Bank of Latvia's Forecasts
In the first quarter, Latvia's economic growth retained the rate of previous quarters even despite the adverse developments in global markets. The seasonally adjusted GDP at constant prices increased by 1.4% quarter-on-quarter, faster than previously projected. From the point of view of GDP expenditure components, this increase was driven by the acceleration in private consumption and stronger-than-expected export growth. In the breakdown by sector, real estate activities, financial and insurance activities as well as construction expanded dynamically. It suggests that in the circumstances when Latvia's foreign trade partners are suffering from economic hardships, the domestic demand supports the retaining of a high growth rate.
The economic growth at the beginning of 2013 was stronger than projected, and the preliminary indicators for the second quarter also imply an on-going advance and a substantial rise in private consumption. Consequently, the Bank of Latvia's GDP growth forecast for 2013 has been raised by 0.5 percentage point to 4.1% (see Chart 7.1). Overall, the medium-term risks to the national economic growth outlook can be considered balanced.
On the one hand, the economic growth in 2013 will still be impacted by unfavourable external factors: the EC projects a recession for the euro area, and the recent data about Russia's economic progress are not encouraging either. Thus exports cannot be expected to pose as a key driving force behind the Latvian economic progress. Instead, private consumption and investment are more likely to play a crucial role in Latvia's economic development. For 2013 overall, Latvia's economy can be projected to maintain positive and relatively fast (in the European context) growth dynamics, albeit the quarterly growth may gradually fall somewhat behind the recently observed rate. It will depend on the expansion of exports, which, primarily as a result of abating effects from the demand factors on manufacturing, is likely to be more restricted than previously experienced on account of eventual adverse impact of the closure of JSC Liepājas Metalurgs on the annual manufacturing sector's growth rate in 2013.
If, on the other hand, disposable income continues on an upward trend and inflationary pressures are low pushing up purchasing power of consumers – all consistently with the projections, private consumption will apparently be in the lead also further on. Moreover, taking into account Latvia's prospective euro area membership, its successful economic development vis-á-vis the other European countries and fresh inflows of financing from the EU funds, a positive contribution is expected also from investment. A constructive resolution of the situation and resumed production at JSC Liepājas Metalurgs would be a driver behind stronger GDP growth.
Chart 1. GDP changes (annual percentage changes; the Bank of Latvia forecast*)
With the direct effect of energy prices and its subsequent impact on costs subsiding, the average inflation of 2013 is likely to go down to 0.7% (see Chart 7.2). Risks to such a forecast are balanced. The prospective changeover to the euro could motivate businesses not to change prices as long as the costs permit, to ensure both convenience settlements (the so-called round prices in public transport, beverages and parking slot-machines, etc.) and an attractive price policy with the existing currency. In addition, the dynamics of energy resources prices in the first six months of 2013 does not signal any need to revise prices or the related policies more often than before.
The domestic supply factors, e.g. higher excise tax on tobacco, delayed raising of electricity tariffs for households, etc., will also affect inflation in 2014. Albeit so far a mechanism for calculating the MPC in electricity rate and the exact date of electricity market liberalisation for households have not been specified. Provided that the actual course of events concerning the two factors above turns out to be less benign than currently predicted, a risk of soaring inflation may emerge.
Even though the oil price poses an aggravating risk due to the political situation in Egypt, it does not go up by leaps and its current value in lats even falls behind the average price of the two initial months of the year.
The effect of the new global grain harvest estimates for the 2013/2014 marketing year is opposite: they are higher than for the 2012/2013 marketing year and thereby create a downward pressure on prices.
Chart 2. CPI changes (annual percentage changes; the Bank of Latvia forecast*)
* The coloured area represents 90% of potential scenarios (the lighter the colour, the lower the scenario's probability).