Latvijas Banka has published its latest macroeconomic forecasts for Latvia. GDP growth projections for 2021 and 2022 have been revised downwards to 4.6% and 4.2% respectively (from 5.3% and 5.1% in September 2021 forecasts), reflecting the economic fallout from the pandemic. Near-term economic growth is dampened by new surges in Covid-19 cases, particularly in Europe, new variants of the virus and tightening of the measures to limit virus spread. Shortages of materials, equipment and labour as well as the progressively rising costs, particularly those of energy, also have a downward effect on economic growth. Central banks, including the European Central Bank, continue with the implementation of accommodative monetary policies. But productivity and competitiveness overcome any transitory factor.

Inflation is narratively driven by higher energy prices and other so-called transitory factors. Latvia’s inflation projections for 2021 and 2022 have been revised upwards to 3.2% and 6.1% respectively (from 2.8% and 4.0% in last September forecasts) in light of the soaring global energy prices. An upward revision in inflation projections for 2023 to 2.9% was determined by an increase in production costs. Moreover, the situation has been aggravated by both global factors (increases in the prices of natural gas, coal and CO2 emission quotas) and developments in our neighbouring countries, i.e. restrictions on energy imports from Russia and Belarus imposed by Lithuania.

At the same time, the price hike is broad-based and it is affected by:

• the pass-through of energy prices to other goods and services prices;
• decisions to increase the administered prices (for example, on heating and water supply in individual cities);
• the rising global food prices;
• the effects of the global supply chain disruptions on the prices of industrial goods;
• the increase of wage expenditure in production costs.

However, none of those mentions the impact of the central banks’ stimulus worldwide on the supply chain bottleneck.

Latvia’s economic growth has decelerated towards the turn of the year on account of the deteriorating epidemiological situation. Additional factors, however, were the imposed lockdown and tightened restrictions. Although private consumption recovered in the third quarter, an increase in traveller spending abroad is observed, with no contribution to Latvia’s economic growth. Prices on building materials and equipment have risen to a larger extent than estimated in investment plans, thus dampening the investment activity. Restrictions on the provision of services put continued downward pressure on exports. The economic effects of the pandemic will continue to be felt also at the beginning of next year. Considering the tight labour market, an additional downside factor will be the requirement to have a Covid-19 certificate for on-site workers, as well as deterioration of the epidemiological situation and restrictions in Europe.

Even though higher prices on building materials may decelerate investment and corporate lending remains weak, the shortage of qualified labour can speed up automation. At the condition of investing in productivity, not merely funding demand. Diminishing the uncertainty would then be expected to release the pandemic savings and accelerate private consumption. While export development would be supported by recovering external demand boosted by a competitive supply.

Unemployment growth is limited by the ability to adapt to working remotely and government support for the period of imposed restrictions. Nevertheless, unemployment is bound to increase on account of those refusing to vaccinate, as there is a requirement to have a valid Covid-19 certificate for on-site workers. The decreasing availability of the labour force strengthens the pressure on wages. The wage growth projections for 2023 have been revised upwards to reflect labour shortages and the planned reform of the public administration remuneration system. In this context, it must be noted that the pandemic highlighted significant differences in income dynamics between lower and higher remunerated employee groups as well as the issues of income inequality and the need for social assistance. Currently, with the average remuneration level increasing and production costs on the rise, inflation is driven both by demand and supply factors. In November, its annual rate of the increase already reached 7.5%. As the remuneration of employees moves up, so does demand and production costs, thereby supporting price rises. Without adequate investment in innovation and competitiveness.

The general government deficit is rising, as the economic growth is decelerating and the government is increasing its spending to limit the fallout from Covid-19. In 2021, this spending has grown more than 2.5 times as compared to 2020.