Luminor Global Economic Outlook, March 2025
At the time of writing global politics is influencing global economy like never before since 1945. Trade-killing tariffs are being introduced by USA against its notional allies at short notice. The European security architecture is being rearranged. The relationship between USA, Russia and China might look very different at the end of the year comparing to the beginning.
This means that the assessment of global background is much more uncertain than usual. We live in bad vibes world. Global economic situation is to a large extent satisfactory, but there is an endless fog of bad forebodings. Rise of radical political forces adds to the toxic cocktail of emotions.
Macro forecasts from leading multilateral institutions (IMF, WB, OECD) and private sector players foresee that the world economy will continue to growth at a smooth pace, ca 3% or slightly above. Outcome could be very different. There is a moderate turmoil in stockmarkets. US consumer confidence is worsening rapidly, especially inflation expectations, especially about the long term that now are much worse than after the start of Russian aggression in Ukraine.
Plus, there are regional issues. While there are no immediate threats to the Baltic security, the perception of security risks will not favour our economies. Increased perception of insecurity might affect consumer spending. While the growth boost from increasing EU fund flows is safe, the inflow of foreign private funds could be affected. USA commitment to the NATO has become more uncertain at least at the rhetorical level. However, time will tell how much the messaging is intended to force the Europeans to get serious after all. Plus, while EU is not a military union, security of its Eastern flank is a matter of principle, thus so called “soft” security element is not irrelevant even these days. Plus, it is hard to see how antagonizing the west even further could serve Russia’s strategic goals in any way.
Apart from the impact of politics, also “purely” economic developments are not entirely favourable. The popular perception of the economic situation is hurt by echoes of high inflation in 2021-2023. Prices for frequently purchased items have been affected most, so people get frequent reminders. Pay cheques have also increased, but people receive them once or twice a month. All this encourages precautionary behavior. Savings rates in Europe are high. Unfortunately caution is the leitmotif of being European these days. The continent is obsessed with risk reduction and precautionary principle. There needs to be a revolution in thinking across the board.
Risks are not only on the downside, by all means. There is a talk about possible strategic agreement between USA, China and Russia about comprehensive solution to their geopolitical differences. While in our region this would be regarded with the suspicion of ”sellout”, it might entail positive aspects like reduced risks of great power conflict, for example, over Taiwan. European rearmament would provide a boost to the European economy, thus also to the Baltics, both directly (production of military and dual use goods) and indirectly (increased demand for other Baltic exports).
Until very recently there was a virtual consensus that USA is performing very well and is likely to continue (IMF forecasts 2,7% and 2,1% growth for this and next year). There is still a chance of that, but the level of uncertainty has increased, the potential for abrupt change is there. Possible triggers:
The very low level of unemployment and resilient cost pressures provide ample evidence about the shortage of resources in an overheating economy. Trump’s measures are unlikely to provide much of a boost. America is already very well supplied with energy. On top of that, measures against immigrants will accentuate inflationary pressures, ca ½ of employees in agriculture are illegal immigrants, share is also high in catering and hospitality.
Overheating economy and high deficits will increase interest rate differentials vs rest of the world, so strong dollar is likely in near term. However, there is also high probability of abrupt change, either political (Plaza type accord) or, more likely, market driven (a rapid, market forced switch to a different fiscal policy regime).
Emphasis on fossil energy could give short term boost to growth. However, it could be largely self-cancelling as lower oil prices from conventional drilling might lower the production in shale fields through lower prices. On the structural issues front, AI and related investments remain a persistent bright spot though with risks involved. We might see massive effects on labour market already under Trump 47 – his campaign manifesto – higher productivity, but also unemployment wave among white collar employees.
The expectations about European economic future and also political future have been very soggy for years. For a long time European economy has faced two massive challenges - USA’s energy abundance with correspondingly low prices and the emerging China high-tech export machine. European industries, especially car manufacturing will go through a lot of China pain, especially because EU cannot close third country markets for Chinese goods. In a remarkable development, Ethiopia closed its market to non-electrical cars in 2024 as these do not make any economic sense in a country with ample electricity supply and no car industry to protect.
