Analytics, Banks, Direct Speech, Economics, Financial Services, Latvia

In the previous quarter, with similar external environment developments already persisting, Latvia's buoyant economic growth looked like "a painting that visually does not fit the frame". However, at this stage growth prospects increasingly rely on domestic factors, which, unfortunately, are not always favourable either.

More comprehensive information on the sectoral development and expenditure components of GDP will be available only in a month; however, the short-term data suggest that the contribution of exports to the growth might have been very poor and is also likely to have had an adverse effect on the wholesale trade development. Meanwhile, recent data suggest that the retail trade development has been successful: in the first quarter the annual rise in real turnover reached 3.7% according to seasonally adjusted data; this is a better result in comparison with the previous quarter. The retail trade is still likely to grow on account of the favourable effect of the income dynamics in 2018. In 2018, the increase in average wages in Latvia as well as changes in the tax policy resulted in faster growth of the real purchasing power of households than in 2017, fostering both consumption and savings. All that supports retail trade, inter alia development and expansion of shopping centres.

However, such "internal reserves" have rather limited capacity. No equivalent increase in the purchasing power is expected this year (e.g. the minimum wage will not be raised). Moreover, although the European Commission data suggest that the consumer sentiment has improved in April, one can hardly call it a rise in optimism since the total ratio has increased due to the evaluation of the financial situation over the last 12 months and plans to make bigger purchases in the coming 12 months. By contrast, the outlook for the financial situation and the overall economic situation over the horizon of the next 12 months has deteriorated slightly. Retail trade sentiment indicators are a bit more optimistic; however, they refer to the next three months only. Retailers probably count on the spending of consumer savings, the growing (albeit at a slower pace) income and households' interest in the newly opened shopping centres.

Although the deterioration of the business sentiment in other sectors (e.g. construction and manufacturing having experienced this trend already since December) and the external environment do not encourage investments in boosting capacity, the agenda of businesses still include launched large-scale investment projects. Similarly, in the first months of this year, some new investment plans have been announced across a wide range of sectors. The absorption of European Union (EU) funds in the first quarter of 2019 (data by the Ministry of Finance) has also been somewhat faster than in the first three months of 2018. However, over the year, investment activity could decelerate on account of a slowdown in the development of primarily external-market-oriented sectors. The port operation, supported by temporary factors last year, is experiencing more moderate growth already at this stage; moreover, in the near future the overall development of the transport sector could be also hindered by the road transportation policy in the EU comprising conditions that are unfavourable for road carriers of the peripheral countries. The manufacturing growth will depend on export opportunities subject to the global growth developments, the international trade policy and the Brexit outcome.

According to preliminary data, the construction growth has moderated in the first quarterfollowing the rapid development in 2018. Nevertheless, favourable conditions continue to support the development of the sector: both the planned investment (including the absorption of EU funds) and improved household purchasing power (and thus the demand in the segment of housing).

The energy sector was still adversely affected by weather conditions in the first quarter. The dynamics of fossil fuel and energy stock exchange prices was not favourable enough to foster increased energy generation in cogeneration regime. In the first quarter, electricity generation saw a double digit year-on-year decrease.

Overall, short-term data show that the development of the domestic-market-oriented sectors could have been relatively more successful (except the energy sector) already in the first quarter. This trend will most likely persist also throughout the year.