Latvian Economy

Monthly newsletter from Swedbank’s Economic Research Department

by Lija Strašuna No. 1 • 13 May 2010

Stabilisation in labour market, but is deflationary pressure easing?

• Unemployment seems to have reached its peak, bringing stabilisation to the
labour market, but the unemployment rate will be high for years to come. Job
creation is and will be slow, as exporting sectors are not able to absorb a large
part of the current unemployed. To lessen the negative consequences of long-
term unemployment, job creation should be supported, and one of the ways to do
it is by changing tax policy.
• Monthly inflation resumed in early 2010 as upward price pressure came from
abroad due to recovering demand and rising commodity prices in the world;
meanwhile, local deflationary pressure is still present. Although global price
growth is expected to slow in the 2nd half of the year due to gradual fiscal
tightening, stronger-than-expected price pressures from abroad might shorten the
envisaged deflation period in Latvia.
• Unless labour cost cuts are replaced by structural reforms, there is a risk of very
low medium-term growth. For the scenario of low inflation together with low
economic growth not to come true, productivity gains through increasing
production volumes are necessary, supported by activities from the government
side to improve the business environment, tax system, education system, etc.

Unemployment seems to have peaked… Unemployment rate, %

25 25
After two years of falling economic activity,
seasonally adjusted GDP increased by 0.3% qoq in
20 20
the 1st quarter of 2010. With recession being over, it
seems that the unemployment rate has reached its 15 15
peak. Registered unemployment rate started to
decrease in the first weeks of April, falling to about 10 10
16.7% by the end of the month (about 190,000
unemployed). In addition, the number of newly 5 5
registered unemployed continues to diminish – from
about 21,800 persons per month in the autumn of 0 0
2009, it is down to 16,300 in March 2010 (in 2004- Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
2007 it was on average 8,000 per month). Newly registered unemployed, thsd people (rs)
According to the State Employment Agency, the Registered unemployment rate
number of job vacancies is also increasing for the Job-seekers' rate, nsa
fourth consecutive month, albeit very slowly and Source: State Employment Agency, Eurostat
from very low levels (2111 positions for the end of
April). The development of confidence indices also
supports signs of stabilisation in the labour market.
The unemployment expectations of consumers
diminished notably during the 1st quarter of 2010.
However, the improvement has been observed in
exporting sectors, while companies operating in the
local market are still coping with weak demand. For
instance, employment expectations of businesses in
manufacturing and services are improving, especially

Economic Research Department. Swedbank AS. www.swedbank.lv

Mārtiņš Kazāks +371 6744 5859, Lija Strašuna +371 6744 5875, Dainis Stikuts +371 6744 5844
Legally responsible publisher: Cecilia Hermansson. +46 8 5859 1588
 Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 1 • 13 May 2010

in such exporting sectors as wood, chemicals, … but the labour market will remain weak in
machinery and equipment, and base metal the upcoming years
industries, as well as in travel, tourism, computers,
and research and development-related activities. Overall, there is some stabilisation in the labour
market, but, as historical experience shows, the
Business confidence, employment unemployment rate will be high for years to come. 1
expectations With low employment, no wage growth, and conti-
80 nuing fiscal consolidation, there is still little hope of
the revival of consumer spending needed to sustain
a meaningful recovery.
40
We see that job creation is and will be slow, as
0 exporting sectors are unable to absorb a large part
of the current unemployed. There are about
230,000 job seekers in Latvia, which is nearly as
-40
many as the exporting sectors currently employ. 2
With private consumption and investment starting to
-80 recover in 2011, job creation will pick up somewhat,
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 but it is clear that part of the current unemployment
Retail trade Manufacturing is a long-term one, as domestic demand sectors will
Services not need as many employees as in the boom
Source: DG ECFIN
years. This situation is encouraging people to
Unemployment emigrate, leading to structural problems in the long
200 100 term by diminishing the size and quality of the
labour force.
160 80
To lessen the negative consequences of long-term
120 60 unemployment, job creation should be supported.
80 40
One of the ways to do this is by changing tax policy.
For instance, targeted and temporary tax dedu-
40 20 ctions might be considered to encourage first
employment among younger people and long-term
0 0 3
unemployed. This initiative should be included
-40 -20 already in the 2011 budget.
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
Is the deflation story dead?
Unemployment expectations over next 12M (rs)
Registered unemployment, thsd people Monthly consumer price inflation in the 1st quarter
Source: State Employment Agency, DG ECFIN of 2010 was caused by more expensive imported
goods and seasonal increases in food prices. At the
Job-seekers’ data for the 1st quarter of 2010 will be same time, prices of local goods and services
available in late May, but currently it seems that our continued to decline. While the total consumer price
earlier forecast of this rate peaking at about 23% in index (CPI) fell by just 0.2% qoq, core CPI (i.e.,
the spring of 2010 holds. We will see the turning excluding fuel, nonprocessed food, and admi-
point in job-seekers’ rate only in August, when nistratively regulated prices) declined by 1.4% qoq
Labour Force Survey results for the 2nd quarter will in the 1st quarter of 2010. Monthly increases in
be published. However, the dynamics of this rate producer prices at the beginning of the year were
will most likely be similar to registered unemploy- mostly driven by more expensive exported
ment dynamics (although the latter might decrease production. On a quarter-on-quarter basis, the
faster due to weaker motivation to register when
unemployment benefits end). Even with a possibility 1
See, e.g., IMF, World Economic Outlook (April 2010),
of unemployment rate to increase again in autumn “Chapter 3, Unemployment dynamics during recessions and
due to seasonal factors, unless recovery in the euro recoveries: Okun’s law and beyond”.
zone is substantially slower than expected due to 2
Swedbank estimations. For instance, there are about 130,000
Greece problems, the unemployment rate reached employed in manufacturing, which is about 14% of total
this spring will still be the maximum. employment. In the service sectors, there might be up to
100,000 people working for exports (about 10% of total
employment).
3
For more details, see IMF, World Economic Outlook (2010).

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 Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 1 • 13 May 2010

producer price index (PPI) of production realised in changes might influence price developments
the local market declined by 0.2%, while that of substantially, though (especially direct taxes, such
exported production rose by 3.2% in the 1st quarter as VAT or excise). Therefore, when planning tax
of 2010. changes, the authorities should consider not only
the fiscal effect and the effect on incomes but also
Core inflation and total CPI, yoy, % the influence on prices. Timing is particularly
20 4 important, taking into account the euro adoption
target in 2014.
15 3
Although low inflation might make the further
10 2 process of competitiveness adjustment slower than
5 1
it would be in the deflation case, it would somewhat
ease the deleveraging process, as well as increase
0 0 budget revenues (e.g., tax revenues would rise due
to growing turnover) and diminish the budget deficit.
-5 -1
CPI growth (yoy), %
-10 -2
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 20
Core inflation, mom Total inflation, mom
Core inflation, yoy Total inflation, yoy 15
Source: CSBL, LaB
10
Overall, it can be seen that upward price pressure
is coming from abroad, due to recovering demand 5
and rising commodity prices in the world. In
addition, the weakening euro exchange rate against 0
US dollar is beneficial for Latvian exporters (outside
the euro zone), although it makes imported energy -5
resources more expensive. Jan.08 Jul.08 Jan.09 Jul.09 Jan.10
Eurozone SE UK
Producer price inflation, yoy RU EE LT
LV Source: Reuters
25
20
15 Competitiveness still improving
10 It should be emphasized that deflation is not a
5 necessary condition for improving competitiveness.
0 What matters is Latvia’s development relative to its
trading partners. In the 1st quarter of 2010,
-5
competitiveness continued to improve due to a
-10 bigger price growth in trading partner countries, as
-15 well as to favourable exchange rate developments.
-20 For instance, the CPI-based real effective exchange
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10 rate (REER) of the lats has already declined by 9%
Total Local market Exported
from its peak in February 2009 – an amount that is
nearly 1/3 of its appreciation since 2006. A similar
Source: CSBL
trend can also be observed in the PPI-based REER.
Although global price growth is expected to slow in So far, the competitiveness adjustment has been
the 2nd half of the year due to a gradual fiscal achieved through labour cost cuts, which cannot be
tightening, stronger-than-expected price pressures continued forever, while productivity improvement
from abroad might shorten the envisaged deflation 4
has been weak. Unit labour costs were also
period in Latvia. Nevertheless, local deflationary reduced in the 1st quarter of 2010 – unemployment
pressure will still be present, as the labour market
will be weak and deleveraging will proceed. This
pressure, together with low global inflation, implies 4
For more details see our recent Swedbank Analysis „Competitiveness
that, even if inflation in Latvia resumes, it will be adjustment in Latvia – no pain, no gain?”, available at
subtle (excluding the effect of tax changes). Tax http://www.swedbank.lv/eng/docs/materiali.php?nmid=0&naid
=3

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 Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 1 • 13 May 2010

rose, and, according to our forecast, wage cuts Risks to future growth
continued. However, it seems that most of the
Unless labour cost cuts are replaced by structural
potential to improve competitiveness through labour
reforms, there is a risk of very low medium-term
cost cuts and weak labour market driven deflation
growth. In our opinion, the risk of stagflation (i.e.,
has been used by now. At the same time, with the
high inflation and no growth) is very small, but the
labour market remaining weak, there are no strong
scenario of low inflation together with low economic
inflationary pressures. Further adjustment through
growth is more likely. In case of low global inflation,
the labour market would be extremely painful,
this would make the process of improving
squeezing domestic demand further and
competitiveness slower and longer than it could be
undermining the recovery. The competitiveness
with local deflation, and export-driven growth would
adjustment is not yet over, but, in our opinion,
also decelerate. For this scenario not to come true,
further gains should be obtained via productivity-
productivity gains by increasing production volumes
enhancing structural reforms.
are necessary, supported by activities from the
Effective exchange rates of the lats,
government side to improve the business
2005=100 environment, tax system, education system, etc.
140

130 Lija Strašuna

120

110

100

90
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
NEER REER_CPI REER_PPI
Source: Bank of Latvia

Swedbank
Economic Research Department
Balasta dambis 1a, Riga, LV 1048, Latvia
www.swedbank.lv
Martiņš Kazāks, +371 6744 5859
Dainis Stikuts, +371 6744 5844
Lija Strašuna, +371 6744 5875
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.

Legally responsible publisher

Cecilia Hermansson, +46 88 5859 1588

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