Manufacturing has yet to feel the impact of Russian sanctions

The September manufacturing data post a slight growth, which is a positive development against the background of developments in the external markets. The impact of Russian sanctions is felt not by the manufacturing sector at large but some enterprises of some branches. Yet these developments will have an impact on further development, including impeding entrepreneurial investment plans.

According to the data of the Central Statistical Bureau, the volume of manufacturing production in September 2014 grew by 1.9% month-on-month (seasonally adjusted data). Year-on-year growth in manufacturing production volume was 1.7%. As for the third quarter, growth was very insubstantial quarter-on-quarter – 0.9%.

A vigorous month-on-month growth in September was posted by the wood industry (+4.4%) and the production of electrical equipment (+17.2), metals (+38.5%) and fabricated metal products (+4.0%). The results were still weak in the production of wearing apparel (-2.3%) and textile products (-0.3%), reflecting the problems with the Russian market and difficulty attracting new workers to the branch. Growth rate was negative both month-on-month (-1.4%) and year-on-year in the production of construction materials, which has no substantial effect on the overall performance of manufacturing, yet represents an adverse sign regarding the future development of the construction branch.

Overall, the September data are positive – most of the sub-branches have posted growth, moreover, in three of them historical records in terms of monthly production have been reached: in the wood industry, in production of computers, electronic and optical equipment and the production of automobiles, trailers and semi-trailers. These, however, are data of just a single month that do not indicate the overall trend and cannot exclude weak performance indicators in October.

The relative recent weakness of manufacturing is primarily determined by external factors. The euro area economies are still weak and such is also their demand for foreign produced goods; this has a direct negative impact on the results of our manufacturers. The weakening of the Russian rouble since the beginning of the year has a negative effect on those manufacturers who are selling their production in this neighbouring country. It was theoretically in September that the most substantial negative effect should have been felt from Russian sanctions. If still in August, manufacturers continued to produce hoping for an improvement in the situation or other markets, in September some of them should have reduced production volume.  Yet, as mentioned above, the direct effect of the sanctions on Latvian manufacturing and export was small and can be compensated by better results in those branches of manufacturing unaffected by the sanctions (e.g., in September that was done by wood industry). The list of products affected by sanctions involves just a small part of the production of Latvian manufacturing. Sanctions thus create problems only for some enterprises of some branches (those that historically have indeed exported to Russia).

Interestingly enough, the September data does not show reduced output of the food industry. The volume of dairy industry production has dropped slightly (month-on-month) but the volume of the fishing industry has grown at the same time. Yet in September and October, positive news has been heard from several businesses in the branch that other markets have been found, which means that in their current form, sanctions will probably have only a small direct impact on manufacturing. A matter quite different is the negative background created by the sanctions that is not conducive to further growth.

A positive piece of news for manufacturing is the possible resumption of operations at the "KVV Liepājas metalurgs" plant in the near future. Albeit there are many questions regarding the business model (raw materials, markets, employees), in case of a positive scenario, the statistics of the manufacturing industry (along with gross domestic product) will improve substantially. Even more important is the regional and social significance of the enterprise: previously, it was the central one in a kind of a cluster, receiving good and services from a whole range of smaller companies.

The further performance of manufacturing will, as usual, depend on developments in the external environment. First of all, the geopolitical situation remains very complicated, albeit without any pronounced escalation. That has a dampening effect on the desire of manufacturers to take on additional risks in investing in new equipment. The effect on the output is not so noticeable now but reduces the potential for increasing the production output in the future.

Second, the future of the sanction regime is not clear. There are several scenarios that include the possibility that sanctions may be prolonged or tightened or, quite the opposite, that they may be weakened. It is clear, however, that as a result of their experiences this year, many entrepreneurs will not try to get back into the Russian market even after the sanctions are lifted.

Third, Latvian exports are in vital need of growth in the euro area. Currently, the situation remains substantially unchanged: growth is weak and unstable. In the second half of this year, the operational indicators are by and large negative and point to a persisting weak euro area economy.