In the first half of this year, despite the global upheavals and the need for manufacturers to reorient themselves, industry has been one of the fastest growing sectors in Latvia.
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On the other hand, the word “recession”, “slowdown” is being heard more and more often. Economists expect that in the second half of the year, demand in Latvian industry will most likely begin to decrease noticeably.
Ministry of Finance (FM) states that accordingly European Commission according to the collected survey results, in June of this year, the indicator of the economic sentiment of Latvian industrialists continued to deteriorate and is the lowest since February 2021, when the economy began to recover from the second wave of Covid-19. The deterioration of sentiment is determined by an expected decline in industrial activity in the coming months.
The current economic events in the EU, as well as the war in Ukraine, have the greatest impact on consumers, followed by the trade and construction sectors, while in Latvia, the negative impact on trade is the lowest, but on consumers the greatest, followed by the construction sector, FM range. It indicates that Latvian industry will continue to reorient itself to new markets at rapidly growing production prices. Until May, the volumes produced in industry in Latvia have only increased, but industrialists in surveys indicate an expected decline in production volumes in the following months.
Clover: We don’t feel the full impact yet
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The need to look for new markets and suppliers of raw materials is indicated by JSC “Citadel banka’s economist Mārtiņš Āboliņš. However, external demand remains strong for now – the beginning of the year has been successful in Latvian industry, and industry has been one of the fastest growing sectors in Latvia in the first half of this year.
Reference to Central Statistical Office according to the published data, he reminds that in May of this year the output of the manufacturing industry in Latvia increased by 7.5% compared to May of last year. “This is a very good result, but I am cautious about the second half of the year in industry. In the world economy, every month there are more visible signs of the approach of recession, Russia by reducing gas supplies, they are trying to cause an even deeper energy crisis in Europe, as well as the full impact of the severance of economic relations with Russia is not yet felt,” he emphasizes.
In May, the majority of manufacturing industry sectors continued to grow in Latvia. Compared to the previous year, the production of auto parts increased by 22.4%, furniture production – 14.8%, clothing production – 20.5% and beverage production – 21.9%. On the other hand, the production of wood products and computers, as well as optical equipment, decreased by 1% and 17.3% respectively in May. “The strong growth in industry over the past year and a half is due to two factors. Firstly, due to the Covid-19 pandemic, the activity of many service industries was limited, so the demand for a wide variety of goods in the world has been atypically high. Secondly, the low level of goods in warehouses, which after the pandemic decisions taken at the beginning to stop production, as well as stock sales, had significantly decreased,” the expert explains.
In the second half of the year, the demand in Latvian industry will most likely begin to decrease noticeably. Due to high inflation, the disposable income of the population will decrease this year in Latvia and Europe, while the lifting of Covid-19 restrictions allows service industries to function more fully again. Therefore, in recent months in Europe and the US, the volume of new industrial orders has been falling, inventory levels are rising and the restocking cycle is coming to an end.
Surveys of Latvian manufacturers show that there are still quite a lot of new orders, but we will probably not avoid the slowdown of global industry. Furthermore, lower demand comes with skyrocketing costs. Since Russia’s decision to reduce natural gas supplies to Europe, natural gas prices in Europe have risen by more than 50%. As a result, electricity prices in Latvia continue to rise, local electricity production capacity in the Baltics is not sufficient for its consumption, for example, Latvia has produced only about 40% of its electricity consumption in the last week, and there is currently no reason to expect a drop in electricity prices in the second half of the year. Due to the high price of electricity, electricity consumption in Latvia has started to decrease in June, and this probably already indicates a lower activity in industry. Producers are forced to pass on the growing costs to consumers, and inflation in Latvia is approaching 20%; however, residents’ incomes do not grow so rapidly, and there is a risk of losing market positions when raising prices. “In my opinion, for many Latvian producers, the second half of the year can be very challenging. We do not feel the influence of Russia yet, external demand will definitely decrease and at the end of the year, I do not rule out a drop in production volumes in Latvia,” sums up Āboliņš.
