Download Baltic Macro Outlook 2016 Q3

Baltic macro outlook – Q3 2016
Rokas Grajauskas
Chief Baltic Economist
Danske Bank A/S Lithuania branch
[email protected]
+370 674 03350
2016-09-30
Investment Research – General Market Conditions
www.danskebank.com/CI
Important disclosures and certifications are contained from page 31 of this presentation
Key messages

All three Baltic economies have been growing at a modest pace in 2016. Lithuania maintained
the highest growth rate (+2.2%) compared to 1.1% in Estonia and 2.1% in Latvia.

Supported by rising wages and growing employment, private consumption remains the key
driver of growth, although exports have also recovered more strongly in all three economies
compared to weak 2015.

Due to lower disbursement of EU funds from the 2014-2020 financial perspective, fixed
investment has taken a hit in all three economies, although in Q2 2016 investment in Estonia
expanded for the first time since mid-2014. Investment is not expected to recover more
strongly before 2017.

Falling investment is reflected in the negative performance of the construction sector, most
notably civil engineering. The transport sector is still trying to recover from loses incurred in
the Russian market, although the Lithuanian transport sector is already growing.

Rising labour costs are eroding corporate profits. The share of profits to added value is now at
record low levels in all three economies.

Despite slow growth, employment continues to expand, thus pushing down unemployment.
Estonia is a relative exception as stronger growth in the labour force compared to employment
has kept unemployment at a higher level in 2016 compared to 2015.
2
Modest GDP growth in 2016

Lithuania maintained the highest GDP growth among the Baltics in H1 2016, growing at 2.2% compared with
1.1% in Estonia and 2.1% in Latvia.

Growth is expected to remain lacklustre throughout 2016. Estonia is set to grow at 1.5%, Latvia at 1.8% and
Lithuania at 2.5%.

In 2017 growth should reach 2.1% in Estonia, 2.7% in Latvia and 2.8% in Lithuania.
Source: Macrobond, Danske Bank Markets estimates
3
Economic sentiment has improved since the Brexit vote

Economic sentiment has improved in all three economies since the Brexit vote in June and is also higher on a
year-on-year basis.

This indicates that the effect of the Brexit on domestic demand will be limited. The key potential effect is from
lower economic growth in main European markets. However, there still needs to be more evidence that economic
growth will be slower in Europe due to Brexit.
Source: European Commission, Macrobond
4
Estonia – balancing out

After negative export growth in 2015, export in H1 2016 was the key driver behind economic growth (+2.2%
y/y).

Growing wages and increasing employment also increased consumption (+3.4%).

After seven consecutive quarters of contraction, investment in Q2 2016 has finally picked up, allowing for
investment growth to be positive in H1 2016 (+2.1% y/y). Investment should continue growing in the second half
of 2016 and into 2017 and will be facilitated be a more rapid disbursement of EU funds from the new 20142020 financial perspective.
Source: Macrobond, Danske Bank Markets estimates
5
Investment taking a deep dip in Latvia

Investment has taken a deep dip this year in Latvia (-21% y/y) largely driven by lower disbursement of EU funds
from the 2014-2020 financial perspective. This brought investment-to-GDP ratio down to just above 16% – the
lowest level since 1997. As EU funding picks in 2017, investment should bounce back to higher levels. We
therefore expect investment growth to be more pronounced (+7.1%) in 2017.

In H1 2016 consumption remained the key driver of growth (+3.6% y/y).

Export of goods and services in H1 2016 expanded by 1.6% y/y.
Source: Macrobond, Danske Bank Markets estimates
6
Falling investment pushes down economic growth in Lithuania

After robust growth in investment in 2015, Lithuania did not manage to avoid a contraction in investment in H1
2016 for the same reason as in Latvia – lower disbursement of EU funds from the 2014-2020 financial
perspective. Capacity utilisation is at record high levels, thus demand for investment remains strong. Investment
should pick up speed in 2017 as EU money reaches the planned investment projects.

