Negative trade balance has led to the largest quarterly current account deficit seen over the past years
Following a build-up of the current account surplus driven by robust expansion of exports in the first half of the year, the trade balance shifted downside sharply in the third quarter. It was the deficit of the balance of trade in goods that was at fault. The above deficit grew rapidly and reached a high since the end of 2013. Overall, the current account deficit amounted to 444.4 million euro or 5.7% of gross domestic product (GDP) in the third quarter of 2018.
The trade balance deficit was caused mainly by the balance of trade in goods, i.e. a pick-up posted by exports in the third quarter of 2018 exceeded that of the previous year by a mere 1.0%, while imports increased by 7.7%, posting a steeper rise than in the first half of the year. Trade with non-euro area countries was the largest contributor to the increase in the deficit, but trade with euro area countries was more balanced. Compared with the situation seen last year, trade with Russia, Poland and Lithuania should be particularly highlighted in terms of a rapid rise in deficit.
The third quarter was also less favourable to exports of services, mostly on account of the shrinking export growth rates in the financial services and construction sectors, i.e. –25.1% and –10.4% respectively. The steep fall in exports of construction services was unexpected vis-à-vis the drop in exports of financial services which was expected due to the shrinking deposits by non-residents. This was probably due to the high demand prevailing in the domestic market and its limited capacity, shortage of employees in particular, as well as due to materialisation of downside risks in the United Kingdom and a sharp decrease in exports to non-conventional markets.
The rate of services imports also picked up noticeably and continued to overtake the brisk pace of services exports as well (12.9% vis-à-vis 9.0%). Although the growth rate of financial services imports was still negative, it was offset by the mounting rate of services imports in other sectors with larger shares in total imports. Imports of information and communication technologies as well as other business services continued to surge, with their share in total imports also expanding. Imports of construction services also continued to grow briskly which was in line with the overall development of the sector seen in the economy; however, the share of the above services represented only about 1.5% in total imports. Meanwhile, import rates of transport services had continued on a downward path since the beginning of the year before they reached 9.4% in the third quarter vis-à-vis 18.3% in the first quarter. Irrespective of the above, imports of air transport services continue to expand and are expected to do so also in the foreseeable future.
Contrary to the situation experienced in the first half of the year, the third quarter trade data suggest that external demand was weaker than expected. The outcome of the risks identified before is also not yet known (Brexit results, the likelihood of trade wars between the US and China, etc.). This makes one cautious when looking forward to what the future holds in store.
The balance of payments data on cross-border financial flows suggest that the third quarter of 2018 saw both foreign assets and foreign liabilities grow by 823 million euro and 792 million euro respectively. The increase in assets was primarily driven by the public sector, Latvijas Banka's foreign assets in the form of securities also posted growth as it continued to participate in the expanded asset purchase programme, but bonds issued by the government amounting to 350 million euro contributed to an upward path of liabilities.
In the third quarter, inflows of foreign direct investment in Latvia accounted for 237 million euro or 3.1% of GDP, exceeding the average quarterly investment level of the previous year. The largest flows were registered in the trade, wood processing, real estate and construction sectors, while in the breakdown by country, it was the Netherlands, Estonia and Lithuania that provided the most substantial net flows.