Due to the war in Ukraine caused by Russia and its consequences, Latvia’s economy has grown half as slowly as could have been predicted on the eve of the war, but the prices of goods and services are about a fifth higher, experts from the Bank of Latvia spoke on Wednesday, “A year in the shadow of the war: what has it cost Latvia’s economy?” said Kārlis Vilerts, head of the Research Department of the Monetary Policy Department of the Bank of Latvia.
“The war is the main reason why the people of Latvia are experiencing a rapid increase in prices unseen for decades and why the economy is stagnating. Of course, not all price increases and economic slowdown are a direct result of the war, but the lion’s share is,” said Willerts.
He explained that there are many reasons why the Russian invasion of Ukraine has not been successful for Latvia’s economy. The three potentially most important are the decrease in trade with Russia and its ally Belarus, the increase in the prices of energy resources and other raw materials, and the lower attractiveness of the region in the eyes of entrepreneurs.
If the economic impact of the trade channel is apparently less than expected, then the increase in the price of energy resources and other raw materials significantly hit the wallets not only of households, but also of companies, Willert pointed out, adding that the war takes place in different forms and fronts, and on the economic front, Russia’s main weapon is energy resources – especially natural gas.
On the eve of the war, Russia was the most important supplier of natural gas, accounting for approximately half of the total natural gas imports of the European Union (EU) in 2021. In the case of Latvia, almost all natural gas imports were from Russia. Willerts explained that this made the European economy vulnerable – if Russia stopped the supply of energy resources, the amount of energy resources available to European countries would be significantly reduced, which could potentially be reflected in production interruptions and other side effects reducing economic activity and prosperity.
“This sword of Damocles forced European countries to urgently look for alternatives to Russian energy supplies, resulting in a huge jump in the prices of natural gas and other energy resources. Higher prices of energy resources mean higher heating, electricity and other bills and thus cause headaches for almost every household. But that’s not all – since oil products, gas and electricity are an important expenditure item for a large number of companies, the increase in the price of energy resources was also reflected in the increase in the prices of other goods and services,” said Willerts.
The calculations of the Bank of Latvia show that the full transfer of the increase in the price of energy resources to other prices takes place within about a year. In many places, it is happening faster – as a result, the increase in the prices of goods and services for more than half of the consumer basket compared to the previous year exceeded 10%.
Very simplified calculations show that in 2022, the increase in the price of energy resources – not to mention the increase in the price of other categories – will cost 1.7 billion euros to Latvian citizens and companies, Willerts informed.
He explained that the situation would have been even more painful if the government had not provided support to reduce household bills. The calculations of the Bank of Latvia show that limiting the prices of electricity, gas and heating has reduced the inflation of 2022 by approximately 2.5 percentage points. In addition, although the activity in the economy has slowed down, as a result of the support measures, the economic recession is considerably – almost 0.7 percentage points – flatter.
At the same time, Willerts admitted that the support costs were impressive – in 2022, approximately 645 million euros were spent on mitigating the energy resource crisis.
He also noted that, looking into the future, the state budget is unlikely to be able to “sustain” such expenses year after year, so the question – how to take care of the availability of energy resources with reasonable costs – is critically important both at the level of the state and also at the level of individual companies and households.
Willerts informed that currently the prices of energy resources have fallen significantly – currently they have returned to the pre-war level. The filling of natural gas storages is at a record high, and no one is really worried about the availability of energy resources this heating season. However, Willert believes that there is no reason to be complacent. Europe has had an atypically warm winter and autumn, and residents and companies have significantly reduced their consumption of energy resources. The situation could have been different, so the questions about the next heating season remain open – until Europe has found sustainable and safe alternatives to Russia, the uncertainty surrounding the availability of energy resources and their price will remain.
Willert also added that the border with Russia and the ghosts of the past make international investors look at us with caution. All this despite the fact that we are part of the EU and NATO. Willerts explained that this is well illustrated by the interest rate at which the Latvian government can borrow funds in the financial markets. If at the end of 2021 the Latvian government’s borrowing costs were almost identical to the French government’s, they are currently more than one percentage point higher.
Borrowing costs have increased, but the activity of foreign investments, at least at the macroeconomic level, has not decreased, Willerts said. Statistics even show that investments are quite high. This is as a result of certain exceptions, excluding which the dynamics have not changed much.
Also, in Willert’s view, there is nothing to worry about exposure to Russia and Belarus – Russian and Belarusian investments have been quite small for several years.
Although the fact that investments have not decreased might seem like very good news, Willerts emphasized that this is not the case at all – for more than seven years, private sector investments in Latvia have lagged behind not only Lithuania and Estonia, but also the EU average. Willert warned that with such sluggish investment activity, it will be very difficult to raise productivity and catch the level of prosperity of Western Europe.
