The Latvian Economy - 2010 July
5
The Latvian Economy Monthly newsletter from Swedbank’s Economic Research Department by Lija Strašuna No. 3 • July 2010 Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000. E-mail: [email protected] www.swedbank.com Legally responsible publisher: Cecilia Hermansson, +46 8 5859 1588. Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Dainis Stikuts, +371 6744 5844. Manufacturing in Latvia – are the current growth rates sustainable? With global demand recovering, Latvian manufacturing has been growing since the 2nd quarter of 2009 – its production volumes currently are 15% higher than in its trough. Nevertheless, they are still 15% lower than their peak in early 2008. The recovery in Latvian manufacturing is not extraordinary, as the dynamics are similar to those in neighbouring and main trading-partner countries. Latvia’s manufacturing and exports shares in GDP are smaller than, e.g., those in Estonia and Lithuania. This implies that, to yield the same GDP growth, Latvia’s exports should rise faster than those of its neighbours. To support export growth, investments are needed to increase production capacity for the existing product mix and to shift to higher-value-added products. This situation calls for improvement in the investment environment (tax policy, entrepreneurial environment, etc.) and enhancing the availability of financing (e.g., equity capital, sovereign risk rating upgrade). Manufacturing recovery is under way The key Latvian exporting sector, manufacturing, suffered dramatically from the global financial crisis and the following fall in demand. With global demand starting to recover, Latvia’s manufacturing has been growing since the 2 nd quarter of 2009, and its production volumes currently are 15% higher than in its trough. Nevertheless, they are still 15% lower than their peak in early 2008. Manufacturing export turnover has grown by more than 30% from its trough and the export share in manufacturing turnover has increased to 59% from 51% in 2008. Latvian exporters were thus able to improve their competitiveness and raise their exports. So, is it a Manufacturing output, 2007=100 (3M average) 60 70 80 90 100 110 120 Jan.07 Jan.08 Jan.09 Jan.10 Denmark EA Estonia Latvia Lithuania Poland Sweden United Kingdom Source: Eurostat success story and will the current expansion be sustainable? A comparison of manufacturing developments in Latvia with those of its neighbours and main trading partners shows that the dynamics are very similar. Poland stands out, as it has been the only EU country to avoid recession, but it has a more closed economy with a larger share of domestic demand. The fall in Estonia was sharper, but it is also recovering a bit faster, perhaps therefore due to a stronger rebound effect. It follows that the recovery in Latvian manufacturing is good, but not something extraordinary. Even more important, Latvian manufacturing and exports shares in GDP are Latvian manufacturing structure 29% 32% 29% 26% 22% 19% 6% 5% 4% 13% 12% 15% 6% 6% 6% 0% 25% 50% 75% 100% 1Q 10 2009 2008 Food, beverages Textiles, clothing Wood, furniture Paper, poligraphy Chemicals, pharmaceuticals Rubber, plastics, minerals Base metals, metal products Machinery, equipment Transport and accesories Other Source: CSBL
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Transcript of The Latvian Economy - 2010 July
The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Department by Lija Strašuna No. 3 • July 2010
Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000.E-mail: [email protected] www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46 8 5859 1588.
Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Dainis Stikuts, +371 6744 5844.
Manufacturing in Latvia – are the current growth rates sustainable? With global demand recovering, Latvian manufacturing has been growing since the
2nd quarter of 2009 – its production volumes currently are 15% higher than in its trough. Nevertheless, they are still 15% lower than their peak in early 2008. The recovery in Latvian manufacturing is not extraordinary, as the dynamics are similar to those in neighbouring and main trading-partner countries.
Latvia’s manufacturing and exports shares in GDP are smaller than, e.g., those in Estonia and Lithuania. This implies that, to yield the same GDP growth, Latvia’s exports should rise faster than those of its neighbours.
To support export growth, investments are needed to increase production capacity for the existing product mix and to shift to higher-value-added products. This situation calls for improvement in the investment environment (tax policy, entrepreneurial environment, etc.) and enhancing the availability of financing (e.g., equity capital, sovereign risk rating upgrade).