Recently these challenges have been supplemented by the risk of trade war with the USA. Fortunately, also the pressure on Europe to change has reached critical mass. Just at the time of writing there is a talk of change in the air. Prompted by increasing security risks, big decisions are being prepared at EU and national levels that would provide ample stimulus through rearmament and infrastructure developments programs. That can change near term outlook profoundly – higher growth, but also higher interest rates, at least the long-term rates. Policy shift comes just at the right time to help European industries battered by increasing competition, energy prices and tariff threats. A cautionary note – not all is decided, a failure to lift the German debt brake would derail a significant part of the effort.
Even without extra stimulus things were likely to improve somewhat. The sluggishness of the European economy is legendary, however, the old continent has its advantages. Growth is likely to accelerate here, not decelerate, like in USA. Average budget deficit and debt burden in EU is lower. The diversity of export specializations, business environments may make it more robust in case there is a change of starring roles among sectors. Its stock market is much more moderately priced. In the absence of macroeconomically significant stimulus, the policy environment would switch back to the “default option” – in conditions of prolonged relative weakness, EURUSD could continue to decline, provide an umbrella for internationally exposed sectors. With time, resources freed from failing sectors will provide a breeding ground for new stars, often in sectors overlooked by intellectual fashion, harnessing Europe’s strengths in engineering excellence, artistic creativity, diverse gastronomical and design traditions etc.
China is a split economy. Situation in real estate is atrocious, housing starts are down ¾ from the peak, consumer demand is sluggish.
On the other hand, export surplus reached almost a trillion dollars in 2024. China has become a leader in many technology areas through a deft mixture of dirigisme and decentralization. China is authoritarian, but not a tyranny. Regional and city governments have a large margin of maneuvre and that has created a highly Darwinian environment of regional development policies that allows a lot of experimentation. Plus, the tendency of provinces to build their own leaders in prestigious industries in combination with the enormous national market has led to the emergence of, for example, over 100 electric car manufacturers. Add the super-efficient supply chains to the mixture and you get a juggernaut that is crushing competitors in the rest of the world, with or without state subsidies.
Even that is not the end of the story. Disaster in real estate markets, failure to provide sufficient alternative investment opportunities for households, as well as insecurity of property rights is creating a capital flight pressure, which is pushing down the currency despite enormous current account surplus. So the issue of Chinese “dumping” of their excess supply will be on top of the global macro agenda. This is important for two reasons. The avalanche of Chinese exports is squeezing industrial profitability, jobs, tax revenues etc. in the rest of the world. Plus, this raises the prospect of another savings glut. Chinese society that is aging and insecure (weak pension systems, health care availability etc.), thus wishes to put aside as much resources as possible. In the process it is dumping savings on other societies that are also aging if somewhat less insecure (that might be an illusion in fact). That is happening at a time when financial markets are already highly priced on average (USA stands out with its valuations, but also represents >1/2 of global equities). This is a highly volatile mixture. If USA and Europe erect high tariffs, China may experience a severe crisis. If not, Second China Shock will continue to destabilize Western societies and lead to an increasing political radicalization.
This is inevitably a big generalization, but the rest of the world (apart from USA, EU and China that constitute ~1/2 of the global economy at PPP and more than that at market exchange rates) is in general doing quite well.
The largest country in this group, India is consistently the fastest growing large economy. Despite the quality of economic policy still leaves a lot to be desired, its private sector continues to pick amply available low hanging fruit, seeded by the cumulative impacts of liberalization, improving rule of law, creation of genuine internal market since early 1990s. The high quality of the elite components of its education system provide human capital for its service exports juggernaut. Plus the ABC (Anything But China) investment policy by multinationals opens the world of manufacturing lead growth, most notably, by shift of Apple assembly operations.