As wage growth accelerates and employment continues growing, consumption is expanding at strong pace
(+5.4% y/y in H1 2016).

Exports in H1 2016 also grew by 5.4%. Growth was particularly robust in Q1 2016 (+9.3% y/y) but slowed down
in Q2 2016 to 1.5% y/y.
Source: Macrobond, Danske Bank Markets estimates
7
Investment still most robust in Estonia

Despite the recent setback, Estonia still maintains the highest rate of investment among the Baltics.

One of the key factors keeping investment rate consistently higher in Estonia is the policy of applying 0% tax on
reinvested profits.
Source: Macrobond, Danske Bank Markets estimates
8
Factors behind GDP change in the first half of 2016
Contribution to GDP change in H1 2016 (EURm, constant prices)
Estonia
Latvia
Lithuania
1500
1000
648
500
0
609
58
165
43
151
256
-107
-426
-418
-511
-500
-373
-1000
Consumption
Investment
Exports
Imports
Source: National statistical offices, Danske Bank Markets
9
Recovery of Estonian exports after the decline in 2015

Estonian exports of goods and services grew by 2.2% in H1 2016. Exports of goods expanded by 1.9% while
exports of services grew by 2.8%.

Nordic markets led the way in growth. Other markets where exports expanded were Mexico, Saudi Arabia,
Nigeria. Key categories to have grown were machinery, furniture, electrical equipment. After a very sluggish start
of the year, sales of Ericsson Eesti recovered in Q2 2016. Overall, exports of products produced by the company
declined by just more than 1% y/y in H1 2016.
Change in Estonian exports of goods in Jan-Jul 2016
(y/y, EURm)
90
78
80
70
60
50
37
40
30
20
18
13
15
Other CIS
US
10
0
-10
Baltics
Nordics
Other EU
-5
Russia
Others
-8
-20
Source: Statistics Estonia, Danske Bank Markets
Note: Export of oil products not included
10
Export growth in Latvia maintained by services

Latvian exports of goods and services in H1 2016 expanded by 1.6% y/y. While exports of services increased by
4.1%, exports of goods declined by 1.4%.

The key category which led the decline in the export of goods was mobile phones (down 36% or EUR152m y/y).
Categories that grew were pharmaceutical products, grain and transport equipment.
Change in Latvian exports of goods in Jan-Jul 2016
(y/y, EURm)
80
58
60
37
40
20
16
0
Baltics
Nordics
Other EU
Russia
-20
Other CIS
-10
US
-8
Others
-40
-60
-68
-80
-100
-102
-120
Source: Statistics Latvia, Danske Bank Markets
Note: Export of oil products not included
11
Strong export performance in Lithuania in H1 2016

Despite slowing down in Q2 compared to Q1 2016, Lithuanian exports of goods and services in the first half of
2016 expanded by 5.4% y/y. Export of goods grew by 4.3% while export of services, driven primarily by transport
services, construction and business services, by 9.3%.

As for goods, the biggest decline was recorded for exports to Russia and other CIS countries (mainly re-exported
fruits and vegetables). Exports expanded to the Nordics and Other markets, such as Saudi Arabia (dairy products,
grain), Japan (tobacco products) and UAE (grain and furniture). Overall, categories to have expanded most were
grain, pharmaceutical products, optical and electronic products.
Change in Lithuanian exports of goods in Jan-Jul 2016
(y/y, EURm)
300
220
200
116
70
100
59
36
0
Baltics
Nordics
Other EU
Russia
Other CIS
US
Others
-100
-127
-200
-300
-244
Source: Statistics Lithuania, Danske Bank Markets
Note: Export of oil products not included
12
Turnover and profit of Estonian companies continue to decline

The turnover of Estonian companies in H1 2016 expanded by 1.5% while profits shrank by 8.5% y/y.

