"Construction" of gross domestic product and construction as the fastest growing industry in the second quarter

This time, the observers of economic processes had to be patient because the adjusted gross domestic product (GDP) indicator was published almost a month later than usual.  It is related to adjustments in the entire GDP time-series with the introduction of the new methodology ESA 2010 for the national and regional accounts. Other European countries are also undergoing such a transition.  

Although the calculations of various indicators have been perfected time and again, this time the changes are more thorough and statisticians have adjusted the GDP levels and growth rates quite substantially. Details on the changes in methodology are available in the information prepared by the Central Statistical Department and on the Eurostat web page.

Even though there are many corrections, the fact that assessments of the unbudgeted taxes from the illegal economy (contraband, prostitution, narcotics trace etc.) or the concealed value added taxes are also included will probably generate the most attention. Previously GDP included only the economic activity (legal in terms of activity) not included in the statements.  

Just as the recalculation of indicators, the assessment of these corrections also takes time, therefore our reflections on the corrected time series and GDP will have to wait; for now let us return to the economic developments in the second quarter on which we now have the expanded GDP indicator by branch, use and income.

GDP in the second quarter grew by 0.9% quarter-on-quarter (excluding seasonal effects); year-on-year growth was at 2.3%, with the annual growth rate gradually dropping.  

The main driver behind GDP growth in the second quarter was private consumption (2.3% increase; accounted for 1.4 percentage points (p.p.) in GDP growth), whose leadership position in recent years has been ensured by rises in average salary and employment. Rise in investment was more moderate (1.8%; 0.4 p.p.), but a more rapid change is observed in the structure of fixed assets: the imports of capital goods (including machinery and equipment) are shrinking but the investment level is maintained with the help of a rather rapid construction growth. Export growth has been similar to investment changes, but, because of its greater proportion, its impact on GDP growth has been more significant (1.7%; 0.9 p.p.). Imports grew more rapidly (by 2.3%), thereby determining the 1.4 p.p. negative contribution to GDP change.

Analyzing by branch, the most rapid year-on-year growth in the second quarter was posted by construction, which grew by 15.8%, thus making the most substantial contribution to the total GDP year-on-year growth (0.8 p.p.). Another positive contribution came from trade (1.7%; 0.2 p.p.), transport and storage (2.2%; 0.2 p.p.), as well as state administration (4.4%; 0.3 p.p.). A negative impact on growth was made by mining and quarrying and the power industry (-5.4%; -0.2 p.p.) as well as real estate operations (-2.8%; -0.3 p.p.).

Against the background of geopolitical developments, the second quarter GDP performance should be considered good, but, in the results of the third quarter, various contradictory factors will become more pronounced. After the introduction of sanctions in August, pessimism has grown in practically all segments – the confidence of the population, industrialists, traders and service providers has deteriorated. Only in the construction industry the mood has improved in recent months.

Overall, the range of export goods affected by sanctions is not great. Yet the economy is affected by the behaviour of all its participants. If the population becomes cautious, it is possible to sharply cut expenses, which in turn means cut opportunities for producers, traders et al. Growth can be impeded even more seriously by postponed investment decisions, particularly those targeted at industry. Thus the deterioration in the mood of participants in the economy is bad news for growth, which can augment the negative direct impact caused by limited exports still further.  

On the other hand, some domestic factors are helping to "heat" the economy in the third factors – the same ones that promoted activity in the construction sector in the first six months:  

1. Amendments to the Immigration Law, which took effect on 1 September and stipulates more stringent requirements[1] for obtaining temporary residence permits.  The desire to manage to supply for purchase affordable housing to potential residence permit obtainers before that date stimulated construction of residential buildings.
2. Impact of elections. The expenditure related to election campaigns – fees for advertising, hairdressers, fuel flow into the economy. It is interesting to note that this year, it is the construction and renovation of schools that posts substantial growth in construction. I would venture a guess that this work may also have been stimulated by the approaching parliamentary elections.   

These are mostly factors with a short term impact, therefore their heating effect will be over by the end of the year. Yet another growth promoting factor may then enter into play: the resumed operations of Liepājas Metalurgs. Just as before, investment is and will be retained by the EU funded infrastructure projects.

In addition to the construction of schools, administrative and residential buildings, construction of hotels has also proceeded at a faster rate.  This could be related to increased demand: tourism flows are continuing to grow, with Riga's current status as a European culture capital and Latvia's upcoming status as the presiding country of the EU playing a role.

We can thus conclude that, given the negative impact of the Russian-Ukrainian conflict and Russian sanctions, GDP growth in Latvia has been relatively stable. Yet this stability is short-lived; neither private consumption, nor the growing construction industry will not be able to sustain it. On the positive side, we should still mention the ability of our exporters to adjust to the situation relatively flexibly and quickly and to change their export markets. Yet worries about external demand and investment in the productive sector necessary for growth  remains, and the Latvijas Banka GDP forecast for  2014 has been again reduced – from   3.3% to 2.9%.