While this is obviously not desirable from security point of view, it has to be recognized that Russian economy is coping with sanctions better than was generally expected. Its long-term prospects are very poor and getting worse rapidly (mostly due to population loss, underinvestment in civilian sectors and advancement of clean energy abroad), but right now its wartime Keynesian economy creates quite a lot of extra demand for China and India, among others.
Also other large economies in Eurasia and Oceania are doing quite well. Indonesia is a largely underreported story, its growth rate is a tad below India (5.3% on average during last ten years), but its large and growing population, crucial role in supplying certain energy revolution materials (primarily nickel) make it important. Indonesia has defined EVs as one of its growth engines as the country tries to move up the value-added chain, it has already received pledges from BYD and Stellantis to build EV factories. Gulf states continue to benefit from stable and rather high hydrocarbon prices, some also from successful diversification efforts. Australia continues its multi-decade long recession free (apart from pandemic times), diversifying from fossil fuels and base metals into being the largest lithium producer.
African growth rates recently have been reasonable, it is forecasted to expand by ca 4% over the next three years, which is good, but not great, given fast population growth and still widespread poverty. The most notable success story is Ethiopia with growth rates occasionally stretching into double digit territory, but there are others expanding at roughly a pace sufficient to double the economy in a decade (ca 7%). Quantity brings quality and vice versa – there are notable examples of both manufacturing and smart service export driven expansions like Rwanda, Kenya and Morocco.
Latin America is growing at its characteristic sedentary pace, forecasted to expand by ca 2.5% in foreseeable future. While Argentina is making progress with its perennial governance problems, Brazil is slipping into fiscal hole, Peru into political instability, but Venezuela is looking more and more hopeless. While the recent glorious screening of Gabriel Garcia Marquez’s most famous novel provides somewhat different impression about the region, birth rates in several countries (Colombia, Chile for example) are not far away from that of the birthplace of Hispanic civilization. This presents the region with the un-appetizing prospect of getting old before getting rich.
Last three years have been marked by startling contrasts in the economic performance of Baltic states – Lithuania continued to boom while Estonia slumped into a deep recession, but Latvia fluctuated between episodes of growth and mild recession. This period is coming to an end. Estonian economy has expanded q/q for three consecutive quarters, thus achieving a positive annual rate in Q4. For Latvia last year was a time of disappointment after a fairly successful 2023, but export sectors are picking up and public sector financed investment boom is in the making. Lithuania is expected to sail along at a decent pace.
This is the pre-eminent issue in public mind right now, thus it will have an impact on economic performance. The impact is likely to be negative in the short run due to confidence effects but could be positive in the long run as European economic outlook has changed for the better on balance. The main driving force will be a huge fiscal stimulus (up to 1 trillion euros) from Germany, supplemented by efforts of other states and rearmament program financed at EU level. While not all plans will survive on the political scene, financial markets are taking this seriously.
The mitigation of the negative psychological impact depends on smart communication from authorities and other opinion leaders, including macro economists.
Consumption growth can provide more support to the economy though a note of caution is attached.
Private consumption in 2024 in Lithuania was up 3.3% in Lithuania from 2022, but down by 0.3% in Latvia and 1.3% in Estonia. Positive factors are quite strong for the private consumption outlook. Household saving growth is strong and accelerating. The total household deposits in the Baltics have reached almost 50 million euros, annual growth rates in January 2025 reached 11%, 9% and 12% in Estonia, Latvia and Lithuania respectively. The burst of inflation had suppressed deposit growth rates to 1%, -1% and 3% during (somewhat differently timed) low points in 2022-2023. The decline of interest rates will both free up household financial resources and encourage lending. Lithuanian consumers are very well positioned to take advantage - their confidence index is the highest among EU countries, real wage growth is the strongest in Baltics. Latvian mood is closer to historic average and resurging inflation is putting an extra note of caution. Estonian confidence is rising from a very low point, but real wage growth will be the most modest (1-2%) due to tax increases. While most of ECB rate reductions have already occurred, markets still expect ECB’s deposit rate to go from the current 2.5% to ca. 2.0% at the end of the year, it was still 4% in early 2024. The macro impact of rate reductions that have already occurred are still feeding through. On the negative side, general feelings of uncertainty and high propensity to save will be a persistent drag. These worries are quite rational, for example the outlook for pension systems is not great. Plus, the negative news background will encourage households to put increase their precautionary savings.