Key sectors that led growth in turnover were accommodation and ICT. Driven by fast growth in consumption,
retail trade expanded by 4.5% (5.1% in real terms). The energy sector experienced the biggest decline due to
problems in the oil shale sector. Other sectors to have declined were construction and transportation.

Manufacturing grew at a modest 1.2% (in real terms declined by 0.4%), while profit of manufacturing companies
contracted by more than a third. Profit of companies producing electronic products increased by more than 10
times but from a very low base. Profitability of this sector increased to just over 2%.
Estonia - change in profit of companies by
sector in H1 2016 (%, y/y)
Estonia - change in turnover of companies
by sector in H1 2016 (%, y/y)
-20
-10
0
10
20
Accommodation
16.7
ICT
12.0
Retail trade
4.5
Agriculture
3.1
Wholesale trade
1.9
Manufacturing
Transportation
Construction
Energy -15.6
1.2
-4.9
-5.5
-100
-50
0
50
100
9.1 times
ICT
Wholesale trade
86.6
Construction
-7.0
Agriculture
-11.4
Energy
Manufacturing
Transportation
200
149 times
Accommodation
Retail trade
150
-17.9
-27.5
-35.9
-43.0
Source: Statistics Estonia, Danske Bank Markets
13
Estonian manufacturing: profits take a hit
Estonia - change in profit of
manufacturing companies in
H12016 (%, y/y)
Estonia - change in turnover of
manufacturing companies in
H1 2016 (%, y/y)
-10
-5
0
5
10
Textiles
15
13.1
Plastic products
9.7
Wood and paper products
8.5
Beverages
7.7
-150
-50
250
10.7 times
Pharmaceutical products
155.2
Transport equipment
70.8
Furniture
66.3
62.0
6.4
Beverages
Electrical equipment
6.3
Chemical products
Transport equipment
5.5
Plastic products
Furniture
5.0
Electrical equipment
Optical and electronic products
-1.8
Wood and paper products
Food products
-1.9
Metal products
53.7
19.9
8.2
-25.0
-45.1
Metal products
-3.9
Food products
-69.5
Machinery
-4.4
Textiles
-70.3
Machinery
-74.1
-5.1
150
Optical and electronic products
Pharmaceutical products
Chemical products
50
Source: Statistics Estonia, Danske Bank Markets
14
Negative results of Latvian companies persist

The turnover of Latvian companies in H1 2016 decreased by 5.4% y/y, pre-tax profits – by 9.1%.

ICT was the only sector which increased both its turnover (+6.8%) and profit (+23.7%). While nominal turnover
of retail trade companies decreased by 5.9%, in real terms the turnover increased by 2.3%.

Manufacturing turnover in nominal terms declined by 2.8% but in real in terms expanded by 3.3%. The biggest
fall in profit was recorder for food producers, who are still recovering from the impact of the Russian embargo.
Latvia - change in turnover of companies by
sector in H1 2016 (%, y/y)
-40
-30
-20
-10
0
ICT
Latvia - change in profit of companies by
sector in H1 2016 (%, y/y)
10
6.8
Manufacturing
-2.8
Wholesale
-4.2
-100
-60
-20
ICT
23.7
Retail
22.9
Manufacturing
2.8
Accomodation
-5.8
Wholesale
Retail
-5.9
Transportation
-25.1
Transportation
-6.4
Agrictulture
-26.6
Agrictulture
Construction
-9.3
-31.6
20
0.3
Accomodation
Construction
3.5 times
8.2 times
Source: Statistics Latvia, Danske Bank Markets
15
Latvian manufacturing: turnover expands in real terms
Latvia - change in turnover of
manufacturing companies
H1 2016 (%, y/y)
-30
-20
-10
Latvia - change in profit of
manufacturing companies
H1 2016 (%, y/y)
0
10
Pharmaceutical products
20
-100
0
100
200
Textiles
50.7
152.5
Wood and paper products
1.3
Plastic products
Beverages
0.9
Pharmaceutical products
Textiles
0.8
Metal products
72.0
Optical and electronic products
0.3
Chemical products
69.3
Plastic products
0.3
Optical and electronic products
65.6
Metal products
-1.2
113.2
85.3
Wood and paper products
8.4
7.8
Electrical equipment
-4.0
Electrical equipment
Chemical products
-4.2
Machinery
-6.0
-7.3
Food products
-7.1
Beverages
Transport equipment
-8.0
Furniture
-16.9
Furniture
-8.9
Transport equipment
-19.1
Machinery
-19.5
Food products -42.6
Source: Statistics Latvia, Danske Bank Markets
16
Most Lithuanian sectors show signs of growth

