Manufacturing concludes the quarter on a positive note

According to the data provided by the Central Statistical Bureau, manufacturing output in March 2016 increased by 2.3% (month-on-month, seasonally adjusted data). Year-on-year, manufacturing output grew by 3.7% (calendar adjusted data). These results indicate that, overall manufacturing output grew by 2.0% in the first quarter of 2016 (year-on-year). However according to seasonally adjusted data, the quarter-on-quarter growth is only 0.5% however.

In March, the production of non-metallic minerals (primarily construction materials) underwent fast growth for a third consecutive month. This is evidence that the substantial drop in construction, which was behind the weak flash estimate of GDP for the first quarter, is a passing phenomenon: in all probability, the producers of construction materials are already increasing their production output as the orders from construction enterprises keep coming in. The second factor that determined the month-on-month growth of manufacturing was the increase in production output by the high technology sub-branches: the production of electrical equipment, computers, electronic and optical equipment and mechanisms were all on the rise.

No notable changes took place in the largest branches of manufacturing. Wood industry maintained the very high output achieved in previous months, whereas food industry experienced a slight setback from high output level of February. The metal manufacturers' performance was slightly weaker in March, yet it has been very strong in the quarter overall.  The results of manufacturing are likely to continue to gradually improve in the second half of the year.

The weak results of manufacturing in the last six months are more related to cyclical factors and less to structural ones. The performance of manufacturing was hitherto determined by demand or, rather, by the fact that it was insufficient. The hitherto weak growth of the economies of Latvia's external trade partners has weakened the demand for the production of Latvian manufacturers. The good news is that both economic forecasts and confidence indicators point to the possibility of a gradual change in this situation.

Another news on the positive side is that gross domestic product (GDP) of the euro area increased by 0.6% in the first quarter (in the course of a quarter), which indicates that, if this growth remains sustainable, demand for Latvian industrial production could soon also grow faster. The downturn in the Russian economy has slowed-down, which gives reason to hope that in those enterprises (electrical equipment, mechanisms and food manufacturers), which still are connected with this market the situation will stabilize gradually.

As far as the medium term prospects are concerned, the structural factors of the sector's growth should not be forgotten. There are no important short-term structural disbalances in the sector that would have an unfavourable impact on its output. At the same time, two circumstances are worth keeping in mind.  

First, the rise in average salary in recent years has been outpacing productivity indicators to a substantial degree. In itself, the fact of salary increase is positive, but the situation that productivity lags behind is cause for worry. The good news is that, up to now profitability indicators have not been affected – those remain comparatively high. Conquering new markets and non-price competitiveness factors of the production (e.g., the quality of goods or their compatibility with preferences of the market, a transitory drop in raw material prices) apparently have been more important than the pressure of compensation on costs.

Thus, if manufacturers will fail to increase productivity (new investments, optimization of manufacturing processes, energy audits and subsequent energy efficiency measures), a situation may be created that the competitiveness of Latvian manufacturer prices may decrease.

Secondly, those manufacturers active in the energy-intensive industry, have been increasingly raising their voices regarding the negative impact of energy costs on competitiveness (compared to countries where power tariffs are lower). Even though economic policy makers have been promising some sort of support to the energy-intensive enterprises for some time now, there have yet to appear clear rules in this area. This lack of clarity can hardly encourage new investment in this energy-intensive branch of industry.