Baltic, Banks, Direct Speech, Economics, Financial Services

The uncertainty surrounding the Baltic economies has diminished but remains large. After the initial fright, consumers across the Baltic countries have regained confidence and the willingness to spend. Even the real estate market barely suffered a dent – transactions and prices are rising, indicating little fear about the longer-term prospects. The economic recovery can be halted if the virus resurges and creates yet another shock to economic sentiment, investments, consumption, and exports. On the other hand, poor planning and over eagerness to spend in the coming years on the part of a government could generate a slew of subpar quality investment projects, misallocate scarce resources, and cause imbalances in the economy and overheating, especially in the construction sector.

Estonia – a heavy hit on manufacturing

After a woeful second quarter, the Estonian economy seems to be on the path of gradual recovery. Retail trade rebounded quickly and in June was already 7.3% higher than a year ago. Manufacturing is also recovering, albeit at a slower pace, and will continue be dragged down by weaker external demand. Expectations for industrial production, exports and the services sector have improved, pointing to a continued recovery in the second half of this year. Due to the limited possibilities to spend and the higher uncertainty, households have increased their savings and have set aside larger buffer against possible risks. However, transactions in residential real estate are recovering quickly from the fright.

The registered unemployment rate increased by only 2 percentage points during the most severe time of the crisis and has stabilised at a moderate level - slightly below 8% - since the end of May. As the government compensation schemes have expired, unemployment could still increase somewhat in the second half of this year, but the worst hit to the labour market is likely behind us. Hard times for the tourism sector, especially for accommodation and travel, will likely last for a longer time. We have revised upwards this year’s GDP forecast to -5.0% and forecast GDP growth to reach 4.5% in 2021, before easing to 3.0% in 2022. In the most likely scenario, we see Estonia’s GDP reaching its pre-crisis level in the second quarter of 2022.

Latvia – not great, but not as bad as expected

Latvia has been relatively successful at managing the COVID-19 crisis so far, and the economy has suffered less than the rest of euro area. Following a sharper than expected drop in the first quarter, activity in the second quarter declined by 9.8% over the same period of the previous year. Several parts of the economy are recovering faster than expected. For instance, industrial production, goods exports, and retail trade seem to have recovered to close to or even above the levels of last year. The registered unemployment rate peaked in June, with government support limiting the extent of the increase. Due to improving economic activity and the opening of more seasonal jobs, the number of registered unemployed inched down in July and early August. Survey data points to an improving outlook, with industrial and construction confidence approaching their long-term averages, while remaining below last year’s levels. Meanwhile, services confidence is still notably depressed and has seen slower improvement than other sectors.

We expect GDP in the third quarter to reflect a strong rebound, with the economy regaining much of the ground lost in the first half of the year. Overall, assuming the virus remains largely under control going forward, GDP projections in mid-May seem to have been overly pessimistic. The forecast for this year has been raised to -5%, with consumption leading the way in recovery, while exports and investments are expected to lag. During the next two years, the front-loading of EU funds should boost investment. Stimulus programs across Europe should also aid the export recovery, especially given that a large part of the Latvian exports is construction related. The economy is projected to reach its pre-crisis level by the start of 2022.

The labour market will be lagging the economy somewhat. We expect the unemployment rate to gradually decline, averaging 8.3% in 2020, with a more marked recovery going forward. Wage growth slowed considerably during the crisis months and is expected to remain sluggish throughout this year, averaging 3%. Labour shortages are expected to reappear in some sectors as a result of broad-scale construction works and investment projects, boosting wage growth in the next two years to 5.5% and 6.0%, respectively.

Lithuania – much ado for almost nothing

The Lithuanian economy was one of the least affected by the pandemic and lockdowns – in the second quarter, its GDP contracted by 3.8% compared with the same period a year ago. Once the easing of the lockdown measures began, Lithuanians were eager to quickly get out and consume. Consumer confidence and retail trade have rebounded quickly, and we no longer forecast that household consumption will shrink this year – the dip was very short-lived. Manufacturing (except for oil products) has also rebounded and in June was already 5.9% higher than a year ago. 

Manufacturing and exports, however, are unlikely to thrive this year as much as household consumption, given the still-weak export markets.

The labour market has also recovered fairly quickly – the number of employees already returned to the pre-crisis level by July. However, a significant number of previously self-employed remain without jobs, as suggested by the elevated unemployment levels. On the other hand, new social benefits for those who have begun looking for a job may have prompted previously inactive people to become jobseekers. Unemployment levels were temporary lifted by a surge of immigrants (mostly returning Lithuanians) – the net immigration has continued increasing and we expect to hit a record high this year. The health of the labour market is also illustrated by rise in job vacancies, which at the end of July reached the highest level in at least 12 years. The resilience of the Lithuanian economy can be explained not only by the successful virus containment policies and upbeat consumers, but also by the massive broad-based government stimulus, very low dependence on incoming tourism, and favourable export structure. We now expect Lithuania’s GDP to return to the pre-crisis level already by the second quarter of 2021. The Lithuanian economy now faces the idiosyncratic and peculiar risk of overheating and excessive inflation, especially in 2022.