The pandemic has caused unpleasant shocks in the Latvian economy, but recovery from it may be the beginning of a period of rapid growth. The Baltic export industries are successfully overcoming the crisis, and their development prospects are good, says economist Pēteris Strautiņš, sharing the conclusions of Luminor Bank’s Baltic Economic Review.
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The crisis will be followed by years of growth
2020 is an unusual, difficult, challenging time for the Latvian and world economy. There are people for whom the pandemic has completely disrupted the rhythm of life and work, so this year employment and income in Latvia will be lower than it could have been. At the same time, this global drama has also been an opportunity for our country to show that we can achieve something by acting effectively and decisively.
Currently, the economic situation is very contrasting. The difficulties caused by the first wave of the pandemic have in most cases been overcome, although some sectors are still close to a standstill. At the same time, there are companies and industries that have proven to be winners.
The GDP curve is also like a saw tooth – the decline in the second quarter was so sharp that even in the motley history of the Latvian economy it turned out to be the quarter with the largest decline compared to the previous period. Currently, in the third quarter, the fastest ever GDP growth in this section could be registered. The end of this year and the beginning of next year could be a break in the economic recovery process.
Economists at Luminor Bank expect that the vaccine, combined with other coronavirus control measures, will begin to affect the course of the pandemic from the second quarter of next year. The delayed effect of the growth incentives used during the crisis, increased household savings and the desire to spend them, as well as huge public investment projects – all this will create a uniquely strong combination of conditions warming the economy in Latvia and the Baltics. If this year Latvia’s GDP will decrease by about 4.8%, next year it will increase by 4.4%, then in 2022 growth in Latvia will continue to accelerate, Luminor experts predict.
From next year until the middle of this decade, growth will be strong for several years, unless the world comes back with some extraordinary surprises. During this time, the main concern will be how to ensure that investment resources are used wisely in times of economic warming and even overheating. The slowdown in growth could become a problem in the second half of the decade, when the big boom in public investment will gradually subside and the time will come when the economy will be increasingly able to feel the effects of demographic change.
Economic locomotive in the nozzle while driving
Already in March, we judged that some of the export industries will survive the crisis well, maybe even benefit – for example, food and medicine production, IT and business services. That is what happened, and the response to concerns about the impact of the pandemic on wood processing proved to be a good one, as did the chemical, electronic and electrical industries. There could be no illusion of what would happen to tourism. The export performance of goods has been one of the best in the EU, but the recovery in tourism and aviation will be a long one.
Further forecasts for Latvia’s exports are favorable, as Latvia’s export product portfolio has proved to be suitable for the new conditions, and the crisis has already accelerated economic restructuring. The expected improvement of the quality of local government in Riga, as well as the growing competence of local governments in industrial policy in other regions will be very important for the development of export sectors.
This year people are saving, next year – will be spending
The decline in consumption calculated by statistics in Latvia in the second quarter by 21% year-on-year was several times higher than in Lithuania and Estonia. This came as a genuine surprise, as changes in retail sales, mobility data and other sources of “fast news” report a rather similar situation.
In real terms, the wage bill in Latvia decreased by only 3.5% during this period, moreover, the income of the population was supplemented by state support. Consequently, there is an increase in savings in the bank accounts of the population – at the end of the second quarter, the amount of deposits of individuals in banks was 10% higher than a year ago.
It is very difficult to predict how consumers will behave, but there is a possibility that the consumption boom may be very strong after the end of the pandemic, as the country has largely protected households from deteriorating financial conditions and people will try to catch up in 2020 by actively traveling and attending events..
Fireworks are expected in the labor market
Economic activity will grow rapidly in the coming years and become incompatible with further population decline. We already know what happened in a similar situation in neighboring countries, where the balance of migration changed and the population stabilized. This should happen sooner or later in Latvia as well. Demand for employees will grow rapidly, which will lead to overheating of the labor market in the fastest growing regions of Latvia, immigration, as well as even stronger internal migration. There are regions where there is a shortage of jobs and this will continue in the future. Rapid wage growth could become a problem for many companies, but it will contribute to economic restructuring.
Prices and living standards will approach the EU average
Inflation is also expected to rise sharply next year, driven by both declining inflation-reducing factors, high investment and the fact that households will spend the money they have saved during the pandemic. If in 2020 the average inflation will be a few tenths of a percent, then next year the average inflation will exceed 2% and in the following years it will continue to increase, overheating the labor market. It will also have an impact on taxes: the strong desire to reduce labor taxes will encourage higher product taxes. Latvia’s standard of living will gradually approach the average level of the European Union, and thus prices will also rise.
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