Home Finance Are the Baltic States Back on the Road to Economic Recovery?

Are the Baltic States Back on the Road to Economic Recovery?

by internationalbanker

By Nicholas Larsen, International Banker


Recent data is reigniting hopes of a return to some semblance of economic normalcy for the Baltic states after they experienced perhaps the most torrid 2022 of all European nations. Despite remaining elevated, inflation in all three nations has dropped back into single-digit territory for the first time since late 2021 (Estonia and Lithuania) and early 2022 (Latvia). The annual inflation rates in June were recorded at 7.9 percent for Latvia, 9 percent for Lithuania and 9.2 percent for Estonia, improved from May figures of 12.1 percent, 11.3 percent and 11.7 percent, respectively. But does this encouraging trend necessarily mean the economic future is bright for the Baltic nations?

Last year, the three diminutive countries with coastlines looking out over the Baltic Sea registered the highest annual inflation rates amongst all European Union (EU) member states—Latvia at an average of 17.2 percent, Lithuania at 18.9 percent and Estonia at a mighty 19.4 percent—while the third quarter saw annual prices in all three countries soar above the 20-percent mark and as high as 24.8 percent in Estonia in August. Thanks largely to the war in Ukraine, which ended up disproportionately impacting the three nations due to their heavy reliance on food and fuel imports—the prices of which skyrocketed following the outbreak of the war—inflation in the Baltic states skyrocketed.

As natural-gas prices climbed in response to waning supply from Russia, these three nations bore the brunt of the soaring energy costs, especially since they were among the first to curtail imports from their heavily sanctioned neighbour. “If there were still any doubts about whether there may be any trust in deliveries from Russia, current events clearly show us that there is no more trust,” Uldis Bariss, chief executive officer of Latvian gas-transmission and -storage operator Conexus Baltic Grid, told Latvian Radio in April 2022. “Since April 1st Russian natural gas is no longer flowing to Latvia, Estonia and Lithuania.”

As such, power prices began to soar to their highest levels throughout the continent, reaching a peak during the summer of 2022 as global natural-gas prices continued to rise. By May, the hourly electricity-price amplitude in the Baltic states being reported by Latvenergo JSC was varying from €6.63 per megawatt-hour (/MWh) to €500.5/MWh, before prices in Estonia, Latvia and Lithuania climbed further, even reaching as high as €4,000 per megawatt-hour—the upper permissible limit at auction—as supply continued to undercut demand in the local market significantly.

And by the end of the year, the Baltics were even being dubbed the “canary in the coal mine” by Latvia’s central bank (Latvijas Banka) governor, Mārtiņš Kazāks, for the decades-high inflation they were experiencing. Kazāks also acknowledged, however, that this part of the world had already experienced dramatic price surges within not-too-distant memory, so it was perhaps more acclimatised to recent economic events than other areas within Europe. “In 1992, when we had just regained our independence, inflation hit 950 per cent,” Kazāks told the Financial Times. “It is not like Germans, who have not seen double-digit inflation for generations. We know it is nasty, but it is not like we have never seen it before.”

Nonetheless, it proved inescapable for the Baltic economies to end up among the poorest overall performers in 2022. “While the region registered a strong post-pandemic recovery fuelled by high levels of accumulated savings and spending on services in 2021 and [the] beginning of 2022, it is being severely impacted by the economic fallout of the war on Ukraine,” Tomas Kairys, head of Baltic States at the European Bank for Reconstruction and Development (EBRD), noted in a January 31 piece for the Baltic Times. “The region is currently seeing a reduction in economic activity, dragged down by historically high inflation, especially in energy and food prices, weakening currencies, waning external demand and a strained geopolitical situation.”

