.
3%
Agri
3%
Manufactur
ing
20%
Other
industry
3%
Constructio
n
7%
Trade
18%
Transport
12%
Tourism
2%
IT
4%
Financial &
insur.
2%
Real estate
6%
Prof. and
admin.
serv.
7%
Public
admin.,
educ.,
health
14%
Arts&entert
ain.
2%
Estonia Latvia Lithuania
THE STRUCTURE OF ECONOMY IS SIMILAR IN ALL 3 COUNTRIES. MANUFACTURING,
TRADE AND TRANSPORT ARE RELATIVELY LARGER SECTORS IN LT THAN IN EE & LV.

4. POST-CRISIS GROWTH: ALL 3 STATES HAVE SURPASSED THEIR PRE-CRISIS LEVELS OF
GDP. LV: A DEEPER CRISIS AND A 4 YEAR LAG IN RECOVERY WITH RESPECT TO LT
AND EE. IN 2018 – BALTICS AMONG THE FASTEST GROWING IN EUROPE
Real GDP
(index, 2008Q1=100, s.a.)
-1
0
1
2
3
4
5
6
7
8
2011 2012 2013 2014 2015 2016 2017 2018
H1
Euro area
Estonia
Latvia
Lithuania
Real GDP growth
(%)
Source: Eurostat, calculations by Latvijas Banka
70.0
80.0
90.0
100.0
110.0
120.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
EA-19
Germany
Estonia
Latvia
Lithuania
Finland
Sweden
UK
Norway

5. THE LATEST PICK-UP IN GROWTH IS BROAD BASED, BUT THE VOLATILE
CONSTRUCTION SECTOR STANDS OUT
-50.0
-40.0
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
40.0
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018H1
5
Growth in value added by sector
(YoY, %)
-50.0
-40.0
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
40.0
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018H1
Estonia Latvia Lithuania
-50.0
-40.0
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
40.0
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018H1
Goods (~23% of the economy)
Construction (~6% of the economy)
Services (~70% of the economy)
Source: Eurostat, calculations by Latvijas Banka

6. CONSTRUCTION IS BOOMING IN THE BALTICS AND POLAND: PARTLY DUE TO EU-
FUNDS, PARTLY – DUE TO PRIVATE INVESTMENT PROJECTS
Volume indices of construction output (2015=100, s.a.)
Source: Eurostat
50
70
90
110
130
150
170
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Germany
Estonia
Latvia
Lithuania
Poland
Finland
Sweden
UK
Norway
H1 2018
YoY
1.9
19.5
33.1
17.4
23.9
0.7
0.3
0.5
2.5

7. CREDIT IS UNLIKELY TO BE THE MAIN DRIVER BEHIND THE UPTICK. CREDIT
RECOVERED IN 2013 IN EE, 2015 IN LT, WHILE LAGGING BEHIND IN LV.
7
Change in credit to households and non-financial corporations
(%)
Source: Eurostat, ECB
-15
-10
-5
0
5
10
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Estonia Lithuania Latvia* Euro area
0
20
40
60
199519971999200120032005200720092011201320152017
Households
0
20
40
60
80
100
120
Non-financial corporations
Loans to NFCs and households
(% of GDP)
* For Latvian data structural changes are excluded – the transfer of the
Nordea credit portfolio abroad as well as the one-off effect of ABLV
liquidation

8. IN PART, THE LACK OF CREDIT CAN BE EXPLAINED BY THE SIZEABLE SHADOW
ECONOMY, ESPECIALLY IN LATVIA
• Key problems
o EE: underreporting of salaries
o LV and LT: underreporting of salaries and
business income
• Increase in 2017:
o % of wages in envelopes ↑ in LV and EE
o % of business revenue concealed ↑ in LT
and EE
• Involvement in shadow economy is greatly
determined by dissatisfaction with business
legislation
8
Size of the shadow economy, 2009–2017
(% of GDP)
0
5
10
15
20
25
30
35
40
2009 2010 2011 2012 2013 2014 2015 2016 2017
Estonia Latvia Lithuania

9. LABOUR MARKET IS TIGHTENING. DECLINING UNEMPLOYMENT AND INCREASINGLY
ACUTE SHORTAGE OF LABOUR IN THE BALTICS, BUT ESP. IN EE
0
2
4
6
8
10
12
14
16
18
20
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018H1
9
Unemployment rate
(% of active population)
Source: Eurostat, ECB, EC, calculations by Latvijas Banka
0
2
4
6
8
2018* 2019*
Euro area
Estonia
Latvia
Lithuania
0
5
10
15
20
25
30
35
40
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Share of entrepreneurs regarding labour shortage as a key
impediment to growth* (seasonally adjusted data; %)
Unemployment forecasts
* based on the weights in value added for
industry, construction and services

10. LABOUR MARKET CONSTRAINTS IN THE FUTURE – POPULATION TO DECLINE IN
THE BALTICS, ESP. IN LT AND LV (WHERE CURRENTLY LARGEST NEGATIVE EFFECT
FROM EMIGRATION)
-0.2
0.0
0.2
0.4
0.6
10
Change in population
(% of total population)
Source: Eurostat
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
Natural change of population Net migration Total
EU
Latvia, Estonia, Lithuania
0
100
200
300
400
500
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2020
2030
2040
2050
2060
2070
2080
Estonia Latvia Lithuania EU (rhs)
Population and baseline population projections, 1995 - 2080
(mil. persons)

