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International Internet Magazine. Baltic States news & analytics Monday, 21.05.2018, 02:36

The manufacturing sector in Latvia continues on an upward trend

Igors Kasjanovs economist, Latvijas Banka,, 13.06.2017.Print version
The manufacturing sector continued on an upward trend also in April 2017.

With the international trade becoming more active, the rise in external demand was also felt by the Latvian manufacturing businesses. As a result, in April the output volume of manufacturing businesses increased by 6.2% year-on-year, albeit posting a slight decline of 0.9% during the month.

The upward trend in the sector is also suggested by the industrial confidence indicators which have reached a long-unseen high. Their improvement was brought about by the businesses' perception of an increase in the volume of orders and a decline in the inventories of finished goods.

While expecting the April data, the most intriguing question was the following: has the growth in the wood industry recovered after two months of decline? The only negative news is that the wood industry has not yet resumed its growth; moreover, it continues declining by 1.4% as compared to April 2016.

This is, however, offset by a range of positive indicators in other sectors such as the food industry (+6.6%), the manufacture of chemicals (+27.8%), the manufacture of computer, electronic and optical products (+29.2%), the manufacture of electrical equipment (+31.9%) and the manufacture of building materials (+8.6%). In addition, excellent results were also recorded in the energy sector (+18.8%) and the mining sector (+20.7%). While the energy sector already demonstrated notable results in the previous months, the leap in the mining sector was most likely related to the recovery of the construction sector.

Following a prolonged period of silence in 2015 and in the first half of 2016, new information about the plans of opening or constructing new factories keeps coming in (e.g. [1], [2], [3], [4]). With external uncertainties diminishing and external demand growing, the risk appetite of manufacturing businesses is also gradually increasing and resulting in new projects. This is also supported by higher lending activity of commercial banks.

However, the business activity in the manufacturing sector is still lacking momentum. The reasons are the same as before: disorganised judicial environment, high energy tariffs, changing tax policy and partly also the geopolitical risks.

Another positive news was received in May. After a long period of consideration, the European Commission finally approved the discount scheme submitted by Latvia regarding the mandatory electricity procurement component (MPC) for energy-intensive manufacturing companies. However, it is worth noting that an 85% discount will only be applied to the share of electricity produced from renewable energy sources.

There is more news regarding the MPC. In its report Complex Measures for the Development of Electricity Market ("Kompleksi pasākumi elektroenerģijas tirgus attīstībai"), the Ministry of Economics has developed three scenarios for limiting or even reducing the MPC increase. The Ministry of Economics supports the solution where the five largest energy manufacturing companies would voluntarily give up their guaranteed payment and would, in return, receive a lump-sum payment financed by reducing the accumulated share capital of JSC Latvenergo. In this way, the MPC could be gradually lowered as from 2019 which would be quite good news and would serve as a positive signal to investors. It is albeit too early to answer the question of whether such a solution is realistic and to what extent it would be supported by all involved parties.

The manufacturing businesses will now most likely turn their attention to the expected tax reform. One cannot say that the manufacturing businesses that have been recently approached were only praising the idea; nevertheless, most of them supported the reform. The main benefit mentioned by the businesses is a higher net compensation of employees which would strengthen the purchasing power.

Changes envisaged in the corporate income tax arrangements (non-taxation of the so-called reinvested earnings) would most likely have positive medium- and long-term effects. It would allow businesses to restructure their balance sheets and make them more attractive to commercial banks in the context of potential lending.\

However, the main factors hindering the development of Latvian businesses remain the unpredictability of the taxation system and the complexity of administrative procedures. Businesses need to be duly informed about any planned changes and their impact on the businesses' day-to-day activities; however, this is still something to strive for.

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