GDP growth somewhat down yet prospects remain promising

According to the flash estimate of the CSB of Latvia, the quarter-on-quarter increase in GDP was 0.5% (seasonal effects excluded) in the second quarter. Meanwhile, the recorded annual growth has been 3.8%, which suggests that the Latvian economy is still retaining the position of fastest growing economy in the European Union (EU).

The still high annual growth notwithstanding, the quarterly rate is pointing to a somewhat decelerating GDP pace, which, however, on the background of European developments does not come as a surprise: some preliminary data, e.g. on retail trade turnover (with seasonal effects excluded, remaining unchanged against the first quarter), volume of manufacturing output (+1.0%) and tax collection, have already signalled an eventual slowdown in growth.

It has been anticipated, yet its timeframe was unclear. The situation in Europe has been deteriorating for quite a time, yet the economy of Latvia has managed to confront it so far. Competitiveness gains during the post-crisis period supported Latvia in acquiring ever larger market shares in its major trade partners' imports. To a large extent, it enabled the country to retain a relatively fast GDP growth even though a major part of the EU countries were gripped by recession. At the current juncture, the economic growth is in the main based on private consumption, yet it is clear that in order to sustain the pace over a medium term, the recovery of exports will be crucial.

Hence at this point, there are no grounds to assert that deceleration in Latvia's economic development has turned into a permanent phenomenon. It is primarily stemming from the contracting contribution of foreign trade, which undeniably is underpinned by unfavourable environment in major trade partner countries of Latvia. In the meantime, the first confidence and real economy data for the EU suggest positive trends at the beginning of the third quarter of 2013. Likewise, the indicators of business and consumer sentiment as well as the Purchasing Managers' Index (PMI) suggest a substantially improving situation. This gives rise to a hope that the brief spell of weakness in the Latvian economy is a short-lived and transitory phenomenon. If the most optimistic projections come true and the EU countries succeed in overcoming recession already in the third quarter indeed, the Latvian manufacturers should feel it towards the close of the year as well. At this point, the recovery of the EU construction sector would be of particular importance, for it would spur up the recently subdued growth in the manufacture of wood and the metalworking sector.

Of late, the investment dynamics gives rise to some concerns, for it was the investment component that recorded the largest contraction in the first quarter 2013. On the one hand, the completion of several large investment projects is an explanation; on the other hand, investment flows are somewhat drying out also in manufacturing, where there is a desperate need for new investment to boost output and be established in export markets. The utilisation of production capacity in manufacturing has for some time been stuck at 72%, which is a rather high point historically. Moreover, for some subsectors this indicator is even higher, thus confirming the need for new investment. Apparently, the uncertainty about future developments in major trade partner countries minimises the risk appetite of businesses. What remains is just hope that the phenomenon is temporary: the new EU planning period, expected at least theoretically to open the door for a more dynamic drawdown from the EU funds, is no longer over the hill and far away. Resources for promoting investment are still available within the current EU fund planning period, likely to be reflected in the end-year or initial next year investment statistics.

It should be noted that the GDP flash estimate is produced based on preliminary statistical data of only some sectors (manufacturing, construction, trade, and taxes on products). The compilation of the complete GDP estimate will be published by the CSB on 6 September 2013. It will enable us to assess the factors determining GDP growth more comprehensively.