In the second half of this year, the economy of the Baltic states will begin to recover, and at least in Latvia and Lithuania there are hopes for a rapid increase in state investment, the chief economist of “Bigbank” Rauls Eames informed the agency LETA.
The main challenge of Latvia, Lithuania and Estonia is the small and open economies, so the problems in all three countries are similar, and the economic growth rate will largely depend on the success of our trade partners, the economist explains.
According to the data of the Central Statistical Administration of Latvia, published last November, from January to September 2023, the share of Latvia’s five largest export partners – Lithuania, Estonia, Germany, Sweden and Russia – made up 48.7% of the total export value. This is 0.4 percentage points more than in the same period in 2022.
Export-oriented economies are significantly affected by changes in interest rates. Looking at the possible developments of 2024, it can be seen that Europe will face a dilemma whether to start reducing interest rates at the beginning of the year or to leave it for the second half of the year, says Eames.
This dilemma is caused by relatively high inflation, which is the main reason why the European Central Bank (ECB) will not cut interest rates in the first half of this year. However, if the economic growth indicators for the fourth quarter of 2023 published in March and April will be very low, this will probably reduce the inflation indicators as well, according to the economist.
Another argument in favor of lowering interest rates is the high level of national debt, Eames explains. Servicing existing loans has already become a significant burden on national budgets, and the cost of taking out new loans to stimulate the economy is high. However, the current forecasts show that the inflation indicators in the Eurozone will not reach the target level in 2024, so the ECB has no reason to rapidly reduce the base interest rates. The president of the ECB has said this very clearly in recent speeches.
Basically, there are three possible scenarios for the Baltic States, according to the economist. Market expectations predict that interest rates will begin to decrease already in March or April, commercial banks believe that this will not happen before August or September, but the Organization for Economic Cooperation and Development predicts that interest rates in Europe will begin to decrease only at the beginning of 2025. Eames does not believe in a sharp drop in interest rates, and past events do not support this either, as the ECB tends to be slow to respond to the necessary changes.
Changes in interest rates directly affect the exchange rate. If the forecasts are confirmed and the US Federal Reserve starts to cut interest rates already in the first half of 2024, but the ECB does not do so until the end of 2024 or the beginning of 2025, then based on simple economic logic, the euro will begin to rise against the US dollar . In turn, this will have a negative impact on the economy of the largest exporters of the European Union, especially Germany.
Eames adds that Germany experienced a recession last year as energy prices stabilized at high levels, directly affecting companies where energy costs make up a large part of their production costs.
“Unfortunately, this causes a chain reaction. The problems in the German economy have a negative impact on the economy of the Scandinavian countries, which also refers to the Baltic countries. There is reason to believe that if Germany has corrected its economic indicators downwards, then the Nordic countries have also done so,” says Eames.
The difference between Sweden and Finland is mainly related to the exchange rate, the economist explains. The value of the Swedish krona against the euro has fallen sharply, helping to ease the economic downturn in Sweden and keeping Swedish companies competitive. However, high interest rates have had a significant impact on the real estate market, which is experiencing a downturn.
Although the weak exchange rate of the Swedish krona gives the Swedish economy a boost, exporters and suppliers from the Baltic countries are facing big problems, because the high exchange rate of the euro makes the products of our companies too expensive for the Swedes. This is painfully felt by both Latvian and Estonian wooden house builders, says Eames.
Finland has similar problems, and as a member of the eurozone, it also has no possibility to influence the exchange rate. Private investments in the construction of residential buildings decreased by 12% in 2023, and another decrease is predicted in 2024.
In both Sweden and Finland, investment and private consumption have fallen, while household savings have increased. Uncertainty about the future is great. Labor market indicators remain good and unemployment is not expected to rise sharply. Wage growth is expected to outpace inflation both this year and next, meaning real household incomes will rise over the medium term. According to Eames, this gives hope that in at least a couple of years, rising consumption will start to boost domestic demand and the economy will start growing again.
The current forecasts show that among the Baltic states, Latvia has the best performance, Estonia the worst. Economic growth of almost 2% is predicted for both Latvia and Lithuania in 2024. Estonia’s central bank “Eesti Pank” predicted in December that Estonia’s economic well-being will decrease by 0.4%. According to “Bigbank” estimates, this forecast is even too optimistic.
Latvia and Lithuania are positive about the development of the labor market, while an increase in unemployment is predicted in Estonia. In Lithuania and Latvia, the unemployment rate will remain between 6.3% and 6.5%, while in Estonia “Eesti Pank” predicts that the average unemployment rate will reach 9% in 2024.
Eames admits that the current forecasts in Latvia and Lithuania are also too optimistic, because the challenges in the Baltic countries are similar. Industrial production, export, import, trade turnover and tourism have decreased, the construction industry has experienced a decline. Future results will largely depend on the success of external trading partners.
The high price of money has also negatively affected the start-up sector, says the economist. Raising money is no longer as easy as it once was, and many startups have had to downsize. As elsewhere in Europe, manufacturing has been the hardest hit, but the service sector is still doing relatively well because people have jobs and can therefore buy goods and services.
Eames points out that the Baltic countries have to take into account another aspect, namely the dynamics of labor costs, and according to “Eurostat” data, labor costs have grown faster than productivity.
“The ratio of these two indicators is shown by unit labor costs. If wage growth is faster than labor productivity, unit labor costs increase. In the Baltics, with a small exception in Estonia, changes in unit labor costs since the period before the coronavirus pandemic have been positive. Unfortunately, the situation when wages growing faster than productivity means that corporate profits are falling as wage growth eats into profits,” says Eames.
Possible solutions for companies in such a situation are relatively limited, explains Eames. From an economic point of view, the most efficient way would be to replace people with machines (robots), but this means layoffs and requires significant financial resources. However, interest rates are currently high. Rationalization also means closing a company in one’s country and moving production to a country where labor costs are lower. Or companies will simply cut spending and production, which again means layoffs.
All these possibilities will at some point lead to an increase in the number of unemployed, according to the economist. The solution would be to increase productivity and move up the value-added network, but this is very difficult to do in a high-interest environment because of the additional investment required. If the traditional partners who previously made foreign investments are also not doing well, we end up in a vicious circle. In addition, we also need a highly skilled workforce that will not appear overnight or by itself, waiting for someone to start increasing productivity.
However, “Bigbank” hopes that the economy will start to recover in the second half of this year. At least in Latvia and Lithuania, there are hopes for a rapid increase in state investments, using both the EU recovery fund and the “Rail Baltic” projects.
“Bigbank” is an Estonian bank that has expanded operations outside of Estonia, establishing branches in Finland, Sweden, Latvia, Lithuania and Bulgaria, as well as offering cross-border services in Austria, Germany and the Netherlands.
2024-02-11 14:45:41
#Bigbank #economist #year #economy #Baltic #countries #start #recover
