Latvia’s economy – from exports to domestic consumption

Latvia’s economy – from exports to domestic consumption

Baltic economic overview - Latvia

Important economic figure forecasts 2017

GDP growth: 3%
Unemployment: 8.4%
Inflation: 0.1%
Doing Business 2017 ranking – 14
 
Sources: Economics Ministry, State Employment Agency, Central Statistical Bureau, World Bank
 
2016 was not the most successful year for Latvia’s economy, mostly due to uncertainty in external markets. Even though at the beginning of the year Latvia’s growth figures were projected at around 3%, in reality Latvia’s GDP increased by only 1.6% last year. If in previous years the main driving force behind Latvia’s economic growth was exports, then last year the economy showed growth thanks to domestic consumption, which was stimulated by an increase in salaries and even deflation in some months. 2017 has started similar to 2016, with economic experts predicting economic growth of 3% this year. This time there is reason to be optimistic, as European Union funding will become more active, and the situation in external markets is also expected to improve.

Growth ensured by domestic consumption

Latvia posted slower than expected growth in 2016 – by 1.6%, which was mostly stimulated by an increase in private consumption, which in turn was facilitated by an increase in salaries, as well as very low inflation, including deflation registered in some months. Meanwhile, exports, which used to drive the Latvian economy, increased by only around 2% last year, mostly due to uncertainty in external markets and slow growth within the EU. Overall, exports were positively impacted by an increase in the export of vehicles, as well as agricultural and food products. Strong manufacturing growth in 2016 was also reported, as the sector’s output increased by nearly 5%, with almost all segments of the manufacturing industry showing good results. The food, timber, wood processing and electronic and optical equipment industries all contributed significantly to the sector’s growth. In the services sector, the hospitality and foodservice industry showed the fastest growth. The main factor holding back growth in 2016 was a sharp drop in investment. In 2016, investment dropped by nearly a quarter from the year before, primarily because of a slow inflow of investment from the EU’s structural funds.

Substantial drop in direct foreign investments

If in previous years there was an increase in the flow of direct foreign investments, then in 2016 foreign direct investment accumulated in Latvia decreased by EUR 211.59 million. From 1991 and until the end of 2016, foreign direct investment in Latvian companies amounted to EUR 7.21 billion. One of the main reasons in the reduction was the decision by Swedbank to reduce its share capital by EUR 367.85 million as part of optimization of Swedbank Group's capital structure. Meanwhile, foreign investors themselves point out to the low levels of investment activity in Latvia. Foreign investors have repeatedly pointed to the geo-political situation, as well as Latvia's unpredictable tax policy and delays with reforms to insolvency regulations. Investors have also pointed out that the state does not have a long-term vision on national development. 16 out of 32 investors surveyed by the Foreign Investors' Council in Latvia voiced readiness to continue investments in Latvia, while ten investors said that they do not plan to invest, and six investors have not made up their minds yet. At the end of 2016, there were 29,273 companies in Latvia that fully or partly belonged to a total of 29,692 citizens or companies from 135 countries. Most investments last year went into warehousing and transport companies, producers of non-metallic minerals, real estate companies, as well as construction, forestry and logging companies.

Faster growth expected this year

Latvia’s economy did not grow as rapidly as expected last year, however, several economic experts pointed out that growth is expected to pick up in 2017 and reach around 3%. Economists from the Bank of Latvia point out that several very positive signals in the external environment have already been observed at the beginning of 2017, meaning that GDP could grow in foreign trade partner countries slightly more than previously projected. At the same time, negative risks remains, which are mostly related to the political environment – the new U.S. presidential administration, as well as elections in various EU countries. Overall, stronger economic growth in 2017 could be ensured by a stable increase in private and public consumption, as well as an improvement in investment activities. In order for the economy to grow as projected, economic experts recommend implanting EU structural funding investments sooner, as well as motivate the business sector to modernize and expand production. A rise in the intensity of structural fund investments will leave a positive impact on growth not just in the long-term, but will also positively impact growth 2017, especially investments in infrastructure. Furthermore, another important condition for economic growth in 2017 is the expansion of export opportunities, which in the short-term will be dependent on global economic development, more importantly within the EU.

Priority sectors

* In 2016, retail and wholesale trade, as well as the real-estate sector, had the most positive impact on Latvia’s GDP. Furthermore, manufacturing sector also showed good results in the final quarter of the year. 
*At the beginning of 2016, a new government was approved, which has put forward faster growth of economic activity, employment and productivity as one of its main priorities, which will be based on reforms that have been carefully discussed with social and cooperation partners, an increase in the yield of the country’s workforce and most valuable natural resources to the national economy, as well as an increase in the quality of life of residents.
* Latvia’s defined priority sectors are food and beverage production, energy, agriculture, forestry, fishery, and transportation and communications. From 2012, for larger investments in these sectors, companies can receive a tax rebate of between 15 to 25% from the investment sum. For even larger investments, companies can receive a further tax rebate. Tax rebates have been given recently to such companies operating in Latvia as Dobeles dzirnavnieks, Thermotechnik Lettland, Olainfarm, Latvijas Mobilais telefons, Latvijas Finieris, Bite Latvija, Livonia Print, Rīgas piena kombināts and several others.
* Another priority sector declared by the government last year was the start-ups sector, where a separate law was drawn up with the aim of facilitating the development of new tech companies. 
 * The state has also drawn up a new National Industrial Policy Plan for 2013 to 2020. The primary objective of the plan is to promote economic structural changes in favor of the manufacturing of products and creation of services with high profitability. This includes increasing the role of industry, the modernization of industry and services, as well as increasing the variety of exports. Over EUR 770 million is expected to be invested by 2020 to implement the plan.
*Financial support for businesses is available through European Union structural funds for specific projects. 
*Latvia’s favorable geographic location has allowed it to become an important transit partner for many European Union countries, as well as countries in the Commonwealth of Independent States. Latvia has three major ports – Riga, Liepāja and Ventspils. Riga and Ventspils ports are located on free economic zones, while Liepaja is located in a special economic zone. Such territories in Latvia offer special tax reductions and other advantages for companies operating in these zones.

Risk factors

* The development of Latvia’s national economy will be closely connected with the ability of entrepreneurs to create competitive products, as well as make production more effective. This is why one of the main risks in 2017 is associated with the allocation of EU funding in 2017, which should in turn facilitate investments in manufacturing.
* The shrinking export dynamics have forced business to think more about strengthening their export capabilities as well as entering new markers. Businesses will have to be more active in finding new markets and retaining the current ones.
* Latvia has quite a substantial energy dependency on Russia, which it is attempting to solve in 2017 through gas market liberalization. On January 1, 2015, the electricity market for households was opened – approximately 850,000 users.
 

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