The economy on the growth and stabilisation track; future uncertainties warrant extra caution

According to the information provided by the Central Statistical Bureau of Latvia (CSB), gross domestic product (GDP) grew by 2.0% quarter-on-quarter in the second quarter of 2011 (at constant prices; seasonally-adjusted data). The annual GDP growth reached 5.6%. In comparison with the GDP flash estimate, the figures have been adjusted 0.2 percentage point downwards for the quarterly changes and 0.3 percentage point upwards for the annual changes.

The given data release is important because, in addition to the traditional adjustment of the flash estimate, the CSB has carried out some other adjustments required by the European Commission regulation on transition to NACE Rev.2 and Eurostat recommendations:

• hereinafter the GDP data will be published based on NACE Rev.2 classification: consequently, the sectoral breakdown of value added has been changed;
• the concept of a "statistical unit" has been changed: hereinafter all operational results of businesses will be attributed to one "statistical" sector only or to the sector indicated as the core business sector by the company;
• the value added of the financial intermediation sector has been revalued;
• the methodology for recording insurance services and certain subsidies on products has been changed.

As a result of the above adjustments, the GDP time series of the previous years have been revised, yet these revisions are to be considered immaterial. Thus, for example, the annual GDP changes for 2009 have been revised from –18.0% to –17.7%, whereas those for 2006 from 12.2% to 11.2%. Such retrospective adjustments are a normal phenomenon: they are carried out in order to adjust the historical data, when receiving new and more precise information or when applying more accurate data estimation methods.

Looking by sector, trade, transport and manufacturing sectors remained the largest contributors to growth, the same as in the previous quarter. The value added of trade increased by 7.3% in comparison with the second quarter of 2010, mainly on account of purchases of durable goods. The value added of manufacturing continued to grow at a quite robust rate of 14.6%. The growth in the transport sector, reaching all-time-highs in transportation by rail and through ports, was also notable at 8.1%.

With the wage bill in the real economy gradually increasing, private consumption continued to improve, with the annual rise reaching 4.4%. Gross fixed capital formation or investment expanded by 21.7% in comparison with the second quarter of 2010, yet the rate of growth slightly decelerated in comparison with 28.6% achieved in the first quarter of 2011.

In annual terms, exports and imports of goods and services have increased by 15.0% and 22.1% respectively. The gap was determined by the growth of the goods imports at 23.7% exceeding that of the respective exports at 14.7%, largely on account of the imports of capital goods. The growth rate of the services exports at 15.8%, in turn, was higher than that of the respective imports at 13.6%.

Currently, Latvia ranks one of the first in Europe in terms of the GDP growth (the first in terms of the second quarter growth). One of the reasons is the low base or the fact that the GDP is still below the pre-crisis level. Yet if we look at the sectoral developments, it is obvious that the economy is emerging from the crises quite changed. Manufacturing and transport sectors are almost back to their pre-crisis levels, while the sectors significantly contributing to the overheating during the pre-crisis period (trade, construction, real estate activities) develop at considerably lower rates. Consequently, the share of manufacturing and transport sectors in the composition of Latvia's value added is expanding this year, which is very important for sustainable economic development.

In the last few months, the media have widely discussed the probability and consequences of the onset of a new crisis. Indeed, currently the external environment background is negative, as already confirmed not only by the leading indicators (confidence indicators, PMI etc.), but also the real economic data. Most major European countries have already reported a significant slowdown in the GDP growth in the second quarter of 2011. Preliminary data for the third quarter suggest that the economies most significantly exposed to the impact of the debt crisis will be back to recession already this quarter. Moreover, the outcome of the Greek sovereign debt problems and its impact on other debt-ridden economies (Italy, Spain, Portugal) as well as other euro area countries are also hard to predict. In addition, the US economic data broadly suggest a slowdown in the economic growth.

At the same time, Latvia's economy continues to develop and the situation in Latvia's main trade partner countries, so far, is better than in Europe overall. The economy is also characterised by certain inertia caused by the concluded supply contracts, launched investment projects etc.; therefore, it is most likely that the extent of the negative effect of the external environment on Latvia's economy will become clear in the fourth quarter. Although Latvia will be adversely affected by the global developments, it is possible that growth will continue. Both the economic adjustment measures taken so far and to be continued will be supportive of that. Timely adoption of a high-quality 2012 budget, providing for no tax increases and a safety buffer should the situation in the European and the global economy deteriorate more than expected will have a decisive role. This safety buffer will be useful for ourselves and will strengthen the confidence of Europe in Latvia in hard times, which is important from the perspective of investment and (a bit further down the road) potentially cheaper refinancing of Latvia's debt. In other words, you should not eat all the contents of the fridge today if you are not sure that you will be able to pack it with new supplies tomorrow...