The Second COVID-19 Wave Has Led to Lower 2021 Growth Predictions

COVID-19’s swift spread since the autumn has caused many countries in Europe and worldwide to reintroduce stricter physical distancing restrictions and stop the services offered by several industries. However, the good news is that the impact of the second COVID-19 wave on the economy has thus far been smaller than in spring 2020. Manufacturers worldwide now have a positive outlook, the decline in GDP has reduced significantly, unemployment levels are down and world trade has returned to its previous levels. However, recovery for the world economy has been uneven and incomplete. At the moment, limited vaccine availability and doubts surrounding the more contagious mutation of the COVID-19 virus mean that some limitations on the economy may be necessary at least until the spring months, meaning that economic recovery in 2021 will be slower than previously anticipated. This has led us to reduce forecasts for Latvia’s economic growth from 3.6% to 2.5%. At the same time, we still see a lot of optimism in the financial markets. Significant budget deficits and monetary stimulus measures will continue to support the economy in 2021, while increasing access to the vaccine gives us cause to hope for a strong economic recovery in the second half of the year, particularly in the service sector. However, there are many risks. The current vaccination pace is too slow, long-term restrictions are a big financial burden for businesses, creating worries over an increase in insolvency, and more signs are pointing to a potential increase in inflation. The spread of new, more infectious COVID-19 mutations in the UK, Ireland and South Africa also bring additional risks.

Like the world as a whole, the economic recovery of the Baltic states in the second half of 2020 was unexpectedly fast, but incomplete. The decline in economic activity in the Baltics in 2020 will be significantly less than in many other European and world countries. The Eurozone’s GDP fell by 4.4% in the third quarter of this year compared with the previous year. Meanwhile, Latvia’s GDP in the second quarter fell by 2.6%, Estonia’s fell by 1.9%, and Lithuania’s grew by 0.1%. However, the situation differs greatly in different sectors of the economy. If manufacturing and trade levels had returned to their previous level by the third quarter of 2020, the situation in the service sector is very serious, and was worsened by the new restrictions. Studies show that other coronaviruses peak in January or February. It would also seem that COVID-19 is seasonal, and the increase in cases in the Baltics in autumn 2020 was directly linked to a cooler air temperature. This leads us to believe that infections will decrease in the spring, although some restrictions will be necessary until April or May. The good news is that the service sector recovers quickly as soon as the epidemiological situation allows, which allows us to hope for a positive second half of 2021, but this will be largely dependent on the ability of the government to provide enough vaccines in the first half of the year.

The second wave of COVID-19 and restrictive physical distancing measures will probably trigger another downturn in economic activity in the Baltics during the end of 2020 and the start of 2021, but this will be less significant than in the spring of 2020. The outlook of Baltic business owners in November and December got slightly worse, but it is significantly better than in the spring. Unlike the first wave, the mood worsened only for the service and retail industries directly impacted by the new restrictions, while the outlook for construction and manufacturing business owners has not changed significantly. Evidence of the stability of the manufacturing sector is stable electricity consumption in December and January. In addition, as confirmed by our customers’ credit card turnover, spending has in general remained stable. Limited availability of services has contributed to an increase in goods segments. Of course, retail restrictions negatively impacted spending in the final weeks of December, but the week before restrictions came into force saw a large increase in spending, and total spending in December, compared with previous months, did not change significantly. Under the influence of these restrictions, 2021 started poorly, but business owners have found ways to adapt, and credit card turnover in the first weeks of January was higher than in March and April 2020.

Inflation in the Baltics is currently close to 0%, as economic activity has decreased significantly due to measures limiting the spread of COVID-19, but inflation will probably increase in 2021. Although there is still a global economic crisis and the increased level of unemployment is slowing wage and price increases, the price of resources worldwide is increasing. For example, since spring 2020, food prices worldwide have increased by 20%, oil prices have increased by 40%, and some metals by more than 50%. In the first half of 2021, we will feel the effects of this in Latvian consumer prices, although the falling US dollar has offset the increased price of resources for inflation within the Eurozone. At the same time, in the second half of the year, inflation will be increased during the anticipated recovery cycle of the world economy, as long as the pace of vaccination is increased and the COVID-19 pandemic has been beaten by the autumn.

The short-term cyclical growth in inflation after the downturn of the economy and resources in 2020 is currently logical, and a temporary growth in inflation was also seen after the 2008-2009 financial crisis. However, the issue is whether this will be followed by a more long-term increase in inflation, or whether the global economy will continue its normal low period of inflation. The largest factor in favour of higher inflation is certainly the more extensive monetary and fiscal stimulus measures which continue. As a result of this, US money supply (M3) grew last year by around 25%, which is the fastest increase since the Second World War, while money supply in the Eurozone grew by around 10%, which is the fastest increase since 2008. Inflation of consumer prices are currently unaffected, because the speed of cash circulation has slowed down, meaning that the money is stored in the financial system. The amount deposited by Latvian households last year increased by 12%, which is the fastest deposit rate since the introduction of the Euro. It is not difficult to imagine a situation in which this money flows into the real economy after COVID-19 restrictions are lifted, particularly if consumer worries over inflation continue to increase in parallel. At the same time, of course, we cannot forget that, even after the record-low interest rates of the 2008-2009 economic crisis, the purchase of financial assets by central banks and significant fiscal deficits created worries over inflation which did not come to pass. Furthermore, structural factors impacting inflation, such as aging Western societies and a low birth rate, as well as the globalisation of the manufacturing system, have not changed due to the COVID-19 crisis. This leads to caution when forecasting a swift increase in inflation this time, but inflation will be an issue for macroeconomic policy in the next few years.

