Practically no growth in the third quarter

The weak economic growth in Latvia is still attributable to the fast drop in investments. The information published today by the Central Statistical Bureau indicates that gross domestic product (GDP) has grown by 0.2% (at constant prices; seasonally and working day adjusted data) quarter-on-quarter and year-on-year growth has been only 0.3%. Full GDP estimate is 0.4 p.p lower than the flash estimate published at the end of October.

Looking at GDP from the expenditure side, the situation is mainly determined by low investment activity, which, for a third consecutive quarter, has made a negative contribution to economic growth. The diminished investment in 2016 can be explained mostly by delayed absorption of the European Union (EU) structural funds. This is particularly evident by the contraction of investment in non-residential buildings and infrastructure as the projects from the previous planning period were finalized and the uptake of the new period appropriations was delayed.  

The situation in the construction sector proves the point as the drop was most substantial in the construction of engineering structures. Even though the situation is rather grim, it seems that the lowest point may have been reached and from now on a moderate recovery in the flow of EU structural funds can be expected. A positive sign is the rise in government investments in October (11% year-on-year), which is a substantial improvement over the first nine months of the year (a drop of 30%). Thus a gradual rise in construction and investment activities is expected, which, however, is likely to be too small to compensate for the drop seen so far. In view of this, in 2016 overall the amount of investments will be substantially smaller than in 2015.

In spite of the slower wage growth and deterioration of the consumer confidence indicators, the increase in private consumption has remained stable. It can be expected that along with faster economic growth and return to higher wage growth (see here), the private consumption will continue to grow steadily.

Compared to the first half of the year, the increase in goods and services imports has diminished substantially – to a great extent because of the low investment activity (evident in falling imports of capital goods). Export of goods and services, on the other hand, showed a moderate growth.

In a breakdown by sector, the poor performance of construction was still the main story. It must be noted, however, that results in other sectors were weak as well. The quarter-on-quarter growth rate (seasonally adjusted) was negative in manufacturing, energy, transport, financial services as well as education sector. The fact that GDP retained quarter-on-quarter growth, albeit tiny, was determined by the slight rise in trade and the relatively strong increase in real estate sector.

The performance of the Latvian economy in 2016 can by no means be considered successful, yet there are several factors that should be kept in mind when assessing the current economic situation and its further developments.

Firstly, larger flows of EU structural funds in 2017 will foster investment growth in the segment of non-residential buildings and other infrastructure, which will help the construction sector to recover.

Secondly, next year's budget indicates the government's plans to implement a rather expansive fiscal policy, increasing expenditure on remuneration for the teachers, internal and judicial affairs system employees as well as expenditure on healthcare and defence.

Thirdly, the foreign demand is expected to grow slightly faster next year, providing better conditions for export growth. These factors combined suggest that growth in 2017 will be faster than we are seeing now.