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Monday, September 8, 2008

Latvia's Economy Has Now Been Shrinking For At Least Two Quarters

Well I think it's now official, or at least as official as its going to get: the Latvian economy is now in recession, as defined by two successive quarters of contraction (quarter on quarter, on a seasonally adjusted basis). The Latvian economy contracted by 0.2% in the second quarter from the first, and by 0.3% in the first quarter from the last quarter of 2007. Not that you would be able to read this information on the data release from Latvijas Statistika, nor would you find any great enthusiasm anywhere for having a technical "linejudge" (like the US NBER recession dating commission) to present this datapoint in a semi official way it seems to me. Indeed Bloomberg seems to have needed to take the bull by the horns and phone the statistics office direct in order to have a conversation with Alla Vanaga, the central statistics office's deputy head of national accounts, and thus extract this otherwise well-guarded piece of information.

The root of the problem is that the statistics office do not publish seasonally adjusted quarterly data, and there may well be very good explanations for this, since, apart from any other reason, with the very violent recent movements in output, they may have difficulty in establishing weights to use in the seasonal adjustment in which they have any great degree of confidence (another example of this type of problem could be found in the seasonally "adjustments" applied to the data we got for retail sales and industrial output - which was often scarcely credible - from statistics offices all across the globe in April, simply because Easter this year was in March). So they have my sympathy, and I'm sure the data Alla Vanga has provided needs to be treated as only a first approximation, which is why I still am reluctant to give up completely my initial feeling that the recession may even go back to Q4 2007. Certainly GDP contracted in Q4 last year, and the only real issue is the seasonal correction to be applied. My gut feeling is we may see some later revisions which will change things slightly, in the meantime, Latvia officially entered recession on 1 January 2008.

Anyway, on to the data, which really is pretty horrible. First off the quarterly evolution of GDP as we now have it.

Now looking at this chart, is there still anyone around out there who is willing to own up to having imagined Latvia was going to have a "soft" landing - and unfortunately, we need to bear in mind that the worst isn't over yet, this is only just starting.

If we look at the annual growth rate - given as 0.1%, but even this number is the effect of a decimal rounding operation, and the accurate number is a miniscule 0.05% - or put another way, the Latvian economy only grew by a bare, inflation corrected, 1.1 million Lats between July 1 2007 and June 30 2008.

And the situation is almost guaranteed to get worse, since we are more than likely about to see some more quarter on quarter contraction, and hence the annual number is also going to head into negative territory. Final private consumption was down 5.02% year on year. As we can see in the chart below, there is no mistaking the boom-bust. The question is really what is likely to happen now to private consumption. I will try and go more into this in the coming months, but there is just no way we are going to see a sudden leap back in consumption. Obviously it won't simply continue shrinking (or at least I hope it won't), but the kind of positive growth we see may be more like what we are seeing in Hungary now, something in the 1% to 2% y-o-y growth range (and this is when the situation "normalises", which is still some distance ahead, and with some hard bridges to cross in between).

And Gross Fixed Capital Formation was down 6.77% on the year. As can be seen in the chart (again below), the slope is rather smoother than in the case of consumption, which is not surprising, since investment obviously comes to a halt some time before consumption does. Equally, we could expect this part to pick up more quickly, and pull consumption along behind it, but for that Latvia has to become an attractive destination for export activity, and this involves putting all the distortions in relative prices straight. Its like you just crashed a bike at the moment, the frame is intact, but all the wheels are bent and buckled, and the chain has snapped.

Finally, if we come to look at foreign trade, we find that imports were down 8.16% on the year, while exports were up 2.49%. This position is more complicated than it seems, since the rate of increase in exports is falling, not rising, and this does not bode well for a sector that now needs to pull the economy, while imports are down strongly on the back of falling domestic demand. But this decline in imports produces a statistical effect whereby the NET trade balance in Latvia improved in Q2, which actually helped GDP growth, that is if imports had held up better, the contraction in the domestic economy would have been worse (i know this must seem a strange result, but GDP accounting is like that). But the rate of import decline cannot be expected to continue indefinitely at the current strong rate, and with the Lat pegged to the euro, and continuing inflation well above the eurozone average, then Latvian products will only become less competitive (oh, I know, people will increase productivity, but everyone else will be trying to do that too), so my feeling is that what we will now see is a slowdown in the rate of contraction in consumer demand, but an increase in the negative component in the trade balance (due to the bottoming out of the import decline, in part supported by the internal demand for imports as internal demand itself bottoms, and remember, with the high Lat, Chinese - eg - imports are quite cheap) and hence we should envisage GDP lingering in contraction territory for some time to come.

Well, that is a brief resumé of where we are at this point. Clearly there are huge downside risks out there, in particular associated with the slowdown in the eurozone, and the future of the Lat peg. There is also a demographic risk associated with the possibility that more people may leave looking for work abroad. But I think we can safely cross all these issues as and when we get to them. For the time being there is enough to digest in what we already have, I think.

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