Forecasts of Latvijas Banka
Latvia's economic growth remained moderate in 2015: according to seasonally and calendar adjusted data, GDP increased by 2.6%. The fourth quarter of 2015 saw a notable slowdown in economic growth suggesting high uncertainty and risks on account of external factors.
The weak performance in the fourth quarter of 2015 was largely due to a contraction in investment and export volume (from expenditure side), a decrease in the value added in construction and financial services and a slight decline in manufacturing performance (from production side). While Latvijas Banka had already projected the slowest growth for the fourth quarter of the year, the announced rate of decline (0.3% quarter-on-quarter; seasonally adjusted data) was still an unpleasant surprise. The downward revision of GDP growth forecast for 2016 is largely due to considerably weaker indicators of the fourth quarter.
With the purchasing power of the employed continuing on an upward trend, in 2016, like in recent years, Latvia's economic growth will be mostly driven by private consumption. The external environment conditions remain complicated. Moderate growth persists in the euro area, and the growth forecast for 2016 has been reduced. Russian economy growth is expected to remain in a negative territory. Although the external demand for Latvian export goods and services is expected to rise more rapidly than in 2015, the external demand forecast for 2016 has been revised downwards on account of the downward revision of growth prospects for some of the trade partners and the overall weakness of the global economy. Consequently, the improvement in exports will be slower than previously expected, as also confirmed by the weak export data of Latvian goods in January.
Although investment increased in 2015 overall, uncertainty surrounding future developments and external risks notably hamper a more rapid investment recovery. Therefore, only moderate investment activity can also be expected in 2016. Despite the fact that investment continues to rely strongly on the availability of the European Union (EU) funds, the absorption of funding in the new EU funds' programming period is delayed.
Looking by sector, construction and transportation in 2016, like last year, will be the major sectors dampening the GDP growth. As for the construction of dwelling space, no significant turning points are likely in 2016, unless a buoyant lending expansion resumes. Meanwhile, a further decline might occur in the construction of non-residential buildings due to the above sluggish start of the new EU funds' programming period. Some recovery may be expected in the second half of the year provided that the absorption of EU funding will accelerate. The new programming period envisages funding for roads, therefore this segment will most likely continue to positively contribute to the effect on the construction growth.
Despite the negative growth rate observed both for transportation by rail and at ports, the value added of the transportation sector did not decline in 2015 due to an increase in transportation by road. Preliminary indicators characterising the performance of transportation by rail and at ports were not encouraging at the beginning of the year. Thus, considering the sanctions and the willingness of Russia to ship the freights to its own ports, performance of these types of transport will most likely decline in 2016. However, Latvian road transport companies are able to attract new freights and find new markets, providing considerable support for the transportation sector in general.
In the first half of 2015, the macroeconomic data improved as a result of the resumed operation of JSC KVV Liepājas Metalurgs and a temporary rise in production capacity. In the second quarter, however, both manufacturing output and value added data suggest negative effects arising from problems in the company's operation. In 2016, the contribution of manufacturing to GDP growth will be considerably weaker than in 2015. The negative January data also raise concerns regarding the development of manufacturing.
In view of the persistently tense geopolitical situation, worsening of the global economic growth forecasts and those of a part of the trade partners, and the weak investment dynamics, Latvijas Banka's GDP forecast for 2016 has been revised downwards from 2.7% to 2.3% (according to seasonally and calendar adjusted data; see Chart 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 this year. This may be of importance when comparing Latvijas Banka's GDP forecast with assessments of other institutions.
Chart 1. GDP changes
The average annual inflation in 2016 will remain low on account of supply-side factors. Inflation forecast for 2016 has been reduced to 0.0% (forecast of September 2015 was 1.3%; see Chart 2).
The forecast of the average annual inflation for 2016 is slightly lower than in 2015. Although moderate economic growth is expected to persist, it has slowed down and a rise in wages and salaries is not projected to be as strong as in previous years. Consequently, the demand side pressure on inflation will not strengthen.
It is highly unlikely that the rapid fall in energy and food prices seen in the global market in 2015 will be experienced again in 2016 as the base for these prices is quite low. Nevertheless, in early 2016 the above prices still continued on a downward trend, affecting costs in many sectors with a slight lag and finding direct reflection in fuel, natural gas and heating prices, but indirect impact can be felt in prices of some tradable goods and services as well.
Inflation will be slightly driven up by changes in indirect taxes directly affecting the prices of goods and services: an increase in excise tax rate for fuel from January and alcoholic beverages from April, and the application of the standard VAT rate to the housing maintenance fees from July.
Risks to the forecast of the average annual inflation for 2016 are on the downside as the slowdown of the global economic growth prevents the demand for resources (including energy) to expand; consequently, the oil price is likely to be lower than projected before.
Chart 2. HICP changes