Latvian manufacturing and exports at the end of 2020 were successful and, despite the second COVID-19 wave, the autumn months in Latvia saw manufacturing and export records. In November, output for the Latvian manufacturing industry grew by 4.3% compared with November 2019, which is the fastest growth in manufacturing since the first half of 2019. Positive trends in manufacturing can be seen not just in Latvia, but also elsewhere worldwide. COVID-19 restrictions have significantly reduced the availability of services. At the same time, extensive stimulus measures have been able to protect people’s income, which has significantly increased demand for various goods. The outlook index for procurement managers from the world’s leading manufacturers has reached the highest level since 2018, and global trade has returned to pre-Covid levels, with the exception of textiles, metal goods and beverages, while a growth in exports in the autumn was encouraged by a good harvest.

Retail has also become one of the fastest-growing sectors in Latvia, although the second COVID-19 wave forced the government to stop in-person sales of unnecessary goods. Before these regulations, retail in the Baltics had returned to its pre-pandemic levels, and retail grew by 1.4% in November in Latvia compared with November 2019. However, retail in Latvia is behind the other Baltic states, which may be partly due to less generous support measures and unemployment benefits. At the same time, we see from our customers’ payment card data that consumption patterns have changed significantly, and spending on services has decreased significantly. This pivot from goods to services is evident both in Latvia and in other countries in Europe and worldwide. Currently, retail is being impacted negatively by in-person sales bans, but businesses have significantly increased remote shopping, and total consumer spending is above spring 2020 levels.

The largest downturns in the economy right now are in the service industries. For example, downturns for transport, hotels and restaurants, and entertainment were between 15-25% in the 3rd quarter of 2020 compared with 2019. At the end of the year, service segments saw reintroduced restrictions, and the decline in these industries became even faster. According to our customers’ credit card turnover, spending on services in Latvia has dropped by 50% since the summer. The good news, of course, is that these industries recover quickly as soon as the epidemiological situation allows, but a full recovery for tourism, catering, entertainment and transport services will take time and will only be possible alongside the vaccine. At the same time, service industries have large potential for postponed demand, and I believe that, in the second half of 2021, these industries will recover very quickly if governments are able to increase vaccination numbers and are able to support the survival of the service industry until then.

The COVID-19 pandemic has not significantly impacted the construction industry, and construction levels in 2020 remained at 2019 levels. Of course, a decline in economic activity and uncertainty over economic development perspectives over the next few years have negatively impacted the investment plans of various sectors and businesses. We can see this in the relatively low, cautious number of loan requests. However, governments are continuing to stimulate the economy, for example, the Latvian government has given an additional 100 million Euro to the road construction sector for 2021, and the real estate market was very active at the end of the year. In December, the number of property transactions grew by 20% compared with December 2019. The second wave has also not seriously affected the construction industry, and pre-emptive indicators lead me to believe that construction in 2021 will remain at 2020 levels. Meanwhile, 2022 could be extremely good for construction, as significant EU regeneration funds and Rail Baltica investments will flow into the economy, which may even bring a risk of overheating if it coincides with the growth cycle for private sector demand.

The increase in unemployment in the Baltics in 2020 was smaller than expected, reaching 7.7% in Estonia, 8.4% in Latvia and 9.3% in Lithuania for the third quarter of the year. Due to the impact of the second COVID-19 wave, unemployment in the Baltics has increased again, although to a much smaller extent than in the spring, and the number of furlough funding recipients in November and December was almost half as many as in the spring. The reduction in the number of job postings has also been less extreme than in the spring. At the same time, wages in the Baltics in 2020 continued to increase. According to official statistics, the average wage in Latvia in the third quarter of 2020 was 5.9% higher than in 2019, while wage increases in Estonia and Lithuania were 3.2% and 10.4% respectively. However, growth in actual income will be lower than the average wage would suggest, as employment and number of hours worked has gone down. For example, our Latvian private customers’ income in December was 2.9% more than in December 2019.

Despite the downturn in the economy brought about by COVID-19 and the increase in unemployment, household deposits in the Baltics in 2020 increased by 12-14%, while business deposits in Lithuania increased by 36%. In Latvia, household deposits grew by around 900 million Euro in 2020, while bank credit portfolios shrank in Lithuania and Latvia. This leads us to believe that the Baltics are currently holding a large amount of inactive money which could flow into spending and investments, particularly if the adoption of the vaccine is successful and expected inflation starts to increase. Savings forced to be made during the crisis are one factor which could promote a fast recovery of the consumer service sector in the second half of 2020.

According to my predictions, the fall in GDP in the last quarter of 2020 and the first quarter of 2021 will be significantly lower than in the spring of 2020, however, it is now clear that some restrictions in the fight against COVID-19 will be necessary until the spring. I believe that the first half of 2021 will differ significantly from the second half, but for 2021 as a whole, according to my predictions, GDP growth in the Baltics states will be somewhere around 2.5%. Meanwhile, unemployment in Latvia at the start of 2021 may reach 9%, although in 2021 as a whole it may stand around 7.5 or 8%.  I have some worries that 2020 growth speeds also decreased in sectors not directly impacted by COVID-19, such as IT services. The biggest risk to my predictions are problems with implementing the vaccines and their effectiveness against new mutations, which would result in further restrictions being introduced next winter. And, apart from COVID-19, there are of course other risks that could impact economic recovery in the second half of 2021, such as unfounded optimism in the financial markets, particularly if increased inflation cast doubt on the sustainability of monetary stimulus policies, the geopolitical situation and further trade conflict escalations, as well as the debt level of countries and businesses after the crisis. However, 2022 might be very good, as significant EU investments will flow into the economy, and GDP growth in the Baltics may reach more than 5%.