The Latvian Economy - No 2, March 2, 2012; Economic growth continues, but Latvia is not immune to euro zone problems

1. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department
by Lija Strašuna No. 2 • March 2, 2012
Economic growth continues, but Latvia is not immune to
euro 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 Latvia's 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), Latvia's GDP
rose by 0.8% in quarterly terms in the fourth quarter 110
of 2011 (seasonally adjusted). This reveals an
expected slowdown in economic growth.
Meanwhile, according to preliminary data, such 100
important Latvian trading partners as Estonia,
Germany, and Sweden experienced quarterly
growth declines (-0.8%, -0.2%, and -1.1%, 90
respectively). According to revised data, the
EE
Lithuanian economy grew by 1%, slower than in the
previous four quarters. 80 LV
LT
Annual growth in Latvia was the strongest in the EU
in the fourth quarter (5% vs. 4% in Estonia and 70
4.4% in Lithuania). However, the early phase of 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10 1Q 11
recovery went more quickly in Estonia and Source: Eurostat
Lithuania, partly owing to their larger export base
and differences in leverage levels. The Latvian Do the latest data suggest that the Latvian
economy is still 16% below its pre-crisis peak in economy is immune to euro zone problems? Of
2007, while Estonia's and Lithuania's trail by 9% course, not… Growth is very likely to have been
and 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: ek.sekr@swedbank.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.

2. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 2 • 2 March 2012
of their industries). Latvia might just lag other While confidence indices declined quite sharply in
European countries a quarter or two. Is Latvia's 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 to
Growth 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 economic
Although the last-quarter results were quite strong, sentiment in Latvia notably improved (similarly to
Latvian economic growth has started to decelerate. that in Germany). The question is how long can
Detailed data are to be published on March 9; such a “walk on water” continue.
however, it is already known that both industry and
retail 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 130
one-off effects, e.g., a decline in heating production
due to the unusually warm weather, and the brief 120
turbulence in the banking sector kicked off by
closure of Latvijas Krājbanka. At the same time, 110
warm weather without snow allowed construction 100
output to continue increasing late last year (+4% in
quarterly terms); freight transportation and tourism 90
also expanded.
80 EZ LV
Real 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 and
Industry, 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.
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3. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 2 • 2 March 2012
Manufacturing 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: Eurostat
However, if demand for Latvian goods from
producers in Baltic Sea region countries continues In 2011 (and also January 2012), retail trade was
to worsen, and they do not need to replenish their mostly driven by purchases of durable goods, owing
inventories, orders for Latvian subcontractors will to rising optimism and lower prices, as well as the
shrink 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 the
much 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 was
Latvia's export growth will be negative this year. mostly due to rising savings expectations.3 The
expected financial situation of households over the
If the confidence of exporters deteriorates, they are next year did not rise much, thus indicating perhaps
likely to postpone investments, especially given the that households are planning some precautionary
credit crunch in Europe. Available EU funds and savings. If the savings rate increases and
already started projects will weaken this negative consumers’ perceptions about the labour market
effect, though. and the overall economy weaken, spending on
durable goods could decline quite sharply.
Since economic growth in Latvia is still very much
export driven, developments in the exporting Consumer confidence, expectations over next 12
sectors 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.
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4. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 2 • 2 March 2012
Tax revenues: so far, so good Economic sentiment and real GDP growth
Although it currently looks like Latvia's 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 are
Tax 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 the
For comparison, tax revenues grew by 12% in 2011 uncertainty surrounding the euro zone debt and
overall. Therefore, the government budget is not financial crisis and its influence on the Latvian
under pressure, at least not yet. Although it is very economy is still high.
likely that a part of tax revenues relates to the fourth
quarter of 2011, this performance indicates that It is also useful to have action plans for several
economic activity has continued to rise in the scenarios in the private sector. Businesses seem to
beginning of this year. be a bit more cautious and flexible in their
behaviour that the government sector – although
Economic 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 tougher
6.4% in monthly terms (seasonally adjusted), developments (they have accumulated reserves
reaching 16.6% annual growth (see also the graph and can adjust their behaviour quite quickly if
on 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 have
however, this is seen as a seasonal phenomenon. risen, but rapid spending growth is a bit worrisome
Unless the rate continues to increase in March, since the level of savings is still quite low and
there are no reasons to worry about this rise. unemployment high.
But uncertainty is still the name of the game. Data
are 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 and
growth is very likely this year, and, given the fourth- growth continues (under the base scenario, we
quarter data for Latvia's main trading partners, this forecast 2% economic growth in 2012, down from
might 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
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5. The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 2 • 2 March 2012
challenges in general. With the existing economic
policy in place, job creation will be too sluggish to
significantly reduce unemployment and income
inequality, or to raise living standards to lessen
emigration.
The latest IMF report on Latvia5 highlighted the
issue of increased poverty and argued that the
current social safety net and tax policy should be
adjusted to improve incentives for the poor to work
and for businesses to create new jobs. Although the
discussion on social policy changes and the
reduction of labour taxes has started, it is far from
over, and no decisions have been made yet. The
declining and aging population requires an
adjustment in the pension system. The government
has just agreed on a gradual increase in the retiring
age beginning in 2014 (not 2016, as planned
before), so that it reaches 65 in 2020 (currently 62).
This will help, but it does not address issues of job
creation, productivity, and income growth, which are
fundamental to pension system sustainability. Skills
and regional mismatches in the labour market
require reforms in education, especially higher and
vocational 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 5875
25709.0
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