The turnover of Lithuanian companies in H1 2016 expanded by 1.1%, while pre-tax profits expanded by 23.6%.
Data from national accounts suggests that corporate profits have been on the decline since 2015. Therefore
unusually high profit figures suggest that more profit has been brought into light from the shadow economy.

Construction and agriculture are the only sectors suffering from both the contraction in sales and profit. Retail
trade turnover in nominal terms expanded by 1.9%, in real terms – by 7.0%.

While in nominal terms manufacturing turnover in H1 2016 declined by 1.3%, in real terms it expanded by 3.0%.
Lithuania - change in profit of companies by
sector in H1 2016 (%, y/y)
Lithuania - change in turnover of
companies by sector in H1 2016 (%, y/y)
-20
-15
-10
-5
0
5
10
Accomodation
15
10.4
-150
0
50
Wholesale trade
4.6
Manufacturing
ICT
4.1
Retail trade
34.6
24.0
Wholesale trade
17.5
-1.1
Transportation
12.9
Manufacturing
-1.3
ICT
12.9
Construction
-4.6
-15.3
Construction
Agriculture
150
63.8
Energy
Agriculture
100
87.0
Energy
4.8
1.9
-50
Accomodation
Transportation
Retail trade
-100
-55.8
2.2 times
Source: Statistics Lithuania, Danske Bank Markets
17
Lithuanian manufacturing: profits expand by more than a third
Lithuania - change in turnover of
manufacturing companies
H1 2016 (%, y/y)
-25
-15
-5
Lithuania - change in profit of
manufacturing companies
H1 2016(%, y/y)
5
15
Machinery
11.5
-100 -50
0
50 100 150 200
Beverages
7.4 times
Beverages
7.7
Plastic products
Plastic products
7.6
Chemical products
30.6
41.7
Transport equipment
5.5
Textiles
27.3
Textiles
4.8
Metal products
24.9
Wood and paper products
4.2
Food products
Metal products
4.1
Transport equipment
12.1
Optical and electronic products
3.4
Optical and electronic products
10.6
Electrical equipment
-3.8
Furniture
Furniture
-5.2
Wood and paper products
Food products
-5.6
Machinery
Chemical products
Pharmaceutical products
-10.3
-13.8
18.3
Electrical equipment
7.7
-14.9
-22.5
-28.5
Pharmaceutical products -43.7
Source: Statistics Lithuania, Danske Bank Markets
18
Wage growth moving higher

A rebound in GDP growth and lower unemployment should maintain considerable pressure on wage growth,
which we expect to remain in the 5-7% range in all three Baltic states in the coming years.
Gross wage growth (%)
35.0
30.0
Latvia
25.0
20.0
15.0
10.0
Estonia
5.0
Lithuania
0.0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015 2016E 2017E 2018E
-5.0
-10.0
Source: National statistical offices, Danske Bank Markets estimates
19
Corporate profits on decline in Estonia

In the context of fast growing labour costs and modest growth in added value, corporate profits are increasingly
being squezzed in all three Baltic economies.

