Economic environment overview: Baltic States economy 2023-2024

The economy of the Baltic States did not perform particularly well in 2023. These are small and open economies where economic growth depends largely on export markets in addition to domestic consumption. Consequently, we could especially observe the negative impact of deteriorating trade partner situations on the macroeconomic indicators of the Baltic States, particularly in the latter half of the year.

Of all three Baltic countries, Estonia experienced the deepest economic decline in 2023 - the forecast by the Bank of Estonia in December predicted a -3.5% economic contraction for the year (while in Latvia and Lithuania, the economic decline in the third quarter was -0.4% and -0.2% respectively), accompanied by decreases in investments and consumption. The reduction in private investments was somewhat offset by a slight increase in public sector investments towards the end of the year, particularly noticeable in Lithuania, which increased the utilisation of EU funds by as much as 25% compared to the same period of the previous year. Latvia also hopes for additional financial injections into the economy through the construction of Rail Baltic in 2024 - they are lagging behind their Estonian neighbours in utilising these two EU financing schemes.

Significant declines were observed in exports, imports, and retail sales turnover in the Baltic States. Additionally, industrial production and construction volumes, as well as tourism, decreased. Due to high interest rates in 2023, raising funds from the market became more difficult for companies, and several companies had to announce layoffs. This situation was exacerbated by a flow of negative news, which made both consumers and entrepreneurs pessimistic about the future.

What does 2024 bring?

While the economic prospects for Latvia and Lithuania are assessed as positive for 2024, Estonia is forecasted by the Bank of Estonia to experience a slight economic decline. Moderate growth in Lithuania's economy next year is supported by increasing domestic demand, which should balance out the decline in export markets. Neither Lithuania nor Latvia foresee problems in the labor market this year; employment remains high, and unemployment is not growing. This, in turn, means rapid growth in average wages, increasing people's purchasing power, and significantly maintaining consumption levels. However, this trend may be influenced by the interest rate environment - if interest rates remain high until the end of 2024, favorable deposit conditions and investment schemes offered to small investors may reduce the amount of money spent on consumption. In Estonia, rapid growth in unemployment is expected in 2024, which, in turn, hinders rapid nominal wage growth.

Diminished inflation and a stable labor market inject positivity

Inflation has slowed down, and labor market indicators remain good. According to the labor force survey data for the third quarter of last year, employment in Estonia was very high, and the unemployment rate was relatively low. In 2023, the labor force survey began to take into account Ukrainian refugees, whose impact on unemployment and employment indicators is two-sided - the labor force is now estimated to be 30,000 people higher, and consequently, the unemployment rate is lower. However, layoffs that began towards the end of the year have likely affected refugees to a greater extent, as due to their limited language skills, they have primarily found low-skilled jobs in Estonia.

Employment in Lithuania has also remained relatively high, and the unemployment rate low. No rapid growth in unemployment or an increase in employment is forecasted for 2024. However, like in other Baltic countries, Lithuania is characterized by a decrease in competitiveness due to the increase in unit labor costs. Unit labor costs in Lithuania and Estonia have increased by about 15% annually for the past two years. The increase in unit labor costs has been contributed by the growth in real wages, which has been faster than productivity growth.

Although the pace of inflation slowed down towards the end of the year, the annual inflation rate was high in all three Baltic countries last year, hovering around 9%. According to Eurostat, in November 2023, compared to November of the previous year, inflation rates were 4.1% in Estonia, 2.3% in Lithuania, and as much as 1.1% in Latvia. Significant inflation deceleration is expected for this year.

In conclusion, compared to previous crises, this economic downturn is slower but lasts longer. It can be assumed that the recovery will also take more time, as the situation of foreign trade partners must improve first. Whether the economic forecasts for Latvia and Lithuania for this year are too optimistic will be indicated by the fourth-quarter economic results, to be published at the end of March or beginning of April.

Raul Eamets
Chief Economist of Bigbank Group