The Latvian economy begins to feel the impact of the external environment

In the situation when the growth in the euro area is low and the large neighbour to the east, Russia, is experiencing substantial turbulence in its economy, the turning moment in the Latvian economy is winding down gradually, without rapid changes in the situation.

According to the flash estimate by the Central Statistical Bureau, gross domestic product in the fourth quarter of 2014 grew by   0.4% (seasonal factors excluded). According to calendar adjusted data, the annual growth is at 1.9%. That in turn means that in 2014 overall, according to calendar adjusted data, GDP has expanded by about 2.4%. This result is slightly weaker than Latvijas Banka's. earlier projections.

It must be noted, however, that this primarily takes place on account of internal reserves. The export market successes of previous years have promoted progress in the labour market, bringing down unemployment and raising real wages, which in turn is reflected in the results of retail trade and some service industries. 

Given the circumstances, 0.4% growth in the fourth quarter is considered adequate for unfavourable developments in the external environment.  At the time when the external environment was pronouncedly unfavourable, the rate of economic growth has gradually slowed. Various kinds of operational information pointed to the fourth quarter possibly being relatively successful. Data suggest that the retail turnover in the fourth quarter increased by 1.5% (quarter-on-quarter), the indicators of freights handled in ports were good in October and November and the tax revenue and external trade indicators were relatively good.

Yet a slightly negative impact on growth was probably left by manufacturing, whose sales indicators in October and November were rather weak. Evaluating the relatively low quarter-on-quarter growth, some surprise may be presented by some of the services branches.  After a relatively strong third quarter in the real estate sector, the last quarter of the year was probably weaker because of the legislative changes regarding Temporary residence permits (TRP).

In all likelihood, in 2015, the economy will have to follow the same course as before.  Economic growth will to a great extent be supported by an increase in household incomes (businesses report raising wages to keep their employees; minimum wage as well as mandatory exemption have also increased) and thus also private consumption. It is clear, however, that if a stable external demand does not resume and thus export prospects do not improve, such an economic model will not be sustainable in the longer term.

On the new monthly asset purchase programme

The external situation remains rather complicated. In the euro area, growth is weak and inconsistent. This month, the European Central Bank (ECB) announced its long-awaited and long-discussed asset purchase programme (or its expansion). It provides for monthly purchases of assets in the amount of 60 billion euro. For now, it is too early to make any conclusions regarding the possible effectiveness of the programme, yet it is clear that it is not a unified solution to the euro area problems – the need for a rational fiscal policy and serious structural reforms remains in place.

Turbulence in the Russian economy

While the euro area is struggling with its own problems, on the other side of the border, in Russia, the economy is experiencing real turbulence. The exchange rate of the rouble experienced a very rapid drop in December and the prospects of economic growth are adversely affected by the low prices of oil that are even twice lower than predicted a while ago when the Russian national budget was being drafted. The economic sanctions introduced by the European Union and Russia (at least in their current form) are now relatively unimportant: the impact of the exchange rate and oil prices is substantially larger.  

The weakening of the Russian economy has particularly impacted those Latvian businesses that used to operate exclusively in that market. If the food producers can hope to reorient to other markets sooner or later, then it is harder for the producers of various mechanisms and electrical equipment. It is influenced by the fact that product certification has primarily taken place in the Russian market and conquering new markets is complicated both from the technological and legal points of view. On a positive note, however, there are reports from some manufacturers who have managed to find new markets or are currently negotiating with the potential new partners.   

GDP projections

Given the developments taking place in the external environment, Latvijas Banka in the middle of January reviewed its GDP growth projections for 2015 from the current 2.7% to 2.0%. Yet the risks related to further economic growth are extensive.  A positive impact on the economy may be had by a serious resumption of operations by "KVV Liepājas metalurgs", a gradual improvement in the geopolitical situation and resumption of more stable growth in the euro area. Yet there are more risks on the negative side: the euro area growth prospects, a further escalation od the geopolitical situation and new sanctions.