Manufacturing recovery is under way
The key Latvian exporting sector, manufacturing, suffered dramatically from the global financial crisis and the following fall in demand. With global demand starting to recover, Latvia’s manufacturing has been growing since the 2nd quarter of 2009, and its production volumes currently are 15% higher than in its trough. Nevertheless, they are still 15% lower than their peak in early 2008. Manufacturing export turnover has grown by more than 30% fromits trough and the export share in manufacturing turnover has increased to 59% from 51% in 2008. Latvian exporters were thus able to improve theircompetitiveness and raise their exports. So, is it a
Manufacturing output, 2007=100(3M average)
60
70
80
90
100
110
120
Jan.07 Jan.08 Jan.09 Jan.10Denmark EA EstoniaLatvia Lithuania PolandSweden United Kingdom Source: Eurostat
success story and will the current expansion be sustainable?
A comparison of manufacturing developments in Latvia with those of its neighbours and main trading partners shows that the dynamics are very similar. Poland stands out, as it has been the only EU country to avoid recession, but it has a more closedeconomy with a larger share of domestic demand.The fall in Estonia was sharper, but it is also recovering a bit faster, perhaps therefore due to a stronger rebound effect. It follows that the recovery in Latvian manufacturing is good, but not something extraordinary. Even more important, Latvianmanufacturing and exports shares in GDP are
Latvian manufacturing structure
29% 32% 29%
26% 22% 19%
6% 5%4%
13% 12% 15%6% 6% 6%
0%
25%
50%
75%
100%
1Q 10 2009 2008Food, beverages Textiles, clothingWood, furniture Paper, poligraphyChemicals, pharmaceuticals Rubber, plastics, mineralsBase metals, metal products Machinery, equipmentTransport and accesories Other Source: CSBL
The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Department, continued
No. 3 • July 2010
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much smaller than, e.g., those in Estonia and Lithuania (9.9% and 43% in 2009 vs. 14.5% and 71% in Estonia, and 18.5% and 54% in Lithuania, respectively). This implies that, to yield the same GDP growth rates, Latvian exports should rise faster than those of its neighbours. Are Latvian manufacturers up to the task?
Developments in Latvian manufacturing industries have varied substantially so far. Those that are oriented towards exports or that managed to shift their sales abroad during the last year performed much better than others. It should be taken into account, though, that the Latvian manufacturing structure is heavily dominated by the wood and food industries. Even if other sectors are able to grow very fast, their impact on the country’s GDP will be much smaller.
Food manufacturing hit by weak domestic demand
The food industry is mostly oriented towards the domestic market: only 24% of the turnover goes toexports. This explains why food manufacturing started to recover only at the end of 2009 and very slowly. Compared with the dynamics in other countries, the fall in Latvian food industry was much sharper. Nevertheless, exports were rising (mostlydue to exports of agricultural products, e.g., grainsand re-exports). Currently, the situation looks better than a year ago; for instance, global dairy prices have gone up, helping Latvian dairy exporters.
Food manufacturing, sa
40
60
80
100
120
140
160
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-60
-40
-20
0
20
40
60
Industrial output, food (2007=100)Capacity utilization, food and beverages (%)Exports, food & agricultural products (2007=100, nsa)Confidence, food and beverages (pts, rs)
Source: CSBL, DG ECFIN
However, the outlook for this industry is not very optimistic, and confidence is still weak. The biggest subsector, meat processing, has limited export opportunities because due dates are short. Weak domestic demand in coming years will continue to undermine the growth of this industry. Another important subsector (also for exporting), dairy
processing, is quite segmented, and consolidation of existing enterprises (which are small from an international perspective) is unlikely. Consequently, although there are large spare capacities, existing producers are not able to ensure volumes sufficient for export orders, and market entry costs for small companies are higher. In addition, many dairy processing companies invested in modernisation of equipment at greater cost during the boom period and are now facing deleveraging pressure.
Food manufacturing output, 2007=100 (3M average)
70
80
90
100
110
120
Jan.07 Jan.08 Jan.09 Jan.10Denmark EA EstoniaLatvia Lithuania PolandSweden United Kingdom
Source: Eurostat
A shift to higher value added product mix is necessary in wood industry
The wood industry was the first to recover, largely due to favourable round wood prices provided by the state vendor (Latvijas Valsts Mež i). After round wood prices fell nearly by half in 2008, they have
Wood manufacturing, sa
40
60
80
100
120
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-60
-40
-20
0
20
Industrial output, wood products (2007=100)Capacity utilization, wood products (%)Exports, wood products & furniture (2007=100, nsa)Confidence, wood products (pts, rs)
Source: CSBL, DG ECFIN
grown somewhat and have by now stabilized at historically average levels; further significant growth is not expected. This, together with substantially lower labour costs, explains the success of wood manufacturers so far. The growth has been generated through exports, which account for about
The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Department, continued
No. 3 • July 2010
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75% of the industry turnover. As a result, the Latvian wood industry has been growing faster than other countries’.
