The Latvian Economy

Monthly newsletter from Swedbank’s Economic Research Department

by Lija Strašuna No. 3 • July 2010

Manufacturing in Latvia – are the current growth rates sustainable?

 With global demand recovering, Latvian manufacturing has been growing since the
2nd quarter of 2009 – its production volumes currently are 15% higher than in its
trough. Nevertheless, they are still 15% lower than their peak in early 2008. The
recovery in Latvian manufacturing is not extraordinary, as the dynamics are similar to
those in neighbouring and main trading-partner countries.
 Latvia’s manufacturing and exports shares in GDP are smaller than, e.g., those in
Estonia and Lithuania. This implies that, to yield the same GDP growth, Latvia’s
exports should rise faster than those of its neighbours.
 To support export growth, investments are needed to increase production capacity for
the existing product mix and to shift to higher-value-added products. This situation
calls for improvement in the investment environment (tax policy, entrepreneurial
environment, etc.) and enhancing the availability of financing (e.g., equity capital,
sovereign risk rating upgrade).

Manufacturing recovery is under way success story and will the current expansion be
sustainable?
The key Latvian exporting sector, manufacturing,
suffered dramatically from the global financial crisis A comparison of manufacturing developments in
and the following fall in demand. With global Latvia with those of its neighbours and main trading
demand starting to recover, Latvia’s manufacturing partners shows that the dynamics are very similar.
has been growing since the 2nd quarter of 2009, and Poland stands out, as it has been the only EU
its production volumes currently are 15% higher country to avoid recession, but it has a more closed
than in its trough. Nevertheless, they are still 15% economy with a larger share of domestic demand.
lower than their peak in early 2008. Manufacturing The fall in Estonia was sharper, but it is also
export turnover has grown by more than 30% from recovering a bit faster, perhaps therefore due to a
its trough and the export share in manufacturing stronger rebound effect. It follows that the recovery
turnover has increased to 59% from 51% in 2008. in Latvian manufacturing is good, but not something
Latvian exporters were thus able to improve their extraordinary. Even more important, Latvian
competitiveness and raise their exports. So, is it a manufacturing and exports shares in GDP are
Latvian manufacturing structure
Manufacturing output, 2007=100
(3M average) 100%
120 6% 6% 6%
13% 12% 15%
110 75%
6% 5%
4%
100 50% 26% 22% 19%
90
25%
80 29% 32% 29%
70 0%
1Q 10 2009 2008
60 Food, beverages Textiles, clothing
Jan.07 Jan.08 Jan.09 Jan.10 Wood, furniture Paper, poligraphy
Denmark EA Estonia Chemicals, pharmaceuticals Rubber, plastics, minerals
Latvia Lithuania Poland Base metals, metal products Machinery, equipment
Sweden United Kingdom Source: Eurostat Transport and accesories Other Sou rce: CSBL

Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000.
E-mail: ek.sekr@swedbank.com www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46 8 5859 1588.
Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Dainis Stikuts, +371 6744 5844.
 The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 3 • July 2010

much smaller than, e.g., those in Estonia and
Lithuania (9.9% and 43% in 2009 vs. 14.5% and
71% in Estonia, and 18.5% and 54% in Lithuania,
respectively). This implies that, to yield the same
GDP growth rates, Latvian exports should rise
faster than those of its neighbours. Are Latvian
manufacturers up to the task?
Developments in Latvian manufacturing industries
have varied substantially so far. Those that are
oriented towards exports or that managed to shift
their sales abroad during the last year performed
much better than others. It should be taken into
account, though, that the Latvian manufacturing
structure is heavily dominated by the wood and
food industries. Even if other sectors are able to
grow very fast, their impact on the country’s GDP
will be much smaller.
processing, is quite segmented, and consolidation
of existing enterprises (which are small from an
international perspective) is unlikely. Consequently,
although there are large spare capacities, existing
producers are not able to ensure volumes sufficient
for export orders, and market entry costs for small
companies are higher. In addition, many dairy
processing companies invested in modernisation of
equipment at greater cost during the boom period
and are now facing deleveraging pressure.
Food manufacturing output, 2007=100
(3M average)
120
110
100

Food manufacturing hit by weak domestic 90

demand
80
The food industry is mostly oriented towards the
domestic market: only 24% of the turnover goes to 70
exports. This explains why food manufacturing Jan.07 Jan.08 Jan.09 Jan.10
started to recover only at the end of 2009 and very Denmark EA Estonia
Latvia Lithuania Poland
slowly. Compared with the dynamics in other Sweden United Kingdom
countries, the fall in Latvian food industry was much Source: Eurostat

sharper. Nevertheless, exports were rising (mostly

due to exports of agricultural products, e.g., grains A shift to higher value added product mix is
and re-exports). Currently, the situation looks better necessary in wood industry
than a year ago; for instance, global dairy prices
have gone up, helping Latvian dairy exporters. The wood industry was the first to recover, largely
due to favourable round wood prices provided by
Food manufacturing, sa the state vendor (Latvijas Valsts Mež i). After round
wood prices fell nearly by half in 2008, they have
160 60
Wood manufacturing, sa
140 40
120 20
120 20
100 0 100 0

