The Economic Situation in Latvia (March 18, 2011)
Assessing the year 2010 as a whole, economy in Latvia has developed successfully. /A.Vilks, Minister of Finance/
Throughout the year 2010 macroeconomic situation in Latvia remained stable. Compared to 2009, the annual GDP in 2010 has decreased by 0.3%, but in the fourth quarter of 2010, compared to the fourth quarter of 2009, it has grown by 3.6%, according to the seasonally non-adjusted data of the Central Statistical Bureau (CSB). Increase of GDP was mainly caused by growth in the following sectors: trade (share in GDP structure – 15.1%) - by 10.6%, manufacturing (13.0%) – by 17.9% and transport and communications (11.5%) – by 1.6%. Volume drop remained in construction (5.4%) – by 9.6%. Experts agree that economic growth has been faster than anticipated, mostly due to stronger private demand and increase in foreign investments. The Bank of Latvia forecasts that economic recovery will continue, but growth will be slower during the 2011. It will be affected by slower external demand growth and tax increases. The forecast of GDP growth for 2011 is 3.3%.
Improvements in economy of Latvia have been recognized by international rating agencies. On 15 March 2011 Fitch Ratings raised Latvia's rating outlook to positive and rated the country at "BBB-". In January 2011 Japanese rating agency Rating and Investment Information, Inc. increased Latvia’s rating outlook by two grades from negative to positive maintaining the Foreign Currency Issuer Rating at BB+. On 11 March Standard & Poor's informed that they had upgraded Latvia's rating outlook from stable to positive because Latvia has become less reliant on external financing. Latvia currently has a long-term BB+ rating and a short-term B rating, just below investment grade. The improved ratings indicate the stabilization of investment environment in Latvia and open the opportunity for further inflow of investment in the future.
In 2010 industrial production output has grown by 13.9% compared to 2009 (according to working day adjusted data). Growth was observed in all industry sectors. Output in manufacturing industries grew by 14%, compared to 2009, with the highest output growth in manufacture of motor vehicles (67.2%), electric equipment (35.3%), other transport vehicles (29.3%) and wood and cork articles (29.0%). It is expected that in 2011 industrial production output will continue to increase, although the growth rate will be slower.
The positive trend in Latvia’s economy mainly stems from the increase in exports. According to CSB data, in 2010 compared to the previous year exports grew by 29.5% and constituted 4,7 bill. LVL, imports – by 24% reaching 5.8 bill. LVL. Even though volumes of export have exceeded pre-crisis level by more than 13% in real terms and export growth shows a positive trend, external trade balance remains negative (1.2 bill. LVL). In Q4 2010 trade balance in services slightly improved and it was 62.1 mill. LVL, mainly as a result of increasing exports of cargo transportation services and financial services.
According to the Bank of Latvia there was a Current Account surplus of 4% of GDP in 2010. Positive trend is related to the increase of foreign direct investments (FDI) (12% (y-o-y) in December 2010) and increase of export in services.
According to the Bank of Latvia and Swedbank data, inflow of FDI in Q4 2010 was 94.5 mill. LVL, totaling 185.5 mill. LVL in 2010 (net flows in 2010 at 1.5% of GDP). FDI primarily went to manufacturing (11.75% in Q3 2010) and real estate. Positive tendency has been observed for the third quarter in a row; there was outflow of FDI observed in Q1 2010 (-72.7 mill. LVL). Total pre-crisis amount of FDI is not reached yet (FDI inflow of 270.3 mill. LVL in Q1 2008).
Latvia continued to receive international financial assistance from the International Monetary Fund and the European Commission under the international bailout program. Latvia’s total external debt in December 2010 was 40% of GDP, accounting for 5069.5 mill. LVL.
Consumer price index has increased to 4% (February 2011, y-o-y), while month to month (m-o-m) results show a 0.3% growth in inflation rate. According to the Bank of Latvia, inflation rate is caused by value added tax (VAT) rate increase from 21% to 22%, as well as the major global price growth mainly for food products and energy resources. Ministry of Finance forecasts 3.5% inflation in 2011 and 2% in 2012. Government of Latvia is aware that additional measures might be needed to comply with the Maastricht criteria.
In February 2011, according to the State Employment Agency data, the registered unemployment rate remained at the previous month level of 14.5% of the economically active population. Since March 2010 when unemployment rate in Latvia reached its peak (17.3%) it has gradually decreased with the exception of January 2011 when the unemployment rate raised slightly from 14.3% to 14.5% (m-o-m). The rise in unemployment at the beginning of the year was caused by seasonal factors and does not indicate a change in tendencies in the labor market; experts agree that the unemployment rate will continue to decrease gradually because of the increasing economic activity. In 2010 the increase in employment was primarily caused by developments in manufacturing and transport sectors, whereas in 2011 the growth in employment level is foreseen also in trade and other services.
External competitiveness has improved considerably in the last years due to the decline of the real effective exchange rate (REER) of the LVL, the ULC (unit labor cost) based REER decrease by almost 20% in Q3 2010 compared to its peak in Q3 2008 and due to the decrease of CPI (Consumer Price Index) and PPI (Producer Price Index) by 10%.
According to the Financial and capital market commission, commercial banks incurred losses of 360.6 mill LVL in 2010 (53.4% less than in 2009). 10 Latvian banks worked with profit (8.3 mill. LVL) and market share of those banks comprised 15.6%. Bank of Latvia has kept refinancing rate unchanged at 3.5%, but reduced the interest rate on deposit facility in order to encourage banks to grant loans to the economy (overnight deposit facility rate was reduced from 0.375% to 0.25%, whereas seven-day deposit facility rate – from 0.5% to 0.375%). Average monthly RIGIBOR (the interest rate for which the commercial banks are ready to lend lats to each other) on overnight loans stood at 0.45%. 3-, 6-, and 12-month RIGIBOR remained almost unchanged in February 2011, at 0.88%, 1.37% and 2.25% respectively.
Budget deficit in 2010 was 7.3%, less than expected (8%). Total income comprised 3.8 bill. LVL, expenditures – 4.7 bill. LVL, total budget deficit was 917 milll. LVL. The budget deficit in 2011 is planned to be 5.5% of GDP, according to ESA 95 methodology. The Government of Latvia strives to reach the budget deficit of no more than 3% of GDP in 2012, in order to fulfill Maastricht criteria and introduce euro by January 2014.
In January 2011 budget revenues were 12% higher than in January 2010 (33.0 million LVL). VAT revenues in January 2011 (y-o-y) grew by 31.5%, excise tax revenues decreased by 0.6%.
Latvia’s economy is recovering faster than anticipated. There are positive tendencies in macroeconomic data and acknowledgement of economic development from the international credit rating agencies. Cost and price drop has improved the competitive strength of Latvia’s export. Introduction of euro in Estonia could boost investors interest in the Baltic region in general.
Nevertheless some weaknesses and risks remain. The ongoing consolidation of the state budget and increases in tax rates can reduce external competitiveness and lessen interest of foreign investors. Changes in tax policy pose also inflation risk and can further increase “grey economy” thus reducing tax collection rate. Challenges remain in the social sector due to the rather high unemployment rate, demographic situation and emigration.
Externally, growing global food and oil prices can accelerate inflation and endanger introduction of euro in 2014. Economic situation in Europe and introduction of fiscal consolidation measures can affect Latvia’s exports to its main trading partner countries.