Russia’s war in Ukraine will mean even higher production costs and problems with raw material supplies for Latvian producers, bank analysts said.
Swedbank’s senior economist Agnese Buceniece points out that the year promised to be full of challenges for the manufacturing industry, but no one even foresaw that the challenges would be so great.
The Central Statistical Bureau (CSB) informs that in January the manufacturing industry produced by 9.3% more than a year earlier and by 1.6% more than in December.
Buceniece informs that surveys by the CSB and the European Commission show that producers’ optimism rose sharply in February, before Russia invaded Ukraine. The volume of orders was at a good level. The main challenges were labor shortages, rising prices and delays in the supply of raw materials and production components.
Tensions in supply chains have so far affected Latvian manufacturers even less than in other countries, such as those in which the economy plays a larger role in the economy and production is more dependent on semiconductors. The companies were relatively successful in passing on the increase in production costs to the final customer. In the future, however, these and other challenges are expected to be greater and to last longer, Buceniece says.
She points out that Russia’s war in Ukraine has led to a further rise in global commodity prices. Russia is the world’s largest exporter of natural gas and wheat, and the second largest exporter of oil. It also plays an important role in the market for certain metals as well as in the production of mineral fertilizers. Ukraine is also a major player in the cultivation and export of wheat, including maize, as well as in the production of fertilizers. Consequently, any direct or indirect sanctions, production and supply disruptions in Russia or Ukraine affecting these groups of raw materials mean a rise in global prices.
“Prices are currently rising sharply and are unlikely to reach their peak. Given their role in global supply chains, we will see even higher prices for raw materials and production components, and supply chain tensions are expected to persist for much longer than expected. “Rising prices will also increase transportation costs,” predicts Buceniece.
She emphasizes that the Latvian economy has a high level of energy dependence on Russia – 90% of Latvia’s natural gas imports come from this country. Therefore, the whole economy, including the manufacturing industry, will not only be affected by even higher energy prices, but also possible energy saving measures if gas supplies from Russia are significantly reduced and cannot be replaced.
However, such forecasts of the economist do not coincide with the fact that Latvia can already switch to gas supply through the Klaipeda LNG terminal in order not to have to use the natural gas supplied by Russia. The liquefied gas gasification capacity of Klaipeda LNG terminal is 40 TWh per season, while the seasonal consumption in Lithuania is 20 TWh, in Latvia – 10 TWh, but in Estonia – five TWh.
As in the economy as a whole, there is a great deal of uncertainty in the manufacturing industry today, Buceniece admits. Companies are trying to assess how the war in Ukraine, Western sanctions on Russia and Belarus will affect their operations. Those who have partners in these countries may face difficulties in settling accounts, which will affect cross-border flows of goods and services. Other transactions are no longer possible because some Russian companies are subject to sanctions. Some large companies in Latvia and elsewhere in the world have announced the termination of cooperation with Russia, regardless of the sanctions, thus expressing their attitude towards the events in Ukraine.
Last year, about 7% of Latvia’s exports of goods in euros went to Russia, Buceniece points out, adding that however, the lion’s share of 1.2 billion euros in exports of goods to Russia is re-exports. These goods are not produced in Latvia, so they do not affect our producers.
Since the annexation of Crimea in 2014, Latvian companies have tried to reduce their economic ties with Russia and diversify their export destinations. Many have succeeded, but for some the dependence on Russia is still very high and the operation of these companies may be threatened, Buceniece believes. Among the manufacturing sectors, pharmacy stands out, as about a sixth of the export of pharmaceutical products from Latvia goes to Russia, and these goods are mainly local products of Latvia.
However, in general, Russia is a much more important source of raw materials and raw materials for the manufacturing industry than the export destination, explains Buceniece. About half of the metal imports in Latvia come from Russia. Steel is of particular importance to the metalworking and mechanical engineering industries. At the moment, when the Russian company Severstall – a major Latvian supplier – is subject to sanctions, metalworking companies must look for alternatives. Steel is also produced in other countries, but higher prices for the material itself and for transportation are currently to be expected.
Buceniece also informs that Russia and Belarus are an important source of wood for some Latvian wood processing companies. So far, sanctions have not had a significant impact on the availability of these resources, but supply disruptions are possible in the future, which will inevitably lead to higher prices. Chemical products imported from Russia are also important in the production processes of certain industries. The rise in fertilizer prices and the jump in wheat prices already indicate that food producers will also have to pay more for food raw materials.
Measures to isolate the Russian and Belarusian economies will also be painful for Latvian producers, but as in any crisis, new opportunities will open up, Buceniece adds. High gas prices will boost demand for firewood. The ability of Russian, Belarusian and Ukrainian companies to offer their products will decrease in the region. This may allow Latvian producers in sectors such as woodworking, metalworking and food production to increase their market shares, as long as the issue of raw materials is resolved, explains Buceniece.
Pēteris Strautiņš, an economist at Luminor Bank, admits that this year has started an excellent year in the industry and will probably be the first quarter as well, but the consequences of the global security, sales and supply chain turmoil caused by the Russian aggression in Ukraine will be visible in March. .
“For the second time in two years, the world is experiencing a crisis that is shattering the normal rhythm of life. This will be a longer and more difficult crisis for the industry than a pandemic. “The cooperation will not be quickly and completely renewable. The industry will have to adapt to the new conditions,” says Strautiņš.
He points out that in the 1990s, diversification in Latvian industry first meant moving away from the markets of the former USSR (except the Baltics). Since joining the European Union (EU), the main vector has been the declining share of traditional industries (food, woodworking, light industry) as the share of mechanical engineering, electronics, chemicals and pharmaceuticals has grown.
“Now getting rid of dependence on Eastern markets is becoming topical again, moreover, at a speed worthy of shock therapy. Unfortunately, this will largely happen at the expense of high-tech industries,” Strautiņš predicts.
The economist emphasizes that Russia, Belarus and Ukraine are important markets for prestigious industries, primarily pharmaceuticals, electrical engineering, and vehicle manufacturing. This industry was developed during the Soviet era and is still dominated by the level of technology and production facilities available, and in the case of pharmaceuticals, by high barriers to entry.
“It is not that the companies in these sectors were not aware of the risks, but the diversification of the markets requires very large investments,” adds Strautiņš.
He emphasizes that losing or shrinking markets will not be the only problem for the industry. There will be major and varied problems with component deliveries. Energy will become more expensive, which can be a major challenge for companies exporting outside the EU, where prices are lower. There are reports of difficulties in component procurement. Russia is a large supplier of steel, and although the purchase of this product elsewhere in the world is not so limited by infrastructure as in the case of gas, it will be very difficult to replace such a large amount, and Strautins believes that the current prices must be forgotten.
The economist adds that although Russia’s economy is less than 2% of the world, it is a very important supplier of nickel, neon (along with Ukraine), titanium and other chemical elements. Strautiņš points out that the direct supply of these non-ferrous metals is not such a big risk for Latvian industry, but we will feel possible disruptions in their supply through participation in global value chains, for example, when their availability will cause difficulties in the production of other components.
“Sanctions also cause damage to those who implement them, but Latvia must be ready to make economic sacrifices so that world peace can be restored as soon as possible,” adds Strautiņš.
–
