Economic Situation in Latvia (July 2011)
In the first half of 2011, the macroeconomic situation in Latvia has considerably improved. According to the seasonally non-adjusted data of the Central Statistical Bureau, after the 0.3% decrease of GDP in 2010, the first quartder of 2011 started off with a 3.5% y-o-y GDP increase. That is not a surprise, merely continuation of a trend witnessed before, to be exact, the 2.9% and 3.6% year-on-year increases during, respectively, Q3 and Q4 of 2010. This increase in GDP was caused by, but not limited to, y-o-y increase in manufacturing, 6.6% increase in transport and communications, as well as 6.5% growth in trade. Some industries shrank, e.g. construction output went down by 15% and retail - by 1.6%. On the whole, a y-o-y GDP increase was achieved nevertheless.
It is believed that GDP growth has been faster in Q2 2011, and that during the second half of 2011 Latvian economy is to face several challenges, including both external (for example, shocks of prices of raw materials) and internal (for instance, changes in tax policy due to the need for consolidation of next year's budget) factors.
Improvements in economy of Latvia have been further recognized by international rating agencies. Following the positive developments during Q1 2011 (Fitch Ratings rating Latvia at "BBB-" and raising the rating outlook to positive, as well as Rating and Investment Information, Inc. changing rating outlook two grades from negative to positive), Q2 has also seen some progress in this area. On 6 June 2011, Moody's Investors Service also changed Latvian rating outlook from stable to positive, leaving credit rating at "Baa3". According to Moody's, this has been done as a reaction to the recovering economy, almost finished convergence to Maastricht criteria, and positive mid-term prospects. Improved ratings indicate the stabilization of investment environment in Latvia and open the opportunity for further inflow of investment in the future.
In May 2011, when compared to May 2010 (according to seasonally-adjusted data), manufacturing turnover grew by 16% (18.9% for exported goods, 13.2% for locally consumed goods). Only 4 of 22 manufacturing sectors experienced a decline in turnover. Industrial production output has incrased by 10.2%, when compared to May 2010. Output in manufacturing has increased by 12.2% (16 out of 22 manufacturing sectors reported increased output y-o-y). As predicted, industrial output and turnover is rising in 2011, but at a diminishing rate. When compared to April 2011, industrial output has decreased by 1.3%.
As shown by Central Statistical Bureau (CSB) data, total foreign trade amounted to 2.9 bill. LVL in Q1 2011, a 38.3% increase, when compared to Q1 2010. In the same period, exports have increased by 389.4 mill. LVL or 41.4% y-o-y, but imports - 432.0 mill. LVL or 35.8%. This development contributed to a positive change in balance of trade, of which 45.3% are now exports (44.3% in Q1 2010).
According to the Bank of Latvia, inflow of FDI in Q1 2011 was 184.3 mill. LVL, almost the same amount as the total FDI inflow in 2010 (185.5 mill. LVL). In Q1 2011, net FDI inflow amounted to 6% of GDP. This was the fourth quarter in a row, when a positive tendency was observed, concerning FDI. Total pre-crisis amount of FDI, however, has not been reached yet (FDI inflow of 270.3 mill. LVL in Q1 2008).
In Q1 and Q2 of 2011, 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 May 2011 was 39.3% of GDP, accounting for 5310.9 mill. LVL.
Consumer price index has increased to 4.8% in June 2011 year-on-year, whereas the month-to-month figure for CPI is 0.3%. This has been largely due to tax increases for, e.g., natural gas, as well as external factors such as global price increases for food products. The y-o-y figure was anticipated by many to be larger (as much as 6%). According to the Bank of Latvia, this did not happen due to a slower growth of heating tariffs and a fall of vegetable prices. The CPI growth forecast for 2011 is now 4.7%, but for 2012 - 2.5-3% (Bank of Latvia). Government of Latvia is aware that additional measures might be needed to comply with the Maastricht criteria.
In July 2011, according to the Bank of Latvia, the registered unemployment rate has decreased to 12.6%, when compared to the 13.2% in May 2011. 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 rose 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 labour market; experts agree that the unemployment rate will continue to decrease gradually because of the increasing economic activity. Decreases in unemployment are caused, according to the Bank of Latvia, by gradual recovery from the recession. For example, in the period from March 2010 to April 2011, when the number of registered unemployed people shrank by 36.4 thousand, the number of registered employees grew by 30.7 thousand.
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 labour 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, the first five months of 2011 have been profitable for commercial banks. During this period, 14 Latvian and 5 foreign banks have accumulated a profit of 80.5 mill. LVL. These banks have a 74.7% share in the Latvian market. In the respective period in 2010, banks incurred losses of 207 mill. LVL. In the end of May 2011, the total amount of deposits in the Latvian banking sector was 10 bill. LVL, which is 1.8% more than in April 2011.
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 mill. 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 the Maastricht criteria and introduce euro by January 2014.
In the first six months of 2011, budget revenues were 2346.5 mill. LVL, but expenditures - 2563.8 mill. LVL, thus, the deficit was 217.3 mill. LVL. In June 2011, there was a 21.6 mill. LVL surplus. The public expenditure grew 2.2% year-on-year in June 2011.
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. The need for a more foreseeable tax policy is evident. Another concern is that changes in tax policy pose also inflation risk and can further increase "grey economy" thus reducing tax collection rate. Tax collection statistics, however, have proved otherwise. Challenges remain in the social sector due to the rather high unemployment rate, demographic situation and emigration. At the same time, the recovering economy has helped with the unemployment. Demographic issues do, however, remain.
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.