Growth forecasts that are anything but growing 28

Foto: Kaspars Krafts, 64
Morten Hansen

 

Latvia has been the fastest growing EU economy for the past few years but it would be careless to assume that this will continue. The Ministry of Finance expects the economy to grow by 4.0% this year, the EU Commission’s spring forecast says 3.8% while Bank of Latvia at the press conference by Governor Rimšēvičs on 6 June lowered its forecast from 4.0% to 3.3%. 

Another lowering of a forecast came even earlier, in March, by SEB bank and from 4.8% to 2.9%. I think that these lower forecasts make a lot of sense and I would not be all that surprised if GDP growth ended even lower for what is it that is supposed to drive growth this year?

After impressive growth, exports stalled in 2013 (see also Figure 3) and not surprisingly so. Growth in trading partner countries is not exactly acting as a locomotive for the Latvian exporters with negative growth in Estonia (Figure 1) and Finland (Figure 2), anemic development in Sweden and Denmark and only half-decent performance in Germany and Poland. And, of course, also Russia is slowing down considerably so we should not expect exports to boost the Latvian growth numbers for 2014.

Figure 1: Economic growth in the Baltic countries, 2012 – 2014, year-on-year, quarterly data


Figure 2: Economic growth in main trading partner countries, 2012 – 2014, year-on-year, quarterly data


So what about domestic demand? Figure 3 shows the well-known story that it was exports that pulled Latvia out of the recession while robust consumption growth followed – but how long can this still ‘creditless’ growth continue?

Figure 3: Growth rates of private consumption, private investment exports and GDP, 2001 – 2013


Consumption as a share of GDP is at 62.5% of GDP (Figure 4), a level that was only exceeded during the big credit boom (where tonnes of borrowing allowed a higher share of consumption in GDP) – I thus find it hard to see that this share could be boosted significantly without more lending going on and this scenario is still not in place, implying, if true, that there should not be a boost to GDP from consumption.

Figure 4: The share of private consumption, private investment and exports in GDP, 2000 – 2013


Figure 4 (and Figure 3) would point at private investment (fixed capital formation) as the main culprit – at 21.1% of GDP it has its lowest share in this millennium. Could this pick up? I don’t see much scope right now. Partly again due to credit markets but also, and this is where I want to put my finger today: Why invest in Latvia? Sure, many advantages and it is easy to set up a business here but it may be quite troublesome to run such a business, e.g. if one needs the legal system. Here, the EU Commission from some of its recommendations (section 14) on Latvia’s 2014 national reform programme:

“Latvia has taken significant action to improve capacities in the judiciary to reduce the backlog and length of proceedings [They are supposed to say something positive… MH]. However, the high judicial backlog still poses a threat to business and reforms to improve the efficiency and quality of the judiciary need to be completed, including as regards insolvency, mediation and arbitration.”

As always, growth does not just happen – but with reforms as suggested above it would be a more attractive place for investment from abroad as well as from within. Let us add the World Economic Forum’s most recent (2013-2014 report) ranking of Latvia among 148 countries (1 = best, 148 = worst) in terms of “Efficiency of legal framework in settling disputes”: 117 and, as a good friend puts it, indeed, it places Latvia lower than such luminaries as Mali (111) and Malawi (56)….

Possibly attractive for dodgy business from the east where “settling disputes” might be done without the legal system but something that might keep local and western firms away.

And the impact of slower growth? Should growth slow from 4% to 3% (and with inflation of 1%) there will be a shortfall in GDP of about 230 mill. EUR, which would (back-of-the-envelope calculation) imply some 75 mill. EUR less in budget revenue. Should it be from 4% to 2% the shortfalls would be around 460 mill. and 150 mill., respectively. Not exactly small potatoes.

The usual conclusion: No time or place for reform fatigue.

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga

 

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