The share of corporate profits in the added value created by Estonian companies is projected to fall to 38% this
year – the lowest since 2009, when corporate profits took a hit due to the financial crisis. The share of net wages,
on the other hand, is projected to reach 36% in 2016.
Break down of added value of Estonian companies (EURbn)
14
12
10
8
6
4
2
0
Corporate profits
Taxes, excl. indirect taxes
Net wages
Source: European Commission, Danske Bank Markets
Note: Profit is gross operating surplus, as calculated in the framework of national accounts (which roughly
corresponds to EBITDA), minus direct taxes. This figure also includes profits accrued in the shadow economy.
20
Similar trend observed in Latvia

Corporate profits have been declining in Latvia since 2013. The share of profits to added value is expected to fall
down to 43% in 2016, while the share of net wages to increase to 31%.
Break down of added value of Latvian companies (EURbn)
18
16
14
12
10
8
6
4
2
0
Corporate profits
Taxes, excl. indirect taxes
Net wages
Source: European Commission, Danske Bank Markets
Note: Profit is gross operating surplus, as calculated in the framework of national accounts (which roughly
corresponds to EBITDA), minus taxes. This figure also includes profits accrued in the shadow economy.
21
Profits most resilient in Lithuania

Despite the recent trend downwards, Lithuanian companies still maintain one of the highest shares of profits to
added value among developed economies (in 2015 only Romania and Ireland had a higher share). In 2016 the
share is projected to fall to 49%, while the share of net wages in added value to increase to 29%.
Break down of added value of Lithuanian companies (EURbn)
30
25
20
15
10
5
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E
Corporate profits
Taxes, excl. indirect taxes
Net wages
Source: European Commission, Danske Bank Markets
Note: Profit is gross operating surplus, as calculated in the framework of national accounts (which roughly corresponds
to EBITDA), minus taxes. This figure also includes profits accrued in the shadow economy.
22
Profits on the decline in all three Baltic states
Profits as a share of gross added value created by companies (%)
65
60
55
Lithuania
50
Latvia
45
Estonia
40
35
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E
Estonia
Latvia
Lithuania
Source: European Commission, Danske Bank Markets
Note: Profit is gross operating surplus, as calculated in the framework of national accounts (which roughly corresponds to
EBITDA), minus taxes. This figure also includes profits accrued in the shadow economy.
23
Inflation to move higher in Estonia

Inflation has so far averaged 0.4% in Estonia in 2016 but is expected to edge higher towards the end of the year
due to a stronger rise in energy prices.

We expect average inflation in Estonia to reach 0.7% in 2016 and 1.9% in 2017.
Inflation rate in Estonia
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
Core inflation
Food
Energy
Headline inflation
2016M11
2016M09
2016M07
2016M05
2016M03
2016M01
2015M11
2015M09
2015M07
2015M05
2015M03
2015M01
2014M11
2014M09
2014M07
2014M05
2014M03
2014M01
2013M11
2013M09
2013M07
2013M05
2013M03
2013M01
2012M11
2012M09
2012M07
2012M05
2012M03
2012M01
-2.0
Forecast
Source: Statistics Estonia, Danske Bank Markets
24
Deflation in Latvia due to energy prices

Inflation in Latvia has so far this year been in a negative territory for all except one month. However, higher energy
prices should lift inflation out into positive territory in the coming months.

We expect inflation in Latvia to average -0.1% in 2016 and 2.0% in 2017.
Inflation rate in Latvia
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
Core inflation
Food
Energy
Headline inflation
2016M11
2016M09
2016M07
2016M05
2016M03
2016M01
2015M11
2015M09
2015M07
2015M05
2015M03
2015M01
2014M11
2014M09
2014M07
2014M05
2014M03
2014M01
2013M11
2013M09
2013M07
2013M05
2013M03
2013M01
2012M11
2012M09
2012M07
2012M05
2012M03
2012M01
-2.0
Forecast
Source: Statistics Latvia, Danske Bank Markets
25
Higher inflation in Lithuania after the fall in prices in 2015

After deep deflation in 2015 (-0.7%) inflation is already higher in Lithuania this year (+0.5% in January-August).
Due to fastest growth in consumption, Lithuania has also so far had the highest core inflation rate among the
Baltics in 2016: +2.0% compared to +1.4% in Estonia and +1.0%.