Stream: The Great Cooldown has begun
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The performance of the manufacturing industry in May also the banks “Luminor” macroeconomics expert Pēteris Strautiņš evaluates it as very good. Despite the world storms, the output of the industry increased by 1.1% during the month, keeping the annual growth at a very high level or 7.5%. The performance of the industry can perhaps even be described with the word “heroic”, he urges, adding that such praise is certainly deserved by pharmaceuticals, the industry most connected to the markets of the former USSR, which was able to increase production compared to last May.
At the same time, he also points to growing concerns about the industry’s performance in the remaining months of the year and next year. “Among economists, it is not uncommon to talk about the world economic recession, perhaps at the end of the year, perhaps next year, as a fact that has already happened, which will be caused by the effects of the war, as well as the economic cooling measures already implemented and still promised by the central banks. Long-term interest rates were rising until the beginning of June, but now they are have stabilized. The financial markets have still priced in the continuation of short-term interest rate increases in the near future, but in the US already a fall next year, thus predicting that overheating will be rapidly replaced by cooling,” notes Strautiņš.
The future of the service industries, at least against the background of the recent past, still looks very bright, but there are big concerns about manufacturing. The time of the pandemic turned out to be very beneficial for it, but the moment is approaching when manufacturers will have to pay for this party. The restrictions on service industries, which “squeezed” a disproportionately large part of the world economy into goods industries, are over. Consumers have bought a lot of all kinds of things and it seems that they will have enough for a while. Traders go from stocking up to stocking down, it acts as an economic cycle booster.
It is natural that the forecasts of Latvian industry captains regarding production in the near future have drastically deteriorated since March. Relative to the historical average, they are most pessimistic in electronics, the sector where the pandemic party was the wildest. A relatively favorable view of the future is in mechanical engineering – in the electrotechnical industry, in the production and repair of equipment, naturally, because no one has canceled the planned investment boom of the energy revolution, reminds the economist.
Commodity prices (S&P GSCI index) give the impression that someone has put the world economy in a quick-freeze chamber. The overall raw material price index fell by 12% compared to the June 8 peak. Prices of industrial metals, which best reflect economic forecasts, have already fallen by as much as 32%. Energy prices, currently driven by the story of war and sanctions, fluctuate without a clear trend. Food prices have decreased by 19% since May 17. The price of wheat is falling at a tremendous speed, a quarter has already fallen from the historical record of mid-May. In a related development, the global container price index “Freightos” has fallen by 40% since its record high last September. So the global raw material and transportation markets are becoming more friendly to producers, but Latvian and European industrialists are saddened by the new regional energy spasms. Gas prices for delivery in a month have reached 157 euros/MWh today, which is twice as much as on June 8, which was the lowest point since the beginning of the war.
Electricity prices are rising again, and there is a double whammy here. Until now, prices were high, but below the level of Western Europe, but now it is the other way around. Between September and May, the average price in Germany was 166 euros, and in Latvia 141 euros. However, electricity is currently more expensive here – the average price for the first four days in July is 297.85 euros. For comparison, the average price in 2020 was 34.05 euros, while last year it was 88.78 euros.
The overall result is still positive
“To sum up what has been said, it is expected that in the second half of the year Latvian producers will be forced into an unpleasant grip by the combination of weakening demand and still very high production costs. However, the overall result for the year will be decent (increase by about 4%), thanks to the increase in the first five months by 6.9%, including beverage production by 24.2%, printing by 18.5%, automobile construction by 17.9%, chemistry by 16.4%.In the previous two years, the engine of industry, woodworking, grew by 5.4%, but in May a decrease of 1 %. In the period from January to May, the production of electronics (-17.6%), paper (-2.5%), equipment (-1.3%), food (-1%) fell overall,” says Strautiņš.
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