RIGA - Latvia's economy should hit bottom in the fourth quarter of this year or early next year before mounting a solid recovery back to positive GDP growth, say analysts at Hansabank Markets, the financial division of Latvia's Hansabanka.
"The lowest point in the current economic cycle is expected to come at the end of 2008 and the first half of 2009, when economic growth will probably become negative for two to three quarters, which means a recession is likely to set in as a drop in domestic demand might be bigger than the positive impact of net exports on GDP growth," the analysts said.
This represents a downgrade to their previous forecast calling for GDP growth in 2008 of 4 percent, now expected at 1.3 percent.
The analysts expect that the restructuring of the Latvian economy, the recovery of the global economy and increasing optimism will pull the economy off the floor by the second half of 2009, with economic growth of 1.3 percent for 2009 and 4 percent in 2010.
Though the slowing global economy is impacting export growth, "Economic recovery will be mostly driven by exports, as the drop in domestic demand will be steeper and longer, and a significant increase in domestic demand is expected only from 2010," say the analysts.
Household consumption is likely to decrease in Latvia in 2008 and 2009 amid rising unemployment and falling purchasing power, the bank said.
"A drop in investment is expected due to decreasing activity in the private sector, first of all in new home construction, and weaker growth prospects in general. Investments in the public sector, however, are expected to grow," analysts said.
This sentiment is supported by Parex Bank's business activity gauge the 'Parex Index,' where second quarter 2008 results show the mood of Latvian businesses still deteriorating. The Index declined by 3.52 points from the first three months of 2008, to 44.04 points, a new low. A reading of 50 is neutral.
Businesses believe that the economic situation will not change over the next six months, and could even get worse. The Parex Index, a survey of 750 businessmen in Latvia representing companies of various sizes and industries presents a subjective overview on expected economic activity in the country.
President of the Bank of Latvia Ilmars Rimsevics says that Latvian GDP will grow by 2.5-2.7 percent in 2008, and that "stabilization of the lending growth rate will support this. This allows hope for a healthy 15-16 percent growth in lending at the end of the year," he added.
Rimsevics added a note of concern over the manufacturing industry's decline. The conditions for the development of the exports are still unfavourable, he says, and slower growth will result from a decline in foreign demand and a steep rise in costs, weakening the competitiveness of Latvia's exporters.
Hansabank analysts expect the Lithuanian economy to expand by 6 percent this year, slowing to 5.5 percent in 2009, then back to 6 percent in 2010. Estonia's GDP, meanwhile, is expected to increase by 2.5 percent in 2008, by 4 percent in 2009 and 5 percent in 2010.
Lithuania's economy, contrary to Latvia's or Estonia's, may yet avoid a sharp decline, though the right actions by authorities are needed, say the analysts.
Hansabank predicts higher inflation in all three Baltic states in 2008 and 2009, as the pressure from global prices, mostly surging oil prices, has been stronger than expected.
"Since food and energy make up a substantial portion of the consumer basket, their impact on consumer prices - both direct and indirect, for instance, through rising heating bills, material costs, etc. - inflation and consumption in the Baltic states is much stronger than in economically developed countries. We expect consumer price inflation in 2008 to be close to 10 percent in Estonia, 16 percent in Latvia and 12 percent in Lithuania," the analysts report.
Weaker domestic demand has already slowed import growth in Estonia and Latvia, and the same is expected to happen in Lithuania soon, having a positive effect on the unsustainably high external trade imbalances in all three Baltic states.
"Therefore, although we expect economic growth in all three Baltic states to keep decelerating, with negative growth figures possible in some quarters in the process, we believe that fast and positive changes are to take place in 2008-2010. The excessively steep price hikes will have slowed to a normal pace by 2010, allowing the countries to join the euro zone in 2011-13, except for maybe Lithuania, the current account deficits will narrow, just like the external debts, and companies will undergo substantial restructuring, moving away from industries dependent on cheap labor and energy," the analysts said.
Hansabanka analysts also expect productivity growth to accelerate in the next two to three years as these economically leaner years will force businesses to focus on efficiency and productivity.
