Economy is riding a cyclical growth wave
In the second quarter of 2018, the Latvian economy continued on a cyclical growth path, although, as expected, slightly lagging behind the pace posted in the first quarter. In historical terms, the construction sector development might look frightening, representing a year-on-year increase of more than 30%; however, it should be noted that at the moment, the overall economic development is much more balanced than more than a decade ago when the sector developed at a similar rate. Inter alia, the activities in the financial and real estate sectors and their contribution to the economy differ significantly. Likewise, the share of investment in the economy remains low despite a relatively steep rise in investment, and more cautious lending policies, the increasing businesses' reliance on their own funds as well as a rather subdued growth of investment in machinery and equipment also partly prevent the emergence of external imbalances: the ratio of the current account balance to GDP has been fluctuating in a relatively narrow band around zero already for several years.
According to the data by the Central Statistical Bureau of Latvia, in the second quarter GDP growth slightly exceeds its flash estimate, amounting to 0.9% in quarterly terms, while reaching 4.4% in annual terms, according to seasonally and calendar adjusted data, and 5.3% – according to non-adjusted data. This is the fastest economic growth in the Baltic States. The average remuneration also demonstrates a rapid increase sustained by labour shortages in several sectors; however, competitiveness indicators (e.g. the market share and profitability in manufacturing) remain stable or even improve.
On the sectoral side, as in the first quarter, the construction sector was the largest contributor to GDP growth. The second largest contributor to GDP growth, the information and communication services sector, maintained its leading position, even showing some momentum. Good performance was observed for the accommodation and catering services sector the consumption of which is boosted by events dedicated to Latvia's centenary.
Meanwhile, the roles of the sectors which in their turn hinder growth have changed – it is the energy sector, and not the financial sector with the downsizing of the non-resident segment, that recorded the largest decrease due to declining energy production levels triggered by drought. Although the financial sector showed a better-than-expected development in the second quarter, this could be a result of temporary factors, without significantly changing the outlook for overall future economic development.
The performance of other sectors ranks midway. The growth of value added in manufacturing still looks subdued, affected by the high level achieved in the previous year and insufficient capacity on the supply side – degree of capacity utilization is high and increasing signs of labour shortages constitute a drag on growth.
On the expenditure side, despite somewhat volatile consumer sentiment in the first half of the year, the role of consumption in GDP growth remained stable in the second quarter. One can only guess to what extent pre-election promises have already helped to boost consumer sentiment in August (considering that from a 12-month perspective respondents' labour market development outlook worsened, but the assessment of the households' financial situation, the overall economic situation of the country and saving possibilities improved).
Despite a rise in uncertainty in the external economic environment, exports performed even better in the second quarter; however, as in the previous quarters, domestic factors like a high degree of capacity utilisation and opportunities to boost productivity remain in the spotlight. Nevertheless, the share of investment in the economy remains low (around 20%) despite the annual growth rate of investment expressed in double-digit figures. Likewise, investment in machinery and equipment that would help to boost productivity and would probably address the capacity utilisation problem has been quite weak recently against the background of other investment (e.g. in buildings and structures).