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1. 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…
After two years of falling economic activity,
seasonally adjusted GDP increased by 0.3% qoq in
the 1st
quarter of 2010. With recession being over, it
seems that the unemployment rate has reached its
peak. Registered unemployment rate started to
decrease in the first weeks of April, falling to about
16.7% by the end of the month (about 190,000
unemployed). In addition, the number of newly
registered unemployed continues to diminish – from
about 21,800 persons per month in the autumn of
2009, it is down to 16,300 in March 2010 (in 2004-
2007 it was on average 8,000 per month).
According to the State Employment Agency, the
number of job vacancies is also increasing for the
fourth consecutive month, albeit very slowly and
from very low levels (2111 positions for the end of
April).
Unemployment rate, %
0
5
10
15
20
25
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
0
5
10
15
20
25
Newly registered unemployed, thsd people (rs)
Registered unemployment rate
Job-seekers' rate, nsa
Source: State Employment Agency, Eurostat
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

2. Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 1 • 13 May 2010
2 (4)
in such exporting sectors as wood, chemicals,
machinery and equipment, and base metal
industries, as well as in travel, tourism, computers,
and research and development-related activities.
Business confidence, employment
expectations
-80
-40
0
40
80
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
Retail trade Manufacturing
Services
Source: DG ECFIN
Unemployment
-40
0
40
80
120
160
200
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
-20
0
20
40
60
80
100
Unemployment expectations over next 12M (rs)
Registered unemployment, thsd people
Source: State Employment Agency, DG ECFIN
Job-seekers’ data for the 1st quarter of 2010 will be
available in late May, but currently it seems that our
earlier forecast of this rate peaking at about 23% in
the spring of 2010 holds. We will see the turning
point in job-seekers’ rate only in August, when
Labour Force Survey results for the 2nd
quarter will
be published. However, the dynamics of this rate
will most likely be similar to registered unemploy-
ment dynamics (although the latter might decrease
faster due to weaker motivation to register when
unemployment benefits end). Even with a possibility
of unemployment rate to increase again in autumn
due to seasonal factors, unless recovery in the euro
zone is substantially slower than expected due to
Greece problems, the unemployment rate reached
this spring will still be the maximum.
… but the labour market will remain weak in
the upcoming years
Overall, there is some stabilisation in the labour
market, but, as historical experience shows, the
unemployment rate will be high for years to come.1
With low employment, no wage growth, and conti-
nuing fiscal consolidation, there is still little hope of
the revival of consumer spending needed to sustain
a meaningful recovery.
We see that job creation is and will be slow, as
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
many as the exporting sectors currently employ.2
With private consumption and investment starting to
recover in 2011, job creation will pick up somewhat,
but it is clear that part of the current unemployment
is a long-term one, as domestic demand sectors will
not need as many employees as in the boom
years. This situation is encouraging people to
emigrate, leading to structural problems in the long
term by diminishing the size and quality of the
labour force.
To lessen the negative consequences of long-term
unemployment, job creation should be supported.
One of the ways to do this is by changing tax policy.
For instance, targeted and temporary tax dedu-
ctions might be considered to encourage first
employment among younger people and long-term
unemployed.
3
This initiative should be included
already in the 2011 budget.
Is the deflation story dead?
Monthly consumer price inflation in the 1st quarter
of 2010 was caused by more expensive imported
goods and seasonal increases in food prices. At the
same time, prices of local goods and services
continued to decline. While the total consumer price
index (CPI) fell by just 0.2% qoq, core CPI (i.e.,
excluding fuel, nonprocessed food, and admi-
nistratively regulated prices) declined by 1.4% qoq
in the 1st quarter of 2010. Monthly increases in
producer prices at the beginning of the year were
mostly driven by more expensive exported
production. On a quarter-on-quarter basis, the
1
See, e.g., IMF, World Economic Outlook (April 2010),
“Chapter 3, Unemployment dynamics during recessions and
recoveries: Okun’s law and beyond”.
2
Swedbank estimations. For instance, there are about 130,000
employed in manufacturing, which is about 14% of total
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).

3. Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 1 • 13 May 2010
3 (4)
producer price index (PPI) of production realised in
the local market declined by 0.2%, while that of
exported production rose by 3.2% in the 1st quarter
of 2010.
Core inflation and total CPI, yoy, %
-10
-5
0
5
10
15
20
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
-2
-1
0
1
2
3
4
Core inflation, mom Total inflation, mom
Core inflation, yoy Total inflation, yoy
Source: CSBL, LaB
Overall, it can be seen that upward price pressure
is coming from abroad, due to recovering demand
and rising commodity prices in the world. In
addition, the weakening euro exchange rate against
US dollar is beneficial for Latvian exporters (outside
the euro zone), although it makes imported energy
resources more expensive.
Producer price inflation, yoy
-20
-15
-10
-5
0
5
10
15
20
25
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
Total Local market Exported
Source: CSBL
Although global price growth is expected to slow in
the 2nd half of the year due to a gradual fiscal
tightening, stronger-than-expected price pressures
from abroad might shorten the envisaged deflation
period in Latvia. Nevertheless, local deflationary
pressure will still be present, as the labour market
will be weak and deleveraging will proceed. This
pressure, together with low global inflation, implies
that, even if inflation in Latvia resumes, it will be
subtle (excluding the effect of tax changes). Tax
changes might influence price developments
substantially, though (especially direct taxes, such
as VAT or excise). Therefore, when planning tax
changes, the authorities should consider not only
the fiscal effect and the effect on incomes but also
the influence on prices. Timing is particularly
important, taking into account the euro adoption
target in 2014.
Although low inflation might make the further
process of competitiveness adjustment slower than
it would be in the deflation case, it would somewhat
ease the deleveraging process, as well as increase
budget revenues (e.g., tax revenues would rise due
to growing turnover) and diminish the budget deficit.
CPI growth (yoy), %
-5
0
5
10
15
20
Jan.08 Jul.08 Jan.09 Jul.09 Jan.10
Eurozone SE UK
RU EE LT
LV Source: Reuters
Competitiveness still improving
It should be emphasized that deflation is not a
necessary condition for improving competitiveness.
What matters is Latvia’s development relative to its
trading partners. In the 1st quarter of 2010,
competitiveness continued to improve due to a
bigger price growth in trading partner countries, as
well as to favourable exchange rate developments.
For instance, the CPI-based real effective exchange
rate (REER) of the lats has already declined by 9%
from its peak in February 2009 – an amount that is
nearly 1/3 of its appreciation since 2006. A similar
trend can also be observed in the PPI-based REER.
So far, the competitiveness adjustment has been
achieved through labour cost cuts, which cannot be
continued forever, while productivity improvement
has been weak.
4
Unit labour costs were also
reduced in the 1st quarter of 2010 – unemployment
4
For more details see our recent Swedbank Analysis „Competitiveness
adjustment in Latvia – no pain, no gain?”, available at
http://www.swedbank.lv/eng/docs/materiali.php?nmid=0&naid
=3

4. Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 1 • 13 May 2010
4 (4)
rose, and, according to our forecast, wage cuts
continued. However, it seems that most of the
potential to improve competitiveness through labour
cost cuts and weak labour market driven deflation
has been used by now. At the same time, with the
labour market remaining weak, there are no strong
inflationary pressures. Further adjustment through
the labour market would be extremely painful,
squeezing domestic demand further and
undermining the recovery. The competitiveness
adjustment is not yet over, but, in our opinion,
further gains should be obtained via productivity-
enhancing structural reforms.
Effective exchange rates of the lats,
2005=100
90
100
110
120
130
140
Jan.06 Jan.07 Jan.08 Jan.09 Jan.10
NEER REER_CPI REER_PPI
Source: Bank of Latvia
Risks to future growth
Unless labour cost cuts are replaced by structural
reforms, there is a risk of very low medium-term
growth. In our opinion, the risk of stagflation (i.e.,
high inflation and no growth) is very small, but the
scenario of low inflation together with low economic
growth is more likely. In case of low global inflation,
this would make the process of improving
competitiveness slower and longer than it could be
with local deflation, and export-driven growth would
also decelerate. For this scenario not to come true,
productivity gains by increasing production volumes
are necessary, supported by activities from the
government side to improve the business
environment, tax system, education system, etc.
Lija Strašuna
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
Legally responsible publisher
Cecilia Hermansson, +46 88 5859 1588
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
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