So far, manufacturing has managed to avoid the negative impact of geopolitical developments

According to the data of the Central Statistical Bureau, the amount of manufacturing production in July 2014 grew by 1.2% (seasonally adjusted data). Year-on-year, the amount of production continued to diminish – by 2.6%.

Year-on-year, there were no significant changes in the growth of sub-branches in July. Manufacturing growth is still experiencing the positive effects of positive growth rates in food production (+3.3%), timber industry (+12.3%), production of  computers, electronic, and optical equipment (+54.5%), as well as in chemical production (+21.9%). Substantially negative annual growth rate remains in the manufacturing of wearing apparel (-20.4%), equipment and mechanisms (-20.0%), as well as instalment and repairs of equipment and devices. Likewise, judging by the publicly available financial statements of enterprises, growth might be negative also in the production of pharmaceuticals and other transport vehicles  (official data are not available for reasons of confidentiality). After a longer interval, positive growth rates are observed in the power and natural gas supply branch (+4.9%).

Without a doubt, the event of the month related to Latvian manufacturing is the economic sanctions introduced by Russia.  We must say right off that as opposed to the news originally appearing in the mass media, the list of sanctioned products is precisely defined affecting particular products (e.g., milk, cheese, some fruits and vegetables). Thus the number of goods affected by the sanctions is small and, overall, the direct impact of sanctions on Latvian goods exports is rather small from the macroeconomic point of view. Thus, in 2013, the sanctioned goods were exported to Russia for the total amount of   53 million euro, which was a mere 0.5% of total Latvian goods exports.

It is relatively easy to find markets for some products elsewhere, but reorienting will be difficult, since the other European Union members also face the same sanctions, which means that competition is keener in the potential alternative markets. Also, albeit the macroeconomic impact of hitherto announced sanctions is rather limited, it will clearly have a substantial effect on some businesses.  On the list of exporters subject to sanctions there are only a few enterprises with sales in Russia above two million euro, and for none of these Russia is the main market. Yet among the enterprises with a turnover of less than two million euro there are some whose proportion of sales in Russia  is very high. Thus these enterprises currently face a relatively high insolvency risk. At the same time, the government has acted swiftly and, within a few weeks of introducing the sanctions, particular instruments have been developed  (tax holidays, support for dairy producers, credit holidays etc.), with whose help limiting of the negative consequences of Russian economic sanctions will  be attempted.

As far as the sanctions are concerned, there is another aspect. The Latvian manufacturers have always been flexible an capable of manoeuvring under the most complicated circumstances. This was demonstrated during previous crises, deterioration in the relations with Russia etc. Therefore, there is hardly any doubt that this time as well the Latvian manufacturers will be sufficiently creative not just in using all the instruments at their disposal to conquer new markets but also in searching for ways of retaining their position and selling their products in Russia.

It is interesting to note that the confidence indicators for August compiled by the European Commission reflect the concern of consumers about the future (at the moment Russia announced the sanctions, there was much speculation in the media about their possible negative impact on the Latvian economy), whereas the outlook of businesses has not deteriorated substantially (it is just slightly below the average of the last 18 months). That alone is an indication of what was said above: the sanctions announced up to now are selective, i.e. they affect a relatively small part of the overall range of products exported to Russia. Yet any serious expansion of the sanctions list will have a more serious impact on the Latvian economy.

A negative surprise was the weak economic indicators of the euro area in the second quarter of 2014. In several countries, the quarterly growth of gross domestic product again returned to negative territory (albeit in some countries, the explanation is the negative effect of weather conditions). The first available data of business tendency surveys also point to a substantial deterioration in the confidence level regarding future economic development even in countries whose economic ties to Russia and Ukraine are not very substantial. These circumstances can slow down the recovery process of the euro area predicted previously.

It is confidence regarding future processes that may generate the biggest problems in Latvia as well. The direct impact of sanctions is small, yet the negative emotional backdrop thus generated has a crucial impact on the actions of all participants in the economy. Households may choose to spend less and accrue more and businesses may postpone their investment projects. Postponing investment is currently a very unwelcome development, because investment activity has been low for a long time and the non-existence of new investment will have a negative effect on the medium- and long-term growth potential of the economy.