Challenges and successes of Latvian economy in 2015

The evaluation of Latvia's macroeconomic growth in 2015 could be divided into three parts: "It worked", "Not quite" and "And yet". This is the theme of this brief blog entry.

In what was Latvia successful?

First, the progress in Latvian economy should be noted in the sense that  GDP growth exceeded expectations (in the first three quarters 2.6% year-on-year). Unemployment dropped to a single-digit number (9.7%), and the purchasing power of the population has increased. The rise in purchasing power is borne out by the y-o-y rise in real net salary in the first three quarters by 7.2%, under conditions of low inflation.  Employers have raised the average compensation level both under the impact of institutional factors and encouraged by the rise in productivity. The rise in purchasing power is also supported by the excellent retail trade indicators for 11 months.

Even though the external environment for Latvia is to a great extent formed by the development of global economy, including the oil market, events in the economies of its neighbours and even weather conditions in New Zealand, not excluding the so-called "refugee crisis", Latvian  exports  continued to grow  gradually.  Without much hope for stabilization of the Russian market, the Latvian exporters have reoriented themselves to other markets or acquired new ones, for example, the dairy branch is expanding in China. Yet the engine behind the economic growth is private consumption (3.6% year-on-year growth in the first three quarters), but a small open economy may be incapable of pulling itself along like this in the long term.  

In what was Latvia less than successful?

The end part of the previous story is also the beginning of "not quite" story. The excess of the contribution of private consumption over that of investment in economic growth was plain to see. Investments are a cornerstone of the economy. Year 2015 demonstrated that the external economic environment was overall too discouraging for investment to grow.  The scant external demand, including in neighbouring Russia, the very pronounced drop in the global prices of resources (energy, agricultural products) are but a few of the reasons why entrepreneurs do not see return from additional investment and do not plan any increase in capacity.  Regarding this, we can say "for now" because the global economy is characterized by cyclical development and currently countries, various areas of activity and people seem to wait for each other, forming a kind of vicious circle, where everyone is afraid of taking the first step.  

And yet..

The low motivation of enterprises in fact provides an explanation for the next story, the "and yet" one. It is investment and innovation that may play an important role in the period of more sluggish growth of the economy. As soon as the external demand recovers, the product will have been developed, examined and ready for the market. Here it is important to note the stabilizing role of monetary policies in order to lessen the impact of cyclical factors. The conditions for borrowing in the euro area, including Latvia, have become more favourable both for entrepreneurs and for households. Even though the impact of the so-called the expanded asset purchase programme (APP) is still slow, within its framework, a great amount of financing has been flown into the economy:  the government and international institution securities in Latvia were purchased in the amount of 1.8 bln. euro, and in the euro area for almost 490 bln.  Thus the monetary policy measures implemented by the euro area, including such unconventional ones as expanded APP, continue to be an important factor stabilizing the euro area economy. It exists and continues to be offered despite the possible lack of motivation of businesses or the rear of the banking sector to lend for something unusual or something that will pay off later – it exists as a necessary precondition to break out of the Catch-22.