Forecasts of Latvijas Banka

08.07.2016.

Economic developments

Latvia's economic growth decelerated towards the end of 2015, as confirmed by the negative GDP growth rate in the fourth quarter. The first quarter of 2016 also saw just a minor GDP increase of 0.1%.

In 2015, Latvia's GDP grew by a mere 2.6%. From the perspective of a desirable long-term economic growth and convergence outlook, it cannot be viewed as a good result. The external developments notably affected the gradual growth slowdown, observed during the post-crisis period; nevertheless, the prolonged period of low investment activity also had an unfavourable impact on the long-term economic growth outlook. To ensure a rise in the potential economic growth, implementation of structural reforms is mandatory, enabling Latvia as a middle income country to approach the level of the most developed countries in the foreseeable future.

The external environment has not improved over the last half-year. The global economic growth forecasts have been revised downwards; Latvia's major trade partners have also revised their projections, mostly downwards. Due to external uncertainties, businesses postpone their investment decisions.

Besides the increasing external uncertainties, factors dampening the domestic activity have also been observed. The delayed drafting of the relevant legislative acts at the beginning of the new EU funds programming period hinders the implementation of investment projects, particularly those in construction and manufacturing. At the same time, as regards business and investment promotion, ensuring a predictable tax policy is essential.

On 14 March 2016, Latvijas Banka released its latest macroeconomic forecast, revising its GDP forecast downwards from 2.7% to 2.3%. The forecast was revised on account of the geopolitical tension, worsening of the trade partner economic growth forecasts, and the weak investment dynamics. At this stage Latvijas Banka has revised the forecast downwards on the basis of the latest macroeconomic data, projecting GDP growth of approximately 2.0% in 2016 (according to seasonally and calendar adjusted data [1]; see Chart 1). In view of the likely recovery of the external demand and the expected higher domestic investment activity associated with the EU funds financing round, GDP could also post an increase of approximately 3% or slightly higher in 2017.

Risks to the economic growth can be considered balanced. Upside risks are mostly associated with the potential easing of the sanctions regime. The major negative risks are the potential bankruptcies of those companies who have failed to re-direct their operation to penetrate new markets after the introduction of Russia's sanctions and a decline in the demand in Russia.

1. Changes in GDP

(year-on-year; %; forecast of Latvijas Banka)

Inflation

Due to the lagged effect of global factors, the average annual inflation will still remain at very low levels in 2016 (see Chart 7.2) and is likely to reach –0.4%; this estimate is lower than the previous one, revised on 14 March. Nevertheless, the global commodity prices currently display a slightly upward trend and the rise in comparison with the historically rather low level observed at the beginning of 2016 might cause quite a substantial increase in several inflation components in percentage terms. Hence both the direct impact of commodity prices, to be reflected in food and energy prices, and the indirect impact, to be observed in the consumer prices of other goods and services, will raise the annual inflation rate in 2017 quite notably, and it could reach 1.3%.

Risks to the forecast of the annual inflation for 2016 are balanced: the global commodity prices could increase at a slightly faster rate, while the demand side pressure is unlikely to be so strong. A more moderate year-on-year rise in wages and salaries is expected in 2016 as the legislation has no substantial positive effect on income growth; hence, the tendency to make savings, having started already in 2015, is expected to persist.

2. HICP changes

(year-on-year; %; forecast of Latvijas Banka)



[1] Latvijas Banka's GDP forecast is based on time series of seasonally and calendar adjusted data. As 2016 is a leap year, the differences between the time series will be more pronounced than usual. This may be of importance when comparing Latvijas Banka's GDP forecast with assessments of other institutions.

 

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