External economic uncertainty may play out to increase the role of domestic demand in the development of manufacturing

According to the data of the Central Statistical Department, manufacturing production output in April grew 0.8% month-on-month (seasonal factors excluded). The annual growth rate, however, was negative (minus 2.8%), thus continuing the trend that started the previous month. Meanwhile, the total industrial production has increased by 0.5%. It benefited from the observed rise in manufacturing, but was impacted negatively by a drop in mining and quarrying (minus 4.1%) as well as in the network energy supply sector (minus 0.4%).

The total manufacturing growth was positive largely due to a substantial increase in the historically volatile output volumes of the production of other transport vehicles. Month-on-month output in the sector increased 2.1 times, which could be related to ship repairs that have resumed after the winter period. Furthermore, the substantial output increase in the production of electrical equipment (20.7%) and pharmaceuticals (11.3%) also helped to raise the total manufacturing output. The negative trend in the basic metals manufacturing sector (minus 24.1% month-on-month and minus 51.9% year-on-year) was expected, because April saw the most substantial drop in production volumes in AS "Liepājas metalurgs" – by far the largest business in the sector. After the drop in the wood pulp, wood and cork product manufacturing in March, there were no month-on-month changes observed in April. Food manufacturing sector contracted slightly, which is in line with the 3.9% drop in the retail sales of foodstuffs. Continuing the trend started at the beginning of the year, output volumes dropped in the chemicals and chemical products manufacturing.

The quarterly data of the business survey by the European Commission (EC), point to potential risks for the overall development of Latvian manufacturing in the coming months. The proportion of those manufacturers who do not see any limiting factors for business development has decreased. Following three quarters of decline, the percentage of entrepreneurs who consider the lack of demand as the main factor limiting business development has increased again. The quarterly survey also points to a deterioration in the volume of new orders; the indicator was at a lower level only in the first quarter of 2010. By sectors, the most substantial drop in capacity utilisation in the second quarter of 2013 can be expected in the manufacturing of non-metallic minerals which currently also has the lowest level of capacity utilisation. Even the manufacturing of basic metals sector, which includes the problem ridden AS "Liepājas metalurgs", reports a higher level of capacity utilisation. This points to potential future risks in the production of non-metallic minerals.

The latest data on May are, however, more positive. The monthly EC survey, for instance, points to both, an improved level of industry confidence in Latvia and a slight improvement in Europe overall. In Estonia, the industrial confidence and the overall ESI (Economic Sentiment Indicator) [i] improved, whereas in Lithuania both indicators showed a modest decline. In Russia, the manufacturing PMI (Purchasing Manager's Index)[ii] in May dropped for a third consecutive month; however, it still hovered slightly above the 50 point mark. Even though the EC-compiled indicators on Germany point to a slight deterioration in the industry confidence, the total German ESI increased slightly month-on-month. Partly thanks to the falling prices for commodities and raw materials, the manufacturing PMI data in May improved in Germany (as in Poland and euro area countries), evidencing stabilisation; yet the indicator still remains below the 50-point mark. The German "Ifo” index[iii] also pointed to an improved business climate in our fourth largest trading partner. Yet upon closer examination, the rise in the manufacturing indicator is primarily based on a more positive evaluation of the current business situation, whereas the appraisals of the business outlook increased comparatively little.

The improvement in the indicators of the EC May survey of Latvian industry is also predominantly related to a more positive evaluation of the production trend observed in recent months. There is an increase in the assessment of domestic order book levels, but the reported export orders have been going down since March, which is hardly surprising given the situation in our export markets in the recent months. If the negative trends observed in May in Europe take upper hand over the positive ones, then, in contrast to the post-crisis years, manufacturing growth will have to rely more on an increase in the domestic demand instead of rapid export growth.