The year began with tremors for financial markets all over the world. Nevertheless, the world’s economy is not looking all that bad in spite of overall negativity surrounding future developments, as concluded in Swedbank’s latest economic outlook.
Latvia’s economic growth is not expected to exceed 3% in 2016-2017. Although growth rate is solid and close to its potential, policy-makers are concerned about it nonetheless. The gradual income equalization process with Europe’s average level has become slower over the past couple of years. The labour market continues to heat up, and this will further enhance consumption, which may lead to economic growth rate reaching or even exceeding 4%. Benefits of this will be purely short-term, however, because excessively fast growth of wages and consumption can potentially create problems that will most likely slow down growth and make the road towards European level of income even longer, notes Swedbank’s lead economist in Latvia Martins Kazaks and senior economist Lija Strasuna.
Negative risks left from the previous years have only increased since the beginning of the year. Economies of the world were weaker than expected last year. It seems the beginning of the year will be largely the same. Although Swedbank economists slightly tune down GDP expectations, the world is nonetheless expected to grow faster in the next couple of years than it did last year. Cheap oil will enhance consumption in developed countries. Eurozone’s situation no longer seems so dire – unemployment is in decline, crediting requirements continue to improve, the policy of the European Central Bank continues being very supportive. The situation in developing countries, on the other hand, is not as promising – currencies are losing their value, debts continue piling and the financial state of many countries is worsening. Considering the recent drop of Russian rouble and oil price, inflation rise and budget cuts, the recession in Russia will be longer and deeper than previously predicted. Weak growth could potentially recover at the end of 2016 or the beginning of 2017. China is trying to control the slowdown and it seems to be working for the moment. Even so, the country’s economic growth is becoming gradually slower. On top of that, fluctuations on financial markets will likely continue in the future.
Oil prices are currently in a vulnerable state, having dropped as low as USD 30 at times. The cause of the drop lies in overproduction. Demand for oil is on a rise, yes, but supply is currently much higher than demand. Because of fluctuating oil production costs are for the most art below the market cost, supply refuses to decline. Shale oil production in USA has declined very little and the previously expected drop is currently nowhere to be seen. Fighting over market shares, OPEC countries are refusing to reduce oil production volumes. Iran will soon re-enter the market with more oil to offer. Oil prices are expected to remain very low – even though new investments in oil industry have already declined, a certain amount of time is needed before changes can appear. USA’s shale oil production can adapt to changing prices very quickly, as opposed to traditional oil production. Development of alternate energy sources can help reduce oil price rise in the future, economists say.
Low oil prices also mean cheaper energy resources for Latvia. Consumer price is expected to remain below 1% this year. This mainly applies to services and is because of administrative measures (application of VAT for management services, larger excise tax for oil products and alcohol). Inflation is only expected to come close to 2% in 2017.
Trade ties with Russia are gradually becoming weaker. Russia’s presence in Latvia’s exports has declined below 8%, which is the lowest level since 2005. This situation will remain because the purchasing power of Russian residents will continue to decline. Weaker trade ties also mean less influence coming from economic shocks in Russia. In relation to Russia, the main risks are not economic but rather geopolitical. After losing exit to Russian and CIS markets, exporters instead turned their sights on Europe and other markets. Stronger growth in Europe also means Latvia’s export growth will be even stronger in 2016-2017.
Latvia’s GDP may grow 3.3% this year and 3% next year. With increased activity on the labour market, there is a possibility that growth may exceed 4%. Although the state budget deficit has a tendency of slightly exceeding the allowed level, the overall financial state of the country is stable. The main negative risks for Latvia’s economy lie outside its borders, which is something that cannot be affected directly. Economists are concerned that this mostly beneficial short-term situation can only bring temporary relief. Without taking action, productivity will remain low and problems from heated up labour market may turn out worse than anticipated. Without sustainable growth, it will take much longer to equalize Latvia’s income level with that of the average one among European member states. In order to speed up growth rates, it is necessary to uphold promises: reduce shadow economy, improve the education and justice systems, economists add.