The geopolitical situation causes a small drop in manufacturing in June

According to the data published by the Central Statistical Bureau, the manufacturing output in June 2014 contracted by 1.3% year-on-year (seasonal effects excluded). The annual growth rate was also negative, at minus 2.2%. Altogether in the second quarter of 2014, the output increased by 3.7% quarter-on-quarter, which is an excellent result and, combined with the relatively good retail data, gives reason to expect a good gross domestic product flash estimate for the second quarter. In the first six months of 2014, compared to the corresponding period of last year, the manufacturing output grew by 1.1%.

By industrial branch, the results in June varied significantly. Output was strong in the wood industry (+2.1% month-on-month; the second best month in history); production of computers, electronic and optical equipment (+5.2%); production of chemical substances (+9.1%) and the metals branch (+28.6%, mind the low level of output, however). Results are negative mostly in the sub-branches more or less connected with the eastern markets: production of beverages (-5.9%); production of textiles (-5.3%); production of wearing apparel (-7.3%); production of electrical equipment (-10.3%); food industry (-0.6%).

Looking at the annual growth rate leads to the same conclusions: it is negative in branches with much exposure to Russia and Ukraine. Judging by the contributions of sub-branches to the total growth of branch output, the data unavailable because of confidentiality conditions in the production of pharmaceuticals and other transport vehicles may also be negative (evidenced by information given by enterprises to the stock exchange).

The first six months of 2014 have been eventful in manufacturing.  The year began with a substantial drop in output in January (as a result of problems in the metals branch and certain statistical details), followed by several months of robust growth, which, in turn were followed by a deteriorating geopolitical situation and its effects. It is the future developments in the geopolitical situation that is most likely to determine the subsequent successes or failures in the medium term. Albeit Russia and Ukraine are very important markets (especially for some of the sub-branches, e.g. the food industry, production of electronic equipment, production of mechanisms and pharmaceuticals), Latvian manufacturers have already proven that they can provide us with positive surprises, changing and adapting to the changes in the economic situation more rapidly than one may think. Yet there is no doubt that at the micro level, businesses with much exposure in the Russian and Ukrainian markets are already facing and will continue to face problems: loss resulting from exchange rates and diminishing demand. Sanctions announced by Europe and the United States do not have a direct effect on Latvian industrialists, yet a negative effect will be felt in the medium term, if only through a weakening external demand by Russia. The one-sided Russian sanctions (including the informal ones: tighter customs procedures; repairs of transit corridors, phyto-sanitary standards etc.) are much more dangerous for Latvian manufacturers.

Current business tendencies are of a mixed nature. The industry confidence indicator aggregated by the European Commission improved slightly both in July and August on account of the projected future output. At the same time, the projected full load of production capacity for the third quarter of this year dropped to 71.5% (from 72.0% in the second quarter), which is the lowest indicator since the second quarter of 2012. For a second consecutive quarter, the percentage of industries that pointed to a lack of demand as a factor limiting growth grew. The quarterly industry survey also provides contradictory information: the projected output for the third quarter is improving while the evaluation of order amount deteriorates.

During a changing economic cycle or in cases of such geopolitical crises, it is important to pay attention to the statistics of the stock levels of finished products. These data currently do not signal any problems, with the stock levels about the same as the average of recent years.

Despite various problems, manufacturing can be expected to conclude 2014 with a small increase in total output. The good news is that in recent months, enterprises have been actively advertising new investment projects, announcing procurement, concluding contracts and beginning construction. We are likely to see this reflected in this year's manufacturing data but in a limited way, but next year it may constitute a new stimulus – perhaps not so much in terms of amounts as in terms of added value.