Government consumption growth diverged sharply in previous three years, it was on average 5.7% in Latvia, but only 0.7% in Lithuania and -0.1% in Estonia. Growth rates will converge, the recent Latvian pace is unsustainable, but in other Baltics growth will accelerate as security states (army, other services) are built up.
For investment the outlook is both very good and uncertain.
On one hand, public investment will be strong, fed both by national and EU funds. The highest point of so called “covid funds” (NextGenerationEU) and “regular” EU fund flows (Structural and Cohesion funds) is ahead in 2025 and 2026. At national level a lot will be spent on increasing the military capacity. Weapons and other equipment will be mostly sourced from Sweden, Germany, France and USA, so providing limited positive impact on local economies. On the other hand, construction of defence lines and military encampments will provide a strong boost.
The biggest impact of geopolitical worries will be on the behaviour of private sector investors. It is very hard to say how they will react. It seems unlikely that industrial investment projects, housing construction projects will be immediately postponed. However, it is very likely that decisions will be put off, leading to weaker private investment dynamics from 2026 onwards.
Recent Baltic export performance looks dismal, real exports of goods and services declined by 10% in Estonia, by 6% in Latvia and by 3% in Lithuania comparing to 2022. The “true” story is somewhat better as trade with aggressor countries that was mostly re-exports was reduced abruptly. Nevertheless, there are genuine difficulties. Construction related sectors (timber, furniture, metal articles etc) suffered from crisis in housing construction largely provoked by interest rate increases. Exports of road transport services were affected by the partial closure of Eastern borders. In Latvia also the “white collar” services disappointed deeply, the break of previous growth trend could be even described as hitting the wall.
Outlook for 2025 is somewhat better and for 2026 – much better.
Construction related sectors start to perform better despite demand still being weak. One of the explanations – business have adjusted to that and are pushing out rivals from higher cost countries. For example, sawmills are going under in Germany and Nordics, but no significant business failures in this segment in the Baltics so far. Engineering was badly affected in 2024 by the weakness of European, especially German industry, but the future seems to be promising due to rearmament efforts.
In Latvia manufacturing investment has increased by 48% in current prices from 2022 to 2024. It is mostly going to the traditional mainstays of timber and food processing, especially plywood production and other areas that help achieve higher incomes with existing skills and infrastructure.
Smart service exports remained strong in Estonia and Lithuania in 2024, and recovery was noticeable in Latvia toward the end of the year. Latvia is moving towards a lasting solution with AirBaltic that will help tourism and business travel development across the region.
An important question about the future – how will AI affect demand for IT and to a lesser extent business services? There are risks definitely. The position of Estonia looks relatively strong as its enterprises are overrepresented among platform owners (Bolt, Pipedrive etc.) so cannot be easily replaced, but may gain from efficiencies.
Electricity prices have been a relative drawback for a region for a long time. This may change. The share of renewables in electricity generation is already high and composition is healthy. All main existing RE types apart from geothermal are significantly represented - wind, sun, hydro (both river and pumped) and biomass + biogas. Plus, regions significant heat energy needs in combination with developed district heating systems mean that the economic efficiency of combined cycle power stations is high. From safety point of view it would be very desirable to have additional baseload power station in Estonia and Lithuania, but no illusions about its expected profitability as the periods of super-low electricity prices will get longer as renewable capacities grow. There is a lot of talk about nuclear power, but due to budget constraints and urgency of the issue one or two extra gas-powered stations in the region are likely.
It is in the interests of the Baltic economies to accelerate transition to electric propulsion as this would allow to replace oil imports with mostly locally produced electricity and would lower maintenance costs. Vehicle unit costs are likely to converge in this decade as production volumes grow, this has already happened in China.