The economy is cooling, but no ice age in sight

The expanded gross domestic product (GDP) data for the fourth quarter of 2014 were published today and thus we can look back at the year overall.

The Latvian GDP in 2014 increased by  2.4% (2.5% by workday adjusted data), with the growth rate having dropped by almost one half year-on-year. The drop in the annual growth rate was also observed over the year, approaching 2% in the fourth quarter. The previous fourth quarter GDP evaluation has been adjusted slightly up (from 1.9% to 2.1% y/y; from 0.4% to 0.6% q/q).

Private consumption in 2014 was the main factor behind growth. It increased by 2.3% and accounted for 1.4 p.p. in GDP growth. The improvement of the purchasing power of the population was stimulated by a rapid increase in disposable income: the rate of increase of real net wage remained at a high (7-9%) level all year. The contraction of shadow economy could also be a partial explanation of this high increase.

The number two factor stimulating GDP growth in 2014 was export. Despite the drop in demand in Russia and the weak growth in the European economies, the real goods and services exports increased by 1.9% (1.1 p.p. contribution to GDP growth). The search for new markets helped in maintaining the production and export volumes.

Because of the geopolitical background, investors were cautious, and this was further exacerbated by the amendments to legislation (Immigration and Insolvency Laws), which, in the last six months of the year, reduced the activity in the construction and real estate sectors.  The formation of gross fixed capital in 2014 retained growth overall (by 1.6%; 0.4 p.p. contribution to GDP growth), by it was primarily ensured by growth in the first six months of the year, whereas in the third quarter, the change was even in the negative area. The low level of investment is currently the main obstacle to a faster economic growth, but, on the positive side, there was a continued increase in investments in manufacturing.  

The real goods and services imports in 2014 grew by 1.5% (0.9 p.p negative contribution to GDP growth). The moderate rise in import can be explained by the weak investment dynamics, the slowing of export (including re-export) and consumption growth and, as well as by the fact that in some goods segments imports are replaced by domestically produced goods. 

By sector, it was, almost in equal proportions, trade (the annual growth of added value created by the sector in 2014 was 2.2%), construction (8.1%), transport and storage (3.2%), as well as state administration and defence (4.5%) sectors that accounted for growth in 2014. The negative contributors to growth were the manufacturing (-0.3%), energy and mining and quarrying (-2.5%) as well as real estate operations (-0.7%) sectors. 

According to Latvijas Banka's projections, GDP could grow by 2% in 2015, with the rate of growth also resuming increase by quarter. Even though the 2% will be the lowest rate of growth within the last four years, given the complicated geopolitical background, such growth should not be considered negligible.

Future challenges, however, are related to our ability to conduct the long since awaited reforms in education and healthcare. It is necessary to consider how economic policies could stimulate enterprise growth, which would increase productivity, and to stimulate new investments and innovations. It would be too early to talk about a total freeze in the economy, yet if the above areas are neglected, we may "miss the train" to higher levels of prosperity.