80 -20
60 -40
40 -60
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
Industrial output, food (2007=100)
Capacity utilization, food and beverages (%)
Exports, food & agricultural products (2007=100, nsa)
Confidence, food and beverages (pts, rs)
Source: CSBL, DG ECFIN
However, the outlook for this industry is not very
optimistic, and confidence is still weak. The biggest
subsector, meat processing, has limited export
opportunities because due dates are short. Weak
domestic demand in coming years will continue to
undermine the growth of this industry. Another
important subsector (also for exporting), dairy
80 -20
60 -40
40 -60
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
Industrial output, wood products (2007=100)
Capacity utilization, wood products (%)
Exports, wood products & furniture (2007=100, nsa)
Confidence, wood products (pts, rs)
Source: CSBL, DG ECFIN
grown somewhat and have by now stabilized at
historically average levels; further significant growth
is not expected. This, together with substantially
lower labour costs, explains the success of wood
manufacturers so far. The growth has been
generated through exports, which account for about

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

No. 3 • July 2010

75% of the industry turnover. As a result, the

Latvian wood industry has been growing faster than Manufacturing output of metals,
other countries’. 2007=100 (3M average)
120

Wood manufacturing output, 2007=100 100

(3M average)
120 80

110 60
100
40
90
80 20
70 Jan.07 Jan.08 Jan.09 Jan.10
Denmark EA Estonia
60 Latvia Lithuania Poland
Sweden United Kingdom
50 Source: Eurosta t

Jan.07 Jan.08 Jan.09 Jan.10
Denmark EA Estonia
Latvia Lithuania Poland
Sweden United Kingdom Source: Eurostat
Going forward, however, wood manufacturing
growth is expected to slow due to capacity
constraints – average capacity utilisation is already
close to pre-crisis levels. Logging volumes grew
somewhat in 2009, albeit remaining at historically
average levels. Current annual logging volumes are
considered to be optimal (i.e., sustainable in the
long term), and there thus seems to be no large
potential for such capacity increase. Of course,
round wood imports could provide some additional
capacity. On the other hand, there is still great
potential to increase value added in the industry –
for instance, value added per cubic meter in the
wood industry is several times lower than in, e.g.,
Germany. Also, there are opportunities to integrate
the wood and energy sectors. It should be taken
into account, however, that several key exporters
invested substantially in modernisation of
equipment a few years ago and, although now
operating at high capacity, still need to deleverage
before getting involved in further large investment
projects.
Latvian metal industry highly influenced by
global developments
The metal industry is very dependent on global
price developments (particularly for base metals).
Thus, when global metal prices plunged in the 2nd
half of 2008, so did Latvian exports. The fall in
manufactured volumes was less sharp, but the
recovery has been very slow (exports are about
70% of the turnover). The overall recovery path is in
line with the dynamics in other countries.
Although the overall capacity utilisation level seems
to be quite low (especially in metal-processing
companies), leading exporting companies are
already operating at near-full capacity and thus
cannot easily increase production volumes. At the
same time, global metal prices have grown and are
expected to remain favourable for Latvian
exporters.
Metal products manufacturing, sa
160 60
140 40
120 20
100 0
80 -20
60 -40
40 -60
20 -80
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
Industrial output, metal products (2007=100)
Capacity utilization, metal products (%)
Exports, metals (2007=100, nsa)
Confidence, metal products (pts, rs)
Source: CSBL, DG ECFIN
The future growth of the industry will depend on the
success of the companies in acquiring new orders
abroad, as well as on them solving their financial
problems. For instance, the performance of the
metal-processing companies varies a lot – there are
many success stories of companies that managed
to obtain export orders and improved their financial
situation rapidly, but there are also many that are
nearly bankrupt (e.g., many of those that were
producing spare parts for local construction
companies). An additional risk is the high
concentration of the base metals industry
(dominated by one company).

