12.09.2014 .

Nordea Economic Outlook: Economic Growth Experiences Headwind

  • Geopolitical conflicts hinder the global economic recovery
  • After four quarters, growth in the Eurozone has stopped
  • Positive employment indexes and expected rise in interest rates in the US
  • Wealth indexes of Latvia's inhabitants improve
  • Latvia's “Achilles' heel” is weak investments

Despite the fact that the world is continuing to recover from the financial crisis, the global economic growth is fragile and once again faces a strong headwind. The main risk factors, both now and in the near future, are weak growth in less developed countries and geopolitical conflicts. The situation in Ukraine and the Gaza Strip, as well as the increasing influence of the terrorist organization known as the “Islamic State” in Iraq and Syria, is promoting caution and an unfavorable investment environment, according to the latest Nordea economic survey.

Europe is facing challenges

"Development in the Eurozone has been slow and uneven. Sometimes, just as it seems that we have finally overcome the crisis, we have to face new headwinds. The German engine is starting to stall, France and Italy are overwhelmed by structural weakness, and the success of the Netherlands and Ireland is insufficient to compensate for the weakness in the largest Eurozone countries. Despite the record low interest rates in Europe, the demand for loans is extremely weak. The total private debt in the Eurozone, just as in Latvia, is continuously decreasing, which is related to both more cautious lending policies among banks and weak demand for new loans.  Companies are being cautious in their forecasts for the future, and the current geopolitical situation does not do any good for the general mood,” says Nordea expert, Gints Belēvičs, about the economic situation in Europe.

Russian embargo hinders growth in Latvia and Europe

“Sanctions introduced by Russia against food imports from European Union Member States will have a negative impact on the food, agriculture and transport sectors in Latvia. The total direct effect will be limited and reduce the growth rate of the gross domestic product in Latvia by approximately 0.4 to 0.5 per cent. However, these calculations include only the direct effect of sanctions, without taking into account the secondary effect which might cause an even more serious economic slowdown in the Baltic States and other European Union Member States.

This year, the direct effect of the Russian embargo will result in losses of approximately EUR 20-30 million from Latvia's total export, which is not a large amount if compared to the overall amount of EUR 4.8 billion during the first half of this year. Currently, the greatest concern is the growth of the Eurozone, which did not turn out as strong as was anticipated, as well as the indirect effect of the Russian embargo that will weaken the economy of our neighbors and other external trade partners.

Re-orientation to other markets will cause difficulties for food manufacturers, since the general global mood  is far from over-optimistic, and demand is relatively weak. The surplus of goods manufactured in Europe will not only reduce prices, but also obstruct entry to new markets.  Food manufacturers whose products have a short shelf life and who cannot delay or stop production, as, for instance, in the case of dairy products, fresh fruits and vegetables, will be affected the most,” explains Nordea's Economy Specialist, Gints Belēvičs, about the effect of the Russian embargo.

Latvia's growth is based on internal consumption and construction

“For the past few years, the main drive of the Latvian economy has been private consumption, which has been joined by the construction sector. As the results of the survey show*, the optimism of inhabitants has increased, reaching the highest indexes with respect to certain criteria. For instance, optimism has significantly increased among households that are planning to purchase or construct a house within the next 12 months. These indexes may promote the activity of the housing market.  Over the last year, Latvia's “Achilles' heel” has been weak investments, particularly in the production sector, which might pose a threat to long-term growth.

Increasing salaries and decreasing unemployment have been a source of good news for Latvian employers. In the low inflation environment, with the tax-exempt minimum increasing and bigger reliefs for dependents being added, the wealth of Latvian inhabitants is improving. This tendency is observed in the consumer mood survey. Next year, salaries will no longer grow that rapidly, yet the positive tendency will remain,” according to G.Belēvičs' analysis of current events in the Latvian economy.

Latvia and Lithuania will be among the most rapidly growing economies of the EU

The rapid economic growth forecast at the beginning of the year for the Baltic States will not take place this year. The most optimistic forecasts are mostly based on the fact that internal consumption will be extremely high, and export markets will recover, since Europe will experience strong growth, which will be fully capable of compensating for the decreased growth in the East. The reality turned out to be far more harsh, and we should expect new challenges in the future.

Even so, this year Latvia and Lithuania will be among the most rapidly growing economies in the European Union. Estonia, on the other hand, is going to experience very slow growth for two years in a row. This year's Nordea forecast for Latvia predicts a 3.3% growth in GDP; however, the risk of downturn is currently stronger, and there is a probability that this number will be even smaller at the end of this year.

Nordea economic forecasts for the end of 2014 and 2015

“Taking into account that export in Latvia has been stagnating for two years already, our economic forecasts for 2015 are optimistic in relation to export growth, which will increase by 2%. Whereas, taking into account the global economic situation, we have reduced our GDP forecasts to 2.9%. Next year, inflation will increase, yet it will still remain below 2%,” according to the forecast of Nordea experts.

                2014      2015
GDP         3.3%      2.9%
Inflation    0.6%      1.7%
Export      1.0%      2.0%
Import      0.6%      1.7%

Current events in the global economy 

US employment improves and inflation increases

The world economic situation analysis carried out by the Nordea Group Economic Outlook suggests that despite the fact that the US economy was stagnant during the first months of the year, due to unexpectedly bad weather conditions, currently it seems that it has resumed its growth. This might mean that the Federal Reserve Bank will now gradually increase interest rates in 2015. The strength of the US economy is mostly observed through the labour market. Employment indexes are very good, and at the moment the US has finally restored 8.8 million jobs, which were lost during the years of recession.
The strength of inflation is increasing and is approaching 2%. This means that the interest rates in the US will grow faster than those in Europe, wherewith the US Dollar will strengthen its value against the Euro.

China continues to experience a “soft landing”

The growth of the second largest economy in the world, China, which is in need of structural reforms, will gradually decrease in the coming years. The Chinese government does not want to reduce investments too quickly, since it will have a negative impact on growth; therefore, after a weak first quarter when the investments were slowed down, during the second quarter the government started investing in rail road infrastructure and restoring poor cities. Currently, one of the main risks for China is overproduction and partial use of capacity, putting deflationary pressure on the production industry. It is unlikely that China will experience a heavy landing, which would mean GDP growth by 4% or less. This is due to the fact that the economy is managed by the central government, which has a range of instruments to prevent such a heavy landing.

* The Directorate-General for Economic and Financial Affairs

For additional information:
Inese Knipše, PR Specialist, Nordea Latvia, tel.: 6 700 5434, inese.knipse@nordea.com