We expect inflation in Lithuania to average 0.7% in 2016 and climb to 2.2% in 2017.
Inflation rate in Lithuania
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
Core inflation
Food
Energy
Headline inflation
2016M11
2016M09
2016M07
2016M05
2016M03
2016M01
2015M11
2015M09
2015M07
2015M05
2015M03
2015M01
2014M11
2014M09
2014M07
2014M05
2014M03
2014M01
2013M11
2013M09
2013M07
2013M05
2013M03
2013M01
2012M11
2012M09
2012M07
2012M05
2012M03
2012M01
-2.0
Forecast
Source: Statistics Lithuania, Danske Bank Markets
26
Labour force grows faster than employment in Estonia

Employment in Estonia continues growing at a healthy rate (0.9% in Q1 and 2.0% y/y in Q2 2016). Sectors
where employment grew most were human health, professional activities and ICT. Sectors where employment
contracted were manufacturing and construction.

Unemployment in Q2 2016 increased marginally from 6.4% in Q1 to 6.6% due to stronger growth in labour force
(+2.6% y/y) in relation to employment. Labour force increased due to the Work Capacity Reform, which aims to
increase employment of disabled people, and greater immigration.
Source: Macrobond, Danske Bank Markets
27
Unemployment still highest in Latvia

At 9.6% unemployment rate in Latvia is still the highest among the Baltics. That is a result of slowest rate of job
creation – employment expanded by 0.8% and 0.9% y/y in Q1 and Q2 2016 respectively.

Sectors where most jobs were created in Q2 were agriculture and forestry, manufacturing, other service
activities. Sectors with the biggest decline in employment were construction, human health and wholesale and
retail trade.
Source: Macrobond, Danske Bank Markets
28
Lithuania enjoys fastest employment growth in the Baltics

Employment in Lithuania is still growing at the fastest rate among the Baltics (by 2.5% and 2.6% respectively in
Q1 and Q2 2016). In Q2 2016 34.7 thousand new jobs were created compared to the same period in 2015.

Sectors with the biggest increase in employment in Q2 2016 were wholesale and retail trade, education and
manufacturing.

The only sectors to have reduced employment in Q2 2016 were transport (although at a lower rate than in Q1),
construction and agriculture.
Source: Macrobond, Danske Bank Markets
29
Macroeconomic forecasts
Private
HICP inflation
consumption
(% y/y)
(% y/y)
Fixed
investment
(% y/y)
Export, goods
& services
(% y/y)
Gross wage
growth
(% y/y)
Unemployment (%)
4.8
-5.8
-1.5
6.1
6.1
0.7
3.9
1.8
1.9
6.7
6.6
2.1
1.9
4.2
3.1
2.1
6.2
6.4
2018
2.4
2.3
3.9
4.2
2.4
5.9
6.3
2015
2.7
0.2
3.4
2.1
1.8
6.9
9.9
2016
1.8
-0.1
3.9
-12.8
1.6
5.3
9.6
2017
2.7
2.0
4.1
7.1
2.7
6.3
9.1
2018
2.9
2.4
3.9
4.9
2.9
6.4
8.5
2015
1.6
-0.7
5.2
10.3
1.2
5.1
9.1
2016
2.5
0.7
5.3
-1.6
3.7
7.3
8.4
2017
2.8
2.2
4.6
6.7
3.1
6.7
7.7
2018
3.0
2.5
4.4
5.5
3.4
6.9
7.1
Year
GDP
(% y/y)
2015
1.1
0.1
2016
1.5
2017
Estonia
Latvia
Lithuania
30
Disclosures
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’). The author of this research report is Rokas
Grajauskas.
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