Luminor Economist: will Latvian economy experience “the great seven years”?

2020 was a year of overcoming extraordinary challenges for the Latvian national economy. Although the balance of the country’s achievements still looks pretty good, it is not as good as it was up to November of the previous year. When could the wave of negative effects of the pandemic break? Why are prospects of the Latvian economy viewed cautiously this year? Answers to these and other questions about the Latvian and Baltic economy were presented by Pēteris Strautiņš, economist at Luminor Bank.

Luminor Bank’s economists are cautious with regard to prospects of economies of the Baltic states, predicting that the GDP of Estonia, Latvia and Lithuania will grow by 2.5%, 2.1% and 1.8% respectively. However, they are very optimistic about 2022 and the following 6 years. Release of consumption sectors from the burden of restrictions and recovery of the export market will give the initial push, while continuation will be provided by the transformed structure of economy sectors, especially the export sector, as well as the reduced debt and increased savings. Additional stimulus for the next development span will also be provided by the great amount of foreign aid. Yet internal development resources, as well as attraction of private investments from the rest of the world will be the main driving force for the Latvian economy. However, there is one pitfall — and that is demography. Still, experience of neighbouring countries shows that rapid development might change this balance as well. 

The economy overcomes the pandemic successfully but not joyfully 

With the exception of the sectors where impact of the pandemic was avoidable, performance of the Latvian national economy last year can be valued more as successful than not. A lot of credit can be given to export of goods, which in real terms increased by 5.5%, while the manufacturing industry was among the best in the EU states last year. Surprisingly favourable was also impact of investments. The contrary can be observed in export of services where the drop is logical (-21.3%); the economic performance last year was also weakened by consumption, which declined by 10.3% in Latvia in contrast to about 2% decline in Estonia and Lithuania.

The pandemic stops but does not ruin the economy 

The risks caused by the pandemic are still relevant; shortage of vaccines stands out, potentially hindering recovery of the services-producing sector. Nevertheless, the negative impact of the pandemic on the economy will start to substantially recede in the second quarter of this year. Improvement of the situation in 2021 in terms of quarters will be fast, yet the year has started from a low point, which is why the anticipated GDP increase is modest (2.1%). In turn progress in 2022 quarterly will be slower but GDP increase will be the highest in the entire recovery period — economists at Luminor predict it will be by 7%. That might sound optimistic, but the average increase in this scenario from 2020 until 2022 will be below 2% and very close to the average result of the Baltic States. Economic activity might restore very quickly after restrictions are lifted, as the pandemic has not had substantial impact on the economic potential. Hotels are empty, but they are not ruined, and activity of other services-producing sectors can be restored quickly and with moderate investments. The pandemic is a huge crisis but it is not a war.

Life will become more expensive, yet more advantageous

The jobs washed away by waves of the pandemic will start to flow back in the summer, yet the annual average proportion of job seekers might be slightly higher than in 2020 when it was 8.1%. If the proportion of job seekers will have decreased to about 7% in early 2022, it can be expected that it will be close to the pre-pandemic level or 6% by the end of the same year. 

A paradoxically sharp rise in the actual salaries happened last year — by 6.2%, in turn the total salary fund increased by 1.9% because the amount of time worked decreased. Renewal of less paid jobs this year might somewhat put brakes on the rise in salaries this year but the pace will quicken again in 2022. That will be advanced by the rapid growth in combination with the drop in birthrates of the post-Soviet era extending to people in the age groups of thirty and older.  

This year we might also experience an unpleasant economic trend — accelerated price increase due to raw materials becoming more expensive and shortage of production capacities, which is why annual inflation in autumn might exceed even 3%. In the long run, inflation will be furthered by price convergence; prices for consumer services in Latvia last year were only 65.5% of the average level in the EU.

What will the following years bring? 

The sharp growth of 2022 will be enabled by simultaneous operation of all the main economic drives — consumption, investments and export — at full throttle. The rise in consumption will gradually wane but will be rather strong in the future as well. This year will be the starting point for a fantastic growth period, provided that structural changes in the export sector continue — rise in the part of high added value services and goods that currently have no insuperable obstacles. 

The Recovery and Resilience Facility and increased volumes of RailBaltica construction will give the initial spark for a rise in investments. Further increase of investment may be promoted by the housing market, which to date has been a great passed opportunity in comparison with the neighbouring countries. It has been hindered both by the improper rent regulations and the negative inertia in the market. Last week the Saeima passed the new rent law and, as representatives of the sector predict, that might increase the annual investments into commercial apartment buildings by about 100-150 million euro. Furthermore, sale of new project apartments has increased by a fifth already during the pandemic, giving reason for hopes that this push will encourage sustainable market development promoted by structural changes, a boom in public sector investments and their impact on salaries and jobs. 

It is evident that the “great seven years” will not be great from the perspective of staff managers of companies, as they will have to put more and more efforts into hiring employees. The raise in salaries will also further economic restructuring, which is a delicate way of saying that some businesses will have to cease their activity. However, migration of labour force from less productive to more productive companies is a self-evident part of the economic development process. Furthermore, labour costs in Latvia are still low against the background of Europe. The average labour productivity is also lower, nonetheless, statistics do not mean destiny — productivity at companies does and will firstly depend on the companies. 

You can view a full review of the Baltic economy on the Luminor website.