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Bank of Latvia expects country’s GDP to drop 6.5% this year

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topical, Covid-19, economic decline, GDP, coronavirus, Bank of Latvia, outlookFor 2020 the Bank of Latvia predicts GDP decline of 6.5%. Annual average inflation is estimated at 0.5%, the bank reports.

«Considering the topical developments in the global economy, including the influence from Covid-19, the Bank of Latvia predicts GDP to decline 6.5%,» as reported by the central bank, adding that last year Latvia’s economy was predicted to experience 2.6% growth in 2020.

At the same time, the bank stresses the latest outlook is modelled under conditions of great uncertainty and is subject to corrections if the world fails to limit the spread of Covid-19, which is a serious pre-condition for economic growth in the second half of the year.

According to Bank of Latvia economists, the rapid spread of Covid-19 creates major uncertainty and forces the general mood of market participants to decline, as well as disrupt entrepreneurship operations, which only increases the risk of a global recession.

«The influence over the global economy will largely depend on the spread of the coronavirus and preventive measures and their length, as well as partial compensation of negative effects using fiscal policy initiatives with a supporting monetary policy of central banks,» notes the Bank of Latvia.

The central bank mentions the international assessments of the influence on global economy and state economy differs, but this is why it should be noted there that it creates narrowing of economic activities and it becomes more and more negative. Estimates vary on a very large scale depending on experts’ assumptions on the possibility of limiting the spread of the coronavirus. The International Monetary Fund predicts negative global growth this year, and the decline is expected to reach the global financial crisis level.

The latest market participants’ outlook for growth in Eurozone varies from -5% to -1.7%.

«This very unfavourable and comprehensive global shock creates short-term problems for companies to secure money flow to cover commitments, putting at risk their solvency. Latvian government’s planned support activities will be the decisive step towards reducing the influence of the crisis so that short-term distortions do not create a major reduction for economic capacity, which would delay recovery once the situation with Covid-19 has settled down and create lasting negative influence one economic activity. At the same time, it is important to support residents stuck in idleness without income and prevent the possible escalation of social problems and domestic demand decline,» stresses the Bank of Latvia.

The central bank also notes the government’s reported supported measures are a step in the right direction. However, they have to be reasonable and meet the scale of the crisis and focused on companies and residents affected the most by the crisis.

The bank adds the European Commission has presented a report on halting fiscal regulations in order to allow governments to act flexibly in relation to budget finances to reduce the consequences of the crisis. EU rules for state support permit governments to provide financial support to companies quickly and effectively.

«Compared to other countries, Latvia has been fiscally responsible and has provided a reasonably low state debt level, which allows providing the necessary support to national economy during a crisis. Additionally, the current situation differs greatly from the 2008-2009 crisis, when the country was forced to reduce expenditures. This time, thanks to the country’s strict fiscal discipline, as well as balanced development of the national economy and lack of macro-economic imbalance, the country has the freedom to borrow money to support its economy,» the bank adds.

The central finance institution stresses that macro-economic indexes reflect the national economy’s development scenario with coronavirus’ negative effect in the first half-year, assuming economic activity will have rapidly recovered after then.

«Latvia and other countries have declared a state of emergency and social distancing measures needed to limit the spread of Covid-19. These measures have already impacted each country’s national economy. Limiting measures directly slow down operations of multiple industries in Latvia. However, negative influence also extends to all sectors of the national economy, causing disruptions for logistical and inter-consumption networks and increasing costs, as well as causing shocks for external and internal demand,» the Bank of Latvia explains.

The bank also notes that the estimate for the 6.5% economic decline this year is based on the assumption that the spread of the coronavirus ends up successfully limited, making it so the impact on the national economy is short-lived.

«It is expected the effect of the coronavirus on the national economy will have reduced in Q4 2020 and this decline will have increased further in Q2. We expect the national economy to start recovering in the second half-year. The same is expected for global demand for goods. Gradual recovery is also expected for domestic consumption. Nevertheless, caution among investors may remain for longer,» explains the bank.

The central bank mentions the prohibition for public events and gatherings, as well as mobility restrictions, will directly stop activities in multiple industries. Accommodation and catering services, as well as leisure and entertainment service industries’ generated VAT is expected to reach 70% in Q2, and average of 30% among these industries in 2020.

The transport service industry is directly affected by the shut-down of international passenger services, as well as the decline in transports due to caution and delays with container freights. This is why the Bank of Latvia predicts this industry an approximately 20% decline.

The Bank of Latvia also stresses the negative effect from Covid-19 will affect a wide range of industries.

According to the bank’s experts, this year exports are expected to decline 8% and imports are expected to decline 9.4% this year.

Investors’ general sense of caution, according to outlooks from the Bank of Latvia, will be reflected in the form of real estate and construction industry decline. These sectors are also affected by other factors, such as delays with delivery of construction materials and unfavourable income and loan accessibility dynamics.

«The negative effect on a wide range of industries will have a sharp impact on the labour market,» the Bank of Latvia reports, adding that thanks to state support, the effect on unemployment growth is considered significantly below the index from the previous global crisis.

At the same time, the Bank of Latvia predicts many companies will optimize costs, including labour costs, halting labour wage growth on top of it. This, together with employment decline and estimates on around 20 000 unemployed people will be reflected in consumption decline, which can be explained with high uncertainty and consumers’ caution.

«It is expected the inflation will drop close to zero, especially in the second half of the year, because oil price decline creates a reductive effect for prices. Oil prices are dropping because of growing coronavirus spread and so-called oil price wars,» the Bank of Latvia mentions.

According to the Bank of Latvia, domestic price decline is expected because of lower economic activity and income decline. Although maybe upward-facing pressure on prices of industrial goods in Latvia because of China’s replacement and supply chain disruptions, but it will not be enough to reduce price decline because of low demand.

At the same time, the Bank of Latvia stresses that as efforts to combat coronavirus last for longer, the vision for economic activity restoration will only worsen, and growth risks and downward facing.

«Nevertheless, considering that the national economy’s dynamic so far has been healthy and without any chronic macroeconomic problems when compared to the previous global crisis, the government supports measures to help reduce the effect of Covid-19 on the national economy during the crisis,» admits the Bank of Latvia.

As previously reported, Latvia has declared a state of emergency in relation to the spread of Covid-19, adopting a number of restrictions for this period of time.

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