But in 2023 thus far, there has been much more to cheer about, particularly as natural-gas prices in the region slid dramatically from their late-August 2022 peak to two-year lows by July 2023, and a raft of fiscal-policy support measures and subsidies have helped households cope with exorbitant energy costs. Consumer and business sentiments have thus improved this year after being battered by the fallout from the war in Ukraine. The pace of interest-rate rises, as set by the European Central Bank (ECB), has also slowed in 2023 as inflation continues to be gradually contained whilst a soft landing for the eurozone economy is engineered. And all three governments are now moving ahead with their plans to diversify their energy needs away from Russian gas imports—with a new floating LNG (liquefied natural gas) terminal in Latvia currently being proposed by investors and renewable-energy production capacity being bolstered mainly through more investment in wind and solar farms among the key methods being designed to secure Baltic energy independence.

That said, persistent challenges remain, as demonstrated by many of the economic figures issued for the first quarter. In Lithuania, for example, retail sales contracted during the January-March period, while manufacturing production declined massively at annual rates of 11 percent, 8.2 percent, 14 percent and 5.1 percent, respectively, in the first four months of the year. High inflation continues to weigh on private consumption in all three economies, moreover, while the costs of replacing Russia as the main fuel supplier are also likely to take their toll on inflation numbers during the coming months.

In terms of the economic outlook for this year, the European Commission (EC) stated it expects Latvia to perform the strongest of the three Baltic economies. “Latvia’s economy will increase by 1.4% this year—slightly ahead of EU’s average index and with a higher growth rate than the rest of Baltic states,” according to the EC’s executive vice-president, Valdis Dombrovskis, who added that for comparison, the Lithuanian economy will grow by 0.5 percent, and the Estonian economy will probably experience a 0.4-percent recession. “Inflation in the EU and Baltic States will gradually go down, but it will still remain on a relatively high level. Inflation in all three Baltic States is expected to reach 9.2%-9.3%, which is significantly above EU’s average index of 6.7%.”

The Organization for Economic Co-operation and Development (OECD) has gone further than the EC by suggesting that onlyLatvia will enjoy positive economic growth among the three Baltic countries this year. The country’s gross domestic product (GDP) will grow by 1.1 percent in 2023, the OECD predicted in June, followed by a healthier 2.4-percent increase next year, both upgrades from its November 2022 forecasts of 0.2 percent and 2.3 percent, respectively. On the inflation front, meanwhile, the OECD stated it sees Latvia’s consumer price index rising by 11.2 percent this year, which will dampen consumer spending, and by 4.8 percent in 2024, while the unemployment rate will remain at 6.6 percent for this year and next.

As for Lithuania, GDP is projected to remain unchanged in 2023 and rebound to 2.6 percent in 2024, while inflation will average 13.1 percent and 5.7 percent for this year and next, respectively. “High inflation will continue to weigh on private consumption. A weak outlook for global trade, uncertainty and geopolitical tensions affecting key trading partners will contribute to a sharp slowdown in exports,” the OECD’s “Lithuania Economic Snapshot” disclosed. “Inflation will start to ease with lower import prices for gas and oil. Public investment, strengthened by EU funds, will support growth.” Lithuania’s unemployment rate, according to OECD estimates, will be 7.6 percent this year but will decrease to 7.1 percent next year.

As for Estonia, the OECD predicted a painful 1.3-percent drop in GDP this year but expects a solid 3.2 percent rebound next year. The consumer-price increases are being chalked up at 9.2 percent and 3.4 percent for 2023 and 2024, whilst the unemployment rate will fall from an estimated 5.9 percent this year to 5.7 percent next year. “Private consumption will remain subdued as real incomes remain under pressure. With higher interest rates, house prices are declining, and housing investment is weak. Stronger external demand will support the initial recovery,” the OECD stated in its June 2023 outlook note for Estonia.

For comparison, the OECD stated it expects the entire eurozone economy to rise by 0.9 percent this year and 1.5 percent in 2024. And in Europe’s biggest economy, Germany, GDP will remain constant this year but grow by 1.3 percent next year.


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