BMI View: On the back of deteriorating relations between the EU and Russia over the Ukraine crisis, we have downgraded our 2015 forecast due to low confidence and poor economic performance limiting investment. Having said that, 2014 was the third consecutive year of double-digit growth in the construction industry, as it rebounds from a deep recession. EU transport and energy network funding will be a driver of growth to 2024, while housing and office demand will continue its strong sustainable recovery.
We estimate strong 2014 construction industry growth of 13.4% year-on-year (y-o-y) to EUR1.47bn (USD2.0bn), before moderating to a 5.4% increase and EUR1.56bn (USD2.0bn) in 2015. 2016 and 2017 will average 6% annual growth. To the end of our forecast period in 2024, growth will slow averaging a healthy, but unspectacular 4.6% annually.
Key Trends And De velopments
The deterioration in EU-Russia relations is adversely affecting Latvia's economic growth outlook, although the full impact will not be seen until Q314 and Q414 data is released. Western sanctions on Russia have led to capital flight and a sharp depreciation of the rouble against the dollar, which has markedly worsened the growth outlook for Russia, which remains one of Latvia's most important trading partners. Real GDP growth in H114 arrived slightly higher than expected, at 2.5% y-o-y and we have revised up our 2014 growth estimate to 2.1% to account for this, from a previous forecast of 1.9%. However, we have also lowered our 2015 growth forecast to 2.2%, from 3.5% previously.
Latvia is a part of the 600-mile Rail Baltica project, a priority project (no.27) of the EU's TEN-T core network funding, linking Finland, Estonia, Latvia, Lithuania and Poland to the rest of the EU by a standard gauge, high speed line. Construction is under way on stage 1 from the Polish-Lithuanian border to Kanaus in Lithuania and is due to be completed in 2015. Stage 2 will extend the line from Riga in Latvia to Tallinn in Estonia, and received a boost in October 2014 when the governments of Estonia, Latvia and Lithuania agreed to create a joint venture (JV) company, RB Rail, to implement the project after years of political wrangling.
The Baltic post-EU ascension housing bubble of 2004-2008 was thoroughly burst by the credit crunch, leading to a fall in construction and a fall in house prices. But now with the global economy in recovery mode, Baltic cities are under-supplied in housing and office space, while demand is being driven by an aspirational younger generation growing in confidence and entering the market, while current owners look to upgrade from old apartment buildings. To this end, residential and non-residential construction has been experiencing double-digit growth since 2010, when it was wallowing in double-digit negative growth caused by the crisis. While we view this sector as construction's outperformer over our forecast period to 2024, a combination of base effects, gradual market maturation, transitional regional relationships and steady if lean economic progress will mean that growth is tamer than it has been.
Gas market liberalisation was on the agenda when an EC post-monitoring commission in November 2014 highlighted concerns the government could miss liberalisation goals set for 2020. According to Latvia Prime Minister Laimdota Straujuma, quoted in The Baltic Course: 'We discussed liberalisation of the gas market, which will begin on April 1 2017, as well as renewable energy. Concerns were expressed that we could fail to attain our goals set for 2020 - I, personally, have no such concerns.'
Latvia remains in fifth place in our Risk/Reward Index (RRIs) for Central and Eastern Europe (CEE). Its overall score of 60.4 points makes it a regional outperformer, with the CEE average just 55.0. However, we believe much of its favourable ranking is indicative of the weaknesses in Europe's construction sector, rather than a reflection of its growth potential, which will be steady and moderate by our forecasts.