Latvia's gross domestic product (GDP) plummeted by 19.6 % in the second quarter of 2009 from Q2 2008, the Central Statistics Bureau reported.
This compares to an 18 % drop in GDP in the first quarter. In seasonally-adjusted terms, the second quarter drop was 18.2 %. Hardest hit were the restaurant and hotel business down 35 %, and retailing, down 28 %. Manufacturing's contribution to GDP was down 19 %.
Prime Minister Valdis Dombrovskis believes the economy is hitting bottom. Perhaps. But the figures that suggest a year-on-year drop of at least 20 % also mean tax revenues will shrink proportionately (at least), putting more pressure on the state budget, which faces cuts of an additional LVL 500 million for 2010. There has been some optimistic speculation of a reduction in the need to cut to LVL 260 million due to expected higher tax revenues (resulting from VAT and other tax increases). However, I think tax revenues will plummet due to GDP stagnating and citizens and enterprises moving to the grey market to avoid paying higher taxes for drastically shrinking government services.
The critical moment in terms of GDP is not what happens in Latvia, but whether there will be GDP upturns sufficient to generate new demand for labor in other EU countries. If that happens, expect a wave of emigration from Latvia as tens of thousands seek jobs and better governance in Britain, Germany, Ireland, Sweden, wherever... This will further shrink the tax base and extend the stagnation of the Latvian economy -- a situation in large part caused by the mindless budgetary and credit expansion of earlier years.
Somewhat better news is that inflation dropped to 2.5 % in July. But it is a statistic of mixed blessings. Are prices lagging after falling purchasing power, which in turn, is affected by lower revenues and wage cuts in both the private and public secor, which in turn lowers revenues for retailers again, which...? You get the point?
Deflation also increases the relative weight of euro-based loan repayments in family budgets, especially as wages fall as well. Devaluation would only aggravate the problem at this stage of the game.