New driver of GDP growth: domestic consumption takes up the baton from exports

The flash estimate of Latvia's economic growth in the fourth quarter suggests that Latvia's growth rates remained elevated. Moreover, this development was observed against a backdrop of already unexpectedly strong performance in the previous quarter. GDP increased by 1.1% quarter-on-quarter and by 5.5% year-on-year (seasonally adjusted data) in the fourth quarter of 2018.

Although detailed GDP data are not yet available, it is highly likely that domestic demand was the main contributor to GDP growth in the fourth quarter, unchanged from the previous quarter, while the performance of exports was weaker than in the first half of 2018. Exports contracted on account of a decrease in the non-resident segment of the financial sector, poorer grain harvest after the extremely dry summer as well as the weakening of the external demand in the second half of 2018 resulting from deteriorating growth rates and import figures in the euro area trade partners. Meanwhile, domestic demand remained stable largely due to a rapid expansion of investment and private consumption driven by a higher level of employment and average wage growth. 

Looking at the sectors supporting domestic demand, the construction sector was a major contributor rebounding sharply in the fourth quarter of 2018. Retail trade also maintained relatively solid growth, with the sales of non-food goods in non-specialised stores demonstrating a particularly rapid increase (also owing to the opening of the IKEA store in Latvia). At the same time, weaker performance was observed in the energy sector which saw a decline in the electricity output due to weather conditions: hydroelectric power stations received lower water inflows and higher average outdoor temperatures lead to moderating consumption.

Manufacturing, the main export-oriented sector, performed relatively well at the end of the year, and the persistently good results of the high technology subsectors are particularly encouraging. Meanwhile, food production continued to report lower figures. The transport sector recorded solid growth in the fourth quarter of 2018; however, the current situation will not last for long: upon completion of the works, a larger part of the transit freight is expected to be redirected to the ports in Russia.

Confidence indicators published by the European Commission show that Latvia's business and consumer sentiment has remained overall relatively strong. However, the lengthy government formation process over the past months hindered businesses from making clear future plans. Hopefully, the recently confirmed government will promptly communicate its future policy plans and priorities to the general public. Meanwhile, uncertainty is amplified by the weakening external demand. This is even more significant as domestic demand alone cannot sustain a small and open economy like Latvia for an extended period of time. Considering the above internal and external factors, Latvia's GDP growth is estimated to moderate in 2019.