11. IN RESPONSE TO THE TIGHT LABOUR MARKET, WAGE GROWTH HAS BEEN STRONG
LATELY. AS A RESULT LABOUR INCOME SHARE HAS RISEN (ESPECIALLY IN EE AND
LV: CLOSE TO EU-AVERAGE)
11
Average monthly gross wages
(YoY, %)
Source: National Statistical Bureaus, Eurostat
Labor income share [(compensation of employees / GVA) /
share of employees in total employment] in 2017 (%)
30
35
40
45
50
55
60
65
70
Slovenia
Bulgaria
Belgium
UK
France
Netherlands
Denmark
Estonia
Germany
Croatia
EU-28
Latvia
Finland
Austria
Portugal
Spain
Luxembourg
Italy
Greece
Cyprus
Hungary
Lithuania
Sweden
Poland
CzechRep.
Romania
Malta
Slovakia
-6
-4
-2
0
2
4
6
8
10
12
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
H1Estonia Latvia Lithuania
EUR, 2017 EE LV LT
Gross 1221 926 840
Net 986 676 660

12. DESPITE THE PRESSURES FROM WAGE GROWTH, INFLATION HAS BEEN
MODERATE IN THE BALTICS.
-2
0
2
4
6
8
10
12
14
16
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018Jan-Aug
Euro area
Estonia
Latvia
Lithuania
ECB target
12
Inflation
(%)
Source: Eurostat, ECB
0
1
2
3
2018* 2019*
Inflation forecasts

13. THE BALTIC ECONOMIES ARE VERY OPEN, AND AS A RESULT – VERY DEPENDENT
ON TRADE GROWTH, WHICH HAS SLOWED IN 2018
Openness (Exports + Imports)/GDP
(%)
40%
60%
80%
100%
120%
140%
160%
180%
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
EA Estonia Latvia Lithuania
Merchandise world trade level and 3m/3m growth
(index 2010=100, %)
13
Source: Eurostat, calculations by Latvijas Banka, CPB World Trade Monitor
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
100
105
110
115
120
125
130
2011 2012 2013 2014 2015 2016 2017 2018
per 3 m % change (rhs) World trade volume

14. MAIN TRADE PARTNERS FOR EE: SCANDINAVIAN COUNTRIES; LV: THE BALTICS
AND RUSSIA; LT: RUSSIA, LV AND POLAND
14
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
Estonia UK
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
Finland Sweden Latvia Germany Russia Lithuania
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
Poland US Others
Source: Centrālā statistikas pārvalde, Eesti Statistika, Eurostat, calculations by Latvijas Banka
Goods exports by country (%)
Estonia Latvia Lithuania

15. GROWTH OF THE BALTIC STATES WILL TO A LARGE EXTENT DEPEND ON THE
ECONOMIC GROWTH IN THE LARGEST PARTNER COUNTRIES.
15
GDP Growth forecasts
(YoY, %)
Source: Forecasts by NCBs, ECB
3.5
3.9
3.2
2.0 2.0
2.9 2.9
1.8
4.6
1.4
0
1
2
3
4
5
6
Estonia Latvia Lithuania EA Germany Finland Sweden Russia Poland UK
2017 2018 2019

16. IN THE MEDIUM-LONG TERM GROWTH MOSTLY DEPENDS ON INTERNAL FACTORS:
PRODUCTIVE INVESTMENT; EFFICIENT USE OF HIGH QUALITY RESOURCES.
16
R&D expenditure
(% of GDP)
Source: Eurostat, Global Competitiveness Report 2017-2018
0
0.5
1
1.5
2
2.5
3
3.5
Latvia
Romania
Cyprus
Malta
Bulgaria
Slovakia
Croatia
Lithuania
Poland
Greece
Ireland
Spain
Hungary
Luxembourg
Portugal
Estonia
Italy
CzechRepublic
UK
Slovenia
Netherlands
France
Belgium
Finland
Denmark
Germany
Austria
EU AVERAGE
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
SlovakRep.
Bulgaria
Hungary
Spain
Cyprus
Latvia
Croatia
Greece
Poland
CzechRep.
Sweden
Lithuania
Luxembourg
Austria
UK
Italy
Portugal
Romania
France
Malta
Ireland
Germany
Denmark
Slovenia
Estonia
Belgium
Netherlands
Finland
EU AVERAGE
In your country, how do you assess the quality of math and science
education *?
* [1 = extremely poor—among the worst in the world;
7 = excellent—among the best in the world]

17. KEY MESSAGES
• The Baltic states have been catching up with the EU, but still some way to go.
• The three economies are fairly similar in terms of structure.
• The Baltics in 2018 are among the fastest growing economies in Europe.
• Growth is broadbased, but the volatile construction sector plays a big role.
• The growth is not driven by excessive credit – slow or non-existent (LV) credit growth in the
recent past.
• In part, the lack of credit can be explained by the still sizeable shadow economy.
• Labour market tightness is an issue in all three countries: falling unemployment, rising
shortage of labour, steep rise in wages. Longer term issues – ageing population
• Despite the steep rise in wages, inflation is moderate.
• EE, LT, and LV are very open to trade – growth in trade partners is a key determinant of growth
in the Baltics.
• Growth is likely to decelerate in the coming years, but to remain robust in all three countries.
• In the medium-long term what can support stronger growth are productive investments
(especially in R&D), efficient state institutions, a high quality education system. 17

18. 18