Year 2016 begins with a sluggish growth

With the investment activity deteriorating and external demand remaining weak, growth of the Latvian economy was barely visible at the beginning of 2016.  The information published by the Central Statistical Bureau indicates that seasonally adjusted gross domestic product (GDP) at constant prices grew by a mere 0.1% , with the year-on-year GDP growth rate reaching only 1.5% (seasonally adjusted data). Even though GDP turned out to be more positive than suggested by the flash estimate (published at the end of April), it still reflects fragile economic activity and substantial risks for further economic growth.

Economic growth of Latvia was primarily impeded by the low investment activity. The decrease in amount of investment reflects the grim results of the construction sector (a year-on-year drop of 19% in value added), thus confirming our previously expressed concerns about the dependence of the construction sector and investments on European Union (EU) structural funds.

It must be noted, however, that in the coming quarters construction activity will gradually recover from the low levels at the beginning of the year, which is evidenced not only by high activity of repair works on roads, but also the production of non-metallic minerals (or primarily construction materials) that has been growing for a third consecutive month. Recently, the number of approved EU structural funds programmes has been growing, although it is likely that, because of time needed to complete the necessary procedures, they will make a direct contribution to the economy only in the second half of this year or at the beginning of 2017. With the new EU structural funds cycle gathering speed and the construction sector slowly recovering, investment activity too should grow gradually. Yet in the area of investment we can hardly hope for a substantial and sustainable leap forward without carrying out structural reforms, which would reinforce investor confidence in the sustainability of growth in the medium term.

The weak external demand is reflected in the decrease of export amounts. Moreover, this is not the only challenge that Latvian exporters face. With wages continuing to grow faster than productivity, the exporting companies can face a drop in competitiveness. For that reason, investment fostering productivity, which would help companies maintain or even increase their market positions, may become ever more significant.

Even though the compensation of employees did not grow as fast as in previous quarter  private consumption remained stable. Further on, however, we may face a slight drop in the private consumption. That may happen if the population increase savings for making larger purchases, for instance, a car or the first payment for a real estate property. This scenario is partially evidenced by the growing activity in the leasing market and real estate sector. The number of transactions with real estate increased substantially in the first quarter of this year, moreover, in Riga the increase is even faster. Commercial banks too are pointing to an increasing demand for mortgage loans. Yet, in the context of slower growth, such a trend may prove inconsistent.

Considering sector performance, the first quarter of 2016 was marked by weak results in construction. As for the rest, the results were relatively good in trade, which mostly resulted from  the good performance of wholesale trade.  The performance of manufacturing was slightly weaker, as already indicated by previously available data on the manufacturing output. It is not entirely clear how the annual growth in transport and storage could still be positive as the data obtained from ports and the railroad is extremely negative. It is possible that they are compensated by the relatively good figures in road transportation, and partially by the drop of prices in the sector.

For a second consecutive quarter, the rate of GDP growth gives little reason for celebration: economic growth has in fact stopped. Even though several factors point to a gradual return of moderate growth in the second half of the year (including recovery of external demand, growing activity in the real estate market and a rise in lending), it may not be enough to ensure that Latvian economy grows as fast as in previous years. Thus the 2016 may be remembered as the year of missed opportunities.  In order to prevent this from happening and achieve faster growth in the future, instead of allowing Latvia to slowly slide into the middle income trap (for more detail see - https://www.macroeconomics.lv/one-foot-latvian-economy-middle-income-tr…), it is time to take on structural reforms, including ones related to healthcare, education, entrepreneurship and judicial systems. It is equally important to carry out reasonable and cautious budget policies, particularly now as the external markets are characterized by high uncertainty.