Wood manufacturing output, 2007=100 (3M average)
50
60
70
80
90
100
110
120
Jan.07 Jan.08 Jan.09 Jan.10Denmark EA EstoniaLatvia Lithuania PolandSweden United Kingdom Source: Eurostat
Going forward, however, wood manufacturing growth is expected to slow due to capacity constraints – average capacity utilisation is already close to pre-crisis levels. Logging volumes grew somewhat in 2009, albeit remaining at historically average levels. Current annual logging volumes are considered to be optimal (i.e., sustainable in the long term), and there thus seems to be no large potential for such capacity increase. Of course, round wood imports could provide some additional capacity. On the other hand, there is still great potential to increase value added in the industry –for instance, value added per cubic meter in the wood industry is several times lower than in, e.g., Germany. Also, there are opportunities to integrate the wood and energy sectors. It should be taken into account, however, that several key exporters invested substantially in modernisation of equipment a few years ago and, although now operating at high capacity, still need to deleverage before getting involved in further large investment projects.
Latvian metal industry highly influenced by global developments
The metal industry is very dependent on global price developments (particularly for base metals). Thus, when global metal prices plunged in the 2nd
half of 2008, so did Latvian exports. The fall in manufactured volumes was less sharp, but the recovery has been very slow (exports are about 70% of the turnover). The overall recovery path is in line with the dynamics in other countries.
Manufacturing output of metals, 2007=100 (3M average)
20
40
60
80
100
120
Jan.07 Jan.08 Jan.09 Jan.10Denmark EA EstoniaLatvia Lithuania PolandSweden United Kingdom
Source: Eurosta t
Although the overall capacity utilisation level seems to be quite low (especially in metal-processing companies), leading exporting companies are already operating at near-full capacity and thus cannot easily increase production volumes. At the same time, global metal prices have grown and are expected to remain favourable for Latvian exporters.
Metal products manufacturing, sa
20
40
60
80
100
120
140
160
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-80
-60
-40
-20
0
20
40
60
Industrial output, metal products (2007=100)Capacity utilization, metal products (%)Exports, metals (2007=100, nsa)Confidence, metal products (pts, rs)
Source: CSBL, DG ECFIN
The future growth of the industry will depend on the success of the companies in acquiring new orders abroad, as well as on them solving their financial problems. For instance, the performance of the metal-processing companies varies a lot – there are many success stories of companies that managedto obtain export orders and improved their financial situation rapidly, but there are also many that are nearly bankrupt (e.g., many of those that were producing spare parts for local construction companies). An additional risk is the high concentration of the base metals industry (dominated by one company).
The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Department, continued
No. 3 • July 2010
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Base metals manufacturing, sa
40
60
80
100
120
140
160
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-60
-40
-20
0
20
40
60
Industrial output, base metals (2007=100)Capacity utilization, base metals (%)Exports, metals (2007=100, nsa)Confidence, base metals (pts, rs)
Source: CSBL, DG ECFIN
Better growth opportunities for smaller-niche sectors with higher value added
Industries with higher-value-added products – e.g., chemicals and pharmaceuticals, various machinery and equipment – have a more favourable outlook. These are very export-oriented sectors – in chemicals and pharmaceuticals, exports account for about 80% of the total turnover, and in machinery and equipment, on average about 85% (in computers and electronics, as much as 90%). The chemicals industry even managed to avoid a fall in production volumes in 2009, while the pharmaceuticals, computers and electronics industries experienced one of the smallest declines.
Chemicals and pharmaceuticals manufacturing, sa
40
60
80
100
120
140
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-60
-40
-20
0
20
40
Industrial output, chemicals (2007=100)Industrial output, pharmaceuticals (2007=100)Capacity utilization, chemicals (%)Exports, chemicals&pharmaceuticals (2007=100, nsa)Confidence, chemicals (pts, rs)
Source: CSBL, DG ECFIN
Consequently, while before the crisis the manufacturing turnover of computers and electronics was the smallest among machinery and equipment sub-industries, the fall in electrical devices and other machinery and equipment was so big that these three now have a nearly equal turnover.
