External environment in the Baltic States and Ukraine

Lithuania’s economy was strongly hit by the effects of the war in Ukraine, waged by Russia. The post-pandemic impetus of the economic recovery achieved in the year prior was diminishing because of the geopolitical tensions. In Q1 2022, GDP grew by 4.8%; afterwards economic activity slowed down for the rest of the year. Figures of the State Data Agency of Lithuania show that year-over-year, GDP decreased in Q4 2022 by 0.4%. Compared to Q3 2022, GDP decreased by 1.7%.

The high inflation which slowed down slightly in summer was once more on the rapid rise in autumn and amounted to 21.7% compared to December 2021. The increase results primarily from the dynamic growth in worldwide food and energy prices, as well as the price of production of food on export markets, along with disrupted supplies of other raw and industrial materials, exacerbated by the war in Ukraine. The global imbalance between the demand for and supply of raw materials and goods also had its effect.

The labor market in 2022 remained healthy. More people became employed and people in working age intensified their participation. What contributed to the higher employment was high economic activity, strong demand for work in many sectors of economy, whereas a record-high participation rate and the entry of Ukrainian war refugees in working age into the labor market provided space for employment to grow. With