Forecasts of Latvijas Banka

14.04.2014.

Economic developments

In the fourth quarter of 2013, the economic growth in Latvia was slightly slower than projected. GDP grew by 3.6% year-on-year (0.8% over the previous quarter). Contribution of retail trade turnover and manufacturing allowed us to hope for more rapid GDP growth; however, the latter slightly moderated on account of weak performance in the energy and construction sectors.

In 2014, the economic development prospects will be affected by domestic factors, generally favourable for further growth. The contribution of industry in 2013 and the publicly available investment projects suggest that growth in industrial output will also continue in 2014; however, new investments might be hindered by negative sentiment effects caused by the impact of the Russian–Ukrainian crisis. Retail trade turnover saw a robust increase, and there is no reason to expect it to fall significantly in 2014. As regards construction, its growth will mostly depend on the available funding and the overall investment activity in the private sector. Private and public funding will remain at approximately the same levels as in 2013, while the amount of EU funds will be cardinally different when broken down by subprogramme. Nevertheless, growth is generally expected to persist in construction as well.

The growth prospects of the transportation and storage sector cause the most prominent concern. 2013 was quite unfavourable for the sector in general: the increase in the demand for freight transportation in the Baltic Sea region moderated and the mutual competition of ports for the freight flow became more pronounced. Moreover, several taxes and duties (port tax and road use duty) have been introduced in 2014; they might hinder more accelerated growth of the sector. With growth recovery in EU countries in the next few years, the demand for transportation services is also expected to increase gradually in the Baltic Sea region; however, it might be dampened by the slowdown of the Russian economic growth.

Despite the persisting gradual improvement of the economic situation in the euro area countries, growing uncertainty regarding the developments in Russia and Ukraine is observed in the external environment. In 2014, the euro area GDP is expected to increase for the first time since 2011. At the beginning of the year several economic confidence indicators (confidence indicators aggregated by the EC, PMI, etc.) suggested gradual economic recovery. Gradual strengthening of the US economic growth is also observed; nevertheless, the tapering of the FRS securities purchase programme might have a negative effect.

The emerging market economies, having been the driving force of the global economic growth in recent years, have lately shown signs of moderating economic growth. In 2013, weaker growth was also observed in two Baltic Sea region countries (Estonia and Finland). The gradual moderation of the Russian economic growth rate is particularly significant for the economy of Latvia. The situation is aggravated by the accelerating tension and uncertainty about the mutual relationship of Ukraine and Russia that could lead to further weakening of the economic growth in the region, with a potentially unfavourable effect also on the Latvian economy, e.g. manufacturing exports and travel and transportation sectors in particular.

Sectoral performance indicators for the fourth quarter of 2013 and the preliminary indicators for the first quarter of 2014 suggest sustainable economic growth. In view of the high production capacity utilisation, as well as intensive drawdown of selected EU funds from the previous planning period in 2014 and 2015, investment growth is likely to be more rapid than projected. External risks, however, are on the downside, and they have increased significantly. They are mostly related to the weakening of the Russian economic activity and uncertainty regarding the future developments in Russia and Ukraine. Consequently, the medium-term risks to the national economic growth outlook are generally considered to be on the downside (see Chart 1). At this stage, the development of the new forecasts is in progress; they will be published in June 2014. 

Chart 1. GDP changes (year-on-year; %;forecast of Latvijas Banka*)

GDP changes (annual percentage changes; forecast of Latvijas Banka*)

* The coloured area represents 90% of potential scenarios (the lighter the colour, the lower the scenario's probability).

 

Inflation

Annual inflation remained low mostly on account of supply side factors. Nevertheless, the inflation rate became positive and was closer to a level characteristic of economic growth periods. The global raw material prices have a favourable impact and inflation expectations are moderate.

Annual core inflation rose to 1.3% and 1.4% in January and February respectively, including a pick-up in prices on non-administered services; however, neither the overall price rise (in monthly and annual terms) nor the increase in service prices exceeded the averages observed in the respective months over the last ten years. The data for the beginning of the year is too small an amount of information to estimate the effect of the euro changeover on prices as many price changes may be temporary. Thus, it will be possible to estimate the impact of the price changes unusual for the season (e.g. the euro changeover) on inflation over a year.

Risks to the average inflation (HICP) for 2014 mostly lie in the postponement of electricity market liberalisation for households. The impact of the above decision on the inflation rate forecast for 2014 is significant (even a decline of 0.6 percentage point could be reached), with a respective increase in the inflation forecast for 2015 (see Chart 2).

The risks related to administered price dynamics might mutually offset each other. Public transport fares in Riga will be lower in 2014 in comparison with 2013. Inter-operator tariffs for telecommunications services have also been reduced. Heating tariffs continue on the downward trend in several cities and towns, both on account of the natural gas price and other factors. However, prices of water supply and sewage are likely to rise in several cities and towns, and the uncertain dynamics of the Ukrainian–Russian relationship might affect the energy price developments. Due to political factors and natural conditions, there is uncertainty regarding the levels of grain prices in this season. Overall, the risks to the inflation outlook currently could be considered to be on the downside.

Chart 2. HICP changes (year-on-year; %; forecast of Latvijas Banka*)

HICP changes (year-on-year; %; forecast of Latvijas Banka*)

* The coloured area represents 90% of potential scenarios (the lighter the colour, the lower the scenario's probability).


Source: Macroeconomic Developments Report. March 2014

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