However, for further growth, investments in capacity expansion are important. For instance, the capacity utilisation of producers in computers and electronics is already a notch higher than in 2007, and in chemicals it is already very close to the pre-crisis level.
Computers and electronics manufacturing, sa
40
60
80
100
120
140
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-60
-40
-20
0
20
40
Industrial output, computers & electronics (2007=100)Capacity utilization, computers and electronics (%)Exports, machinery and equipment (2007=100, nsa)Confidence, computers and electronics (pts, rs)
Source: CSBL, DG ECFIN
Electrical devices manufacturing, sa
40
60
80
100
120
140
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-60
-40
-20
0
20
40
Industrial output, electrical devices (2007=100)Capacity utilization, electrical devices (%)Exports, machinery and equipment (2007=100, nsa)Confidence, electrical devices (pts, rs)
Source: CSBL, DG ECFIN
Other machinery and equipment manufacturing, sa
40
60
80
100
120
140
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
-60
-40
-20
0
20
40
Industrial output, other machinery&equipm. (2007=100)Capacity utilization, other machinery&equipment (%)Exports, machinery and equipment (2007=100, nsa)Confidence, other machinery&equipm. (pts, rs)
Source: CSBL, DG ECFIN
The Latvian EconomyMonthly newsletter from Swedbank’s Economic Research Department, continued
No. 3 • July 2010
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To boost exports, new investments are necessary
Latvia is not the only country that intends to revive its economy through export growth. So do the other Baltic countries, as well as the Nordic and Eastern European countries. This means that competition in the region is increasing. And the anticipated slowdown of growth in Europe, along with the withdrawal of stimuli, will only exacerbate this competition. So far, Latvian export market shares in main trading partners’ imports have been rising owing to improving competitiveness (mostly due to sharp labour cost cuts), but the adjustment needs to continue; otherwise, gained advantages may easily be wasted. From a long-term sustainability perspective, diversification of the manufacturing structure and product mix, as well as of the destination countries for exports, is beneficial forLatvian industry. This would reduce the dominance of the wood and food industries and improve the export outlook.
Manufacturing growth in the coming years can be achieved either through an increase in capacity for the existing product mix (as successful exporters are already facing capacity constraints or will soon do so) or a shift to higher-value-added products (including an expansion of capacity for new products, more advanced use of existing equipment, etc.). Capacity utilisation will increase somewhat when currently unused facilities that are stuck between owners (i.e., undergoing insolvency procedures) are put back to use, but this effect will be short term. In addition, further capacity expansion in some of the industries with the current product mix (e.g., wood) is not really possible due to limited local resources; thus, a natural choice in these industries is to shift to higher-value-added products. This calls for more investments.
Business environment must be improved to attract investors
To make investments attractive, improvements in the investment environment are crucial. These involve entrepreneurial environment (e.g., easing bankruptcy procedures and lowering administrative barriers), tax policy (e.g. rebalancing the tax burden and providing a clear plan for the future changes), higher education, innovation climate, etc.1 Very important is enhancing financing availability –improving the country’s sovereign risk ratings to lower interest rates, as well as strengthening the financial sector via diversification of financial markets (e.g., access to equity capital).Implementation of these structural reforms is a vital condition for Latvia’s exports to grow faster than those of their competitors. This would raise potential GDP growth and speed up convergence with advanced EU countries, as well as raise the purchasing power of Latvia’s inhabitants.
Lija Strašuna
1 For regional comparison of Latvian competitiveness, see http://www.swedbank.lv/docs/materiali.php?nmid=0&naid=7
SwedbankEconomic Research DepartmentBalasta dambis 1a, Riga, LV 1048, Latviawww.swedbank.lv
Martiņš Kazāks, +371 6744 5859Dainis Stikuts, +371 6744 5844Lija Strašuna, +371 6744 5875
Legally responsible publisherCecilia Hermansson, +46 88 5859 1588
Swedbank’s monthly newsletter is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported in this publication. However, we cannot guarantee the accuracy or completeness of the report and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s monthly newsletter.
