Published: 18.10.2011 Updated: 17.05.2022

While many sectors might see a strengthening of their activity as a result of the easing of the Covid-19 containment measures, the impact of the pandemic on the economic growth has been largely overshadowed by the escalation of the geopolitical situation, i.e. Russia's invasion of Ukraine. 24 February 2022 has changed the perception of the economic environment: in conditions of high uncertainty, GDP growth is estimated to moderate due to the cutting of economic ties with Russia and Belarus, lower availability of global resources and rising prices. This exerts an upward pressure on inflation – inflation is expected to reach higher levels and persist.

GDP forecasts 2022 march

The GDP growth forecast for 2022 has been revised downwards to 1.8%. The negative economic impact of the escalation of the geopolitical situation will manifest itself mainly through the following channels:

  • falling exports to the aggressor countries;
  • supply chain disruptions and seeking for alternative solutions,
  • rising global prices and
  • deteriorating confidence and growing uncertainty in the region.
    • The shifting away from the economic cooperation with Russia and Belarus will weigh on foreign trade flows already in the coming quarters due to direct trade sanctions, settlement problems as well as suspension of the cooperation that is not affected by sanctions.
    • The restructuring of supplies of imported commodities and components received from the countries engaged in the war through finding alternative suppliers will force some businesses to scale down production and will translate into higher prices.
    • As a result of the war, the previously rising global energy prices will stabilise at high levels. Along with substantial increases in energy and commodity prices, the terms of trade are expected to deteriorate, which can be offset by the projected pick-up in the prices of wood and grain – two products that are important for exports. The higher prices weighing on the purchasing power of households will also dampen the recovery of real private consumption.
    • More pessimistic sentiment, heightened uncertainty and higher costs are expected to lead to a strong and negative impact.on investment flows. The change in sentiment will also contribute to reduced consumption.

The forecast for 2023 has also been revised downwards to 3.2%, and this is determined by the time span required for the restructuring of energy and commodity supply chains, as well as for the rearrangement of export markets. Growth is expected to accelerate (to 4.1%) in 2024, spurred by the improving sentiment of economic agents, the rebound in consumption and private investment.

Although the GDP forecast may be affected by both the growth enhancing and growth restricting factors, the risks to the economic growth forecast are overall tilted to the downside.

Upside risks to growth:

  • the demand in several manufacturing sectors might be higher than in the forecasts to find substitutes for the goods from Russia, Belarus and Ukraine that are currently not available in Latvia and the Western markets, e.g. in the textile industry, the manufacture of wood and articles of wood and food products;
  • in the short term, the flow of refugees from Ukraine may support the demand in the apartment rental market in Riga. The involvement of Latvia's population in supporting refugees may also boost consumption;
  • in the long run, after the end of the war, external demand may grow faster than previously estimated, owing to the rising demand, particularly to support the reconstruction of the infrastructure and buildings in Ukraine.

Downside risks to growth:

  • slower growth might be related to more significant supply chain disruptions that may arise if alternative ways of substituting some imported commodities and components are not find in a timely manner, which in turn may push several businesses to cease their activity or even force some industries such as construction, metalworking, mechanical engineering, manufacture of electrical and electronic equipment to scale back;
  • it is hard to assess the impact of precautionary considerations of consumers and investors, and it may be more significant than estimated; the impact of the price surge on investment decisions may be more negative than expected, prompting postponement of projects and – in the area of private consumption – major purchases;
  • a further escalation of the geopolitical crisis may amplify all the above mentioned negative shocks, thus postponing the economic recovery.

Inflation forecasts March 2022

Inflation growth is expected to continue in the coming months. Moreover, the rise will be steeper than previously projected on the back of the surge in global food and energy prices triggered by the Ukraine-Russia war. The impact is expected to be most pronounced in the first half of 2022. Annual inflation is likely to exceed 10% during the second quarter.

The inflation forecasts for 2022 and 2023 have been revised upwards to 9.5% and 3.7% respectively, while the inflation forecast for 2024 has remained unchanged (2.1%). The upward revision to the forecast is primarily driven by the strong increase in energy prices in early 2022 and after the outbreak of the war in Ukraine when they gained momentum. Due to rising global resource prices, the estimate of the increase in food prices has also been raised, while the estimate of the rise in the prices of industrial goods has also been increased due to supply chain bottlenecks and soaring energy prices.

The energy market is currently surrounded by considerable uncertainty, and there are sharp movements in oil and gas prices, posing upward risks to the inflation forecast. As the prices of these resources are an important component of headline inflation, uncertainty surrounding the range of inflation growth is also rising; therefore, an additional analysis of the forecast scenarios was carried out (for the analysis of scenarios, see Section 7.2 in Macroeconomic Developments Report)

Macroeconomic indicators