Growth in 2017: fastest in the last six years

Nevertheless, according to the flash estimate, economic growth reached  4.5% in 2017 overall. In the fourth quarter of 2017, GDP increased by 0.3% quarter-on-quarter, whereas the year-on-year growth was relatively strong and amounted to 4.2% (4.8% in seasonally adjusted terms).

Following the dynamic development in the third quarter, growth was expected to slow down on account of a higher base effect. However, it decelerated at a somewhat faster rate than the previously available data suggested. Latvia's economic sentiment indicator remained on an upward trend, and the external environment was favourable. The construction sector continued to expand rapidly (21%) supported by atypically mild weather at the end of the year. Moreover, higher purchasing power contributed to the development of retail trade (5%) and probably that of other services sectors as well. In the fourth quarter, GDP growth was most likely adversely affected by the agriculture and energy sectors due to unfavourable weather conditions. The transport sector, which previously followed a surprisingly positive trend, as well as the financial sector, where the profitability of banks declined notably, may also have posted rather weak results.

Latvia is a small and open economy and, therefore, it is strongly affected by the external environment. Along with growth in external markets finally accelerating, manufacturing, with almost two thirds of its output exported, also expanded rapidly. In November, manufacturing reached a new record high; however, problems with the availability of raw materials in the wood industry, one of the largest subsectors, have most likely constrained the development of the sector in December and also at the beginning of 2018.

Judging from three-quarter data, the export-oriented transport sector developed surprisingly well. Last year, freight transportation by rail and via ports, Latvia's former pillars of the transport sector, continued on a downward trend for the third consecutive year, with the decline becoming increasingly more pronounced towards the end of the year[1].

At the same time, the sector got help from other players. Freight transportation by road expanded owing to faster economic growth in the region and domestically, whereas investments made in airport development and airline activity contributed to an increase in the number of air passengers and the transported volume of freight. Nevertheless, cargoe transport by rail and via ports still accounts for a significant share of the sector which, therefore, may have negatively affected the GDP growth in the fourth quarter.

Another important lesson learned is that volatility in a particular sector may have a considerable impact on overall annual economic growth. For instance, the decline observed in construction in 2016 and the consequent surge in 2017 had a major effect on the GDP growth rate. Moreover, the construction sector influenced other sectors as well: in 2017, growth was recorded with respect to the mining and quarrying output, manufacture of building materials, manufacture of metal products, etc.

Last year the construction output returned broadly to the level recorded in 2015; however, the assessment of labour shortage was twice as high as two years ago, and currently more than 20% of construction businesses perceive this as a problem. Continued absorption of European Union funds and increased private investment suggest that considerable growth is also expected for this year. It will, however be dampened by labour shortage which will become increasingly pronounced and will be reflected in a steeper rise in remuneration, thereby further increasing total construction costs.

The third lesson learned – let's not underestimate the importance of weather conditions. In 2017, they negatively affected farmers and the logging industry, thus resulting in declines in both sectors in the third quarter and most likely in the fourth quarter as well. Weather conditions will probably influence the output volume also this year.

In the energy sector, by contrast, the rainfalls of the previous year brought about a considerable increase in the output of hydropower plants. While in the fourth quarter, the energy sector most likely saw a year-on-year decline on account of the warm weather conditions. This was due to the fact that, as opposed to the steep rise in the volume of electricity generated by hydropower plants, combined heat and power plants, which are more important in terms of value added, produced only half as much electricity as last year.

Detailed GDP data providing information on the performance of individual sectors as well as the components of GDP by expenditure will be published at the end of February.

[1] This development was related to Russia's decision to redirect its export freight to Russia's own ports. If the political conditions remain unchanged, the trend will most likely continue also in the upcoming years.