Higher GDP growth expected in the forthcoming quarters, yet external risks and domestic obstacles exist

Revised data of the Central Statistical Bureau of Latvia (CSB) reveal that in the first quarter of 2011 the GDP expanded by 0.3% quarter-on-quarter (at constant prices; seasonally-adjusted data) and by 3.5% year-on-year. Both the quarterly and the annual growth figures have been adjusted upwards by 0.1 point in comparison with the flash estimate of the CSB. 

With the wage-bill gradually increasing, in the first quarter of 2011, private consumption continued on the upward trend observed in the previous two quarters, albeit the rate of growth remained low. The annual growth was 3.6% which confirms that households remain prudent in their spending. This is also confirmed by the confidence survey results summarised by the European Commission. Namely, the number of households planning major purchases within the next 12 months remains broadly unchanged. Consumer outlook regarding the situation in the economy and personal finances within the next 12 months also has not improved significantly. 

The status of the gross fixed capital formation or investment component, however, has changed notably. Although the construction sector did not demonstrate significant growth in the first quarter (in fact, a decrease was reported), gross fixed capital formation increased by 28.4% year-on-year. Non-financial investment statistics already previously showed that the non-financial investment grew by 30.0% year-on-year at current prices in the first quarter of 2011. Of non-financial investment, the highest growth was reported in the electricity and gas supply sector. This is a very positive turn, yet it has to be noted that the level of investment still remains very low from a historical perspective. 

The first quarter of 2011 has been relatively successful for foreign trade where the real annual growth rate of exports reached 14.7%, whereas that of imports stood at 20.7%. Exports of goods is supported by improved competitiveness and strengthening external demand in most major trade partner countries. It has to be noted that price increases spurred by climbing prices of wood and metals on world commodity exchanges also play an important role in the export growth. Moreover, the current global economic situation suggests that the rise in the foreign demand could decelerate already in the nearest future. The first quarter of 2011, was successful also in exports of services, favourably affected by the growing transportation services by rail and through ports. The growth rate of imports exceeded that of exports in the first quarter of 2011 on account of the increase in investment, yet new investment inspires hope that positive export and investment dynamics will continue also in the next quarters. 

Construction reported a quarter-on-quarter decrease of 15.0% (seasonally-adjusted data) in output in the first quarter of 2011 which can be explained by the adverse weather conditions. Manufacturing output shrank by 1.8% (a 14.6% year-on-year increase was still preserved), mainly on account of instability in the output volumes and not on an objective deterioration of the situation in manufacturing. Moreover, some sub-sectors, like wood industry and ship-building, were also adversely affected by the bad weather conditions, the same as the construction sector. Transport sector contributed positively to growth, with its value added increasing by 6.6% year-on-year in the first quarter of 2011. This was determined by considerable improvement in freight turnover in all the main types of transportation: by rail, through ports and by road. It can be explained by the decent economic growth figures achieved in Russia and also by the fact that, when its ports freeze over, Russia ships part of its freight specifically through the Baltic sea ports. Retail turnover contracted by 1.6% quarter-on-quarter in the first quarter of 2011 (excluding sales of motor vehicles): after having paid the increased utility bills, households had a smaller amount of funds at their disposal as well as the climbing prices on fuel resulted in a decrease in consumption. Nevertheless, the overall contribution of the trade sector to the annual GDP growth was positive, mainly on account of the sales of motor vehicles, and the value added in trade increased by 6.5%. The hotels and restaurants sector also operated successfully, reporting the steepest annual growth rate at 27.6%, although its share in the overall structure of the economy is negligible. 

Several negative factors combined in the first quarter of 2011 resulting in a deceleration of the economic growth. The GDP growth is expected to pick up in the second quarter, as suggested by the preliminary statistics on manufacturing output and new orders in manufacturing, freight turnover at ports and by rail as well as the confidence indicators. In the second half of the year, however, the Latvian economy will have to face several obstacles. Potential new price shocks on the world commodity exchanges (for instance, the extreme drought conditions currently persisting in China have caused speculations about grain prices in autumn already now) which may slow down the global economic development as well as several leading indicators pointing to slower global growth can be mentioned as the external environment risks. It is also possible that the domestic environment risks are even more important: the fast adoption of decisions about the 2012 budget and the imminent last fiscal consolidation round that do not include any tax raises would considerably reduce the political uncertainty and stimulate business, economic activity and bring larger revenue to the budget. Reasonable cutting of the budgetary spending can provide both an additional incentive to economic growth as well as ensure the quality of public finances. The year 2012 is also particularly important in the context of euro changeover. The fact that the Latvian economy is on the right track is confirmed by the improvement of the future outlook by international rating agencies, yet, as the rating itself lingers at quite a low level, the conclusion is that more work needs to be done.