GDP growth rate dropping, mood of investors and forecasters turns more cautious

The adjusted indicator of the first quarter gross domestic product (GDP) has confirmed earlier calculations. Quarter-on-quarter, GDP grew by 0.6% (seasonal factors excluded), which basically matches the increase of the fourth quarter of 2013. Year-on-year, however, a gradual drop in the growth rate has been observed, with it "waning" each subsequent quarter by about one percentage point (pp) - from 4.6% in the third quarter of last year to 2.8% in the first quarter of this year.

The Russia-Ukraine conflict has provoked a deterioration in the mood of investors and weakened external demand. True, this factor is more pronounced in confidence data and the drop in exports is seen in only a few industrial branches. The Latvian economic sentiment index and consumer confidence are relatively stable; if however we are to assess the performance of the Baltic countries overall, then the confidence indexes show a tendency to deteriorate (particularly rapidly in Estonia), whereas on average the mood in the countries of the European Union is improving dynamically. This points to worry in the region regarding future development because of the Russia-Ukraine conflict. At the moment, it is the main external risk factor that in turn is exacerbating domestic risks.

The gross fixed capital formation in the first quarter grew by 2.2%. Against the background of weak investment growth last year and emerging investor caution as demonstrated in confidence indicators, investment growth looks good. Yet it should be kept in mind that investments always "react" with a delay, for the investors are trying to finish the projects already begun. For that reason, it is not surprising that construction in the first quarter has continued to build muscle, helped by the weather beneficial for construction work and Latvia joining the euro area. Yet the imports of capital goods in the first quarter dropped and there are a few negative signs in the building permit statistics.

The private consumption growth rate in the first quarter dropped to +2.1% (in the previous quarter it was still twice as much) and lost its dominance in contributing to GDP growth – with its 1.4 pp contribution it shares the 1-2 place along with export. A substantial increase in salary growth rate was observed in the first quarter, yet it was promoted by several one-off factors and a drop in growth rate is expected from now on. Even though the increase in disposable income allows households to increase expenditure, the habits of saving play an important role. With the geopolitical situation unresolved and preparing for the liberalization of the power market in 2015, the population could remain cautious and form accruals, slightly limiting consumption. 

The real goods and services export developed a growth rate reduction trend, even slipping into the negative area for a while, therefore the first quarter growth of 2.3% is particularly commendable. Taking into account weaker growth in some export markets, exporters have nevertheless asserted their fighting spirit and have managed to increase their market shares based on their recovered competitiveness and flexible adjusting to market changes.

The real goods and services import has dropped also in the first quarter (by 1.7%), primarily as a result in the drop of intermediate consumption goods necessary for export and investment or capital goods. The drop in the import of consumer goods was small. The drop in import along with the rise in export has led to a positive net export contribution to GDP growth (2.5 pp).

Evaluating by branch, the greatest contributor to GDP growth was construction, which can be explained by the warm winter, and which was already pointed to both by survey data and data on construction in actual prices.  After the positive first quarter operational data, growth in the transport branch is also hardly a surprise. Despite the small quarterly drop in retail trade, the added value in trade has increased slightly overall. Such service branches as financial activity and art and entertainment also continue to grow rapidly. According to the substantial drop in output observed from the manufacturing operational data in January, the added value in this branch has dropped quarter-on-quarter, yet year-on-year, the branch continues to grow. If the warm winter has brought a substantial rise in added value in construction, it has had an opposite effect on the power industry where, like in the rest of the euro area, a drop has been observed.

As far as predictions for 2014 overall, GDP growth at the approximate rate of 3.3% (Latvijas Banka has reduced its forecast by 0.7 pp) will be maintained with the help of private consumption and export. Yet exporters' performance can be substantially affected by investments whose future dynamic is currently most in doubt – even though the year has started half-way hopefully, it is not clear that we will continue to receive positive news. In any case, inadequate investments could impede growth, therefore the investment dynamic will be decisive and even if we do not experience dramatic drops, the rate of growth could be lower than we predicted at the beginning of the year.  Caution is felt in confidence indicators, albeit it does not always become reflected in the actual production and export volumes, for the exporters have a way of surprising everyone with their ability to quickly find new markets.