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Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 3 • July 2010

Base metals manufacturing, sa

However, for further growth, investments in capacity
expansion are important. For instance, the capacity
160 60
utilisation of producers in computers and electronics
140 40 is already a notch higher than in 2007, and in
chemicals it is already very close to the pre-crisis
120 20
level.
100 0
Computers and electronics
80 -20 manufacturing, sa
140 40
60 -40
120 20
40 -60
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10 100 0
Industrial output, base metals (2007=100)
Capacity utilization, base metals (%) 80 -20
Exports, metals (2007=100, nsa)
Confidence, base metals (pts, rs) 60 -40
Source: CSBL, DG ECFIN
40 -60
Better growth opportunities for smaller- 1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
Industrial output, computers & electronics (2007=100)
niche sectors with higher value added Capacity utilization, computers and electronics (%)
Exports, machinery and equipment (2007=100, nsa)
Industries with higher-value-added products – e.g., Confidence, computers and electronics (pts, rs)
Source: CSBL, DG ECFIN
chemicals and pharmaceuticals, various machinery
and equipment – have a more favourable outlook.
Electrical devices manufacturing, sa
These are very export-oriented sectors – in
chemicals and pharmaceuticals, exports account for 140 40
about 80% of the total turnover, and in machinery
and equipment, on average about 85% (in 120 20
computers and electronics, as much as 90%). The
100 0
chemicals industry even managed to avoid a fall in
production volumes in 2009, while the 80 -20
pharmaceuticals, computers and electronics
industries experienced one of the smallest declines. 60 -40

Chemicals and pharmaceuticals 40 -60

manufacturing, sa 1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
140 40 Industrial output, electrical devices (2007=100)
Capacity utilization, electrical devices (%)
120 20 Exports, machinery and equipment (2007=100, nsa)
Confidence, electrical devices (pts, rs)
100 0 Source: CSBL, DG ECFIN

80 -20
60 -40 Other machinery and equipment
manufacturing, sa
40 -60 140 40
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
Industrial output, chemicals (2007=100) 120 20
Industrial output, pharmaceuticals (2007=100)
Capacity utilization, chemicals (%) 100 0
Exports, chemicals&pharmaceuticals (2007=100, nsa)
Confidence, chemicals (pts, rs) 80 -20
Source: CSBL, DG EC FI N

Consequently, while before the crisis the 60 -40

manufacturing turnover of computers and
40
electronics was the smallest among machinery and
1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10
equipment sub-industries, the fall in electrical
devices and other machinery and equipment was
so big that these three now have a nearly equal
turnover.
-60
Industrial output, other machinery&equipm. (2007=100)
Capacity utilization, other machinery&equipment (%)
Exports, machinery and equipment (2007=100, nsa)
Confidence, other machinery&equipm. (pts, rs)
Source: CSBL, DG ECFIN

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

No. 3 • July 2010

To boost exports, new investments are Business environment must be improved to

necessary
Latvia is not the only country that intends to revive
its economy through export growth. So do the other
Baltic countries, as well as the Nordic and Eastern
European countries. This means that competition in
the region is increasing. And the anticipated
slowdown of growth in Europe, along with the
withdrawal of stimuli, will only exacerbate this
competition. So far, Latvian export market shares in
main trading partners’ imports have been rising
owing to improving competitiveness (mostly due to
sharp labour cost cuts), but the adjustment needs to
continue; otherwise, gained advantages may easily
be wasted. From a long-term sustainability
perspective, diversification of the manufacturing
structure and product mix, as well as of the
destination countries for exports, is beneficial for
Latvian industry. This would reduce the dominance
of the wood and food industries and improve the
export outlook.
attract investors
To make investments attractive, improvements in
the investment environment are crucial. These
involve entrepreneurial environment (e.g., easing
bankruptcy procedures and lowering administrative
barriers), tax policy (e.g. rebalancing the tax burden
and providing a clear plan for the future changes),
higher education, innovation climate, etc.1 Very
important is enhancing financing availability –
improving the country’s sovereign risk ratings to
lower interest rates, as well as strengthening the
financial sector via diversification of financial
markets (e.g., access to equity capital).
Implementation of these structural reforms is a vital
condition for Latvia’s exports to grow faster than
those of their competitors. This would raise
potential GDP growth and speed up convergence
with advanced EU countries, as well as raise the
purchasing power of Latvia’s inhabitants.

Manufacturing growth in the coming years can be

achieved either through an increase in capacity for
the existing product mix (as successful exporters
are already facing capacity constraints or will soon Lija Strašuna
do so) or a shift to higher-value-added products
(including an expansion of capacity for new
products, more advanced use of existing
equipment, etc.). Capacity utilisation will increase
somewhat when currently unused facilities that are
stuck between owners (i.e., undergoing insolvency
procedures) are put back to use, but this effect will
be short term. In addition, further capacity
expansion in some of the industries with the current
product mix (e.g., wood) is not really possible due
to limited local resources; thus, a natural choice in
these industries is to shift to higher-value-added
products. This calls for more investments.

1
For regional comparison of Latvian competitiveness, see
http://www.swedbank.lv/docs/materiali.php?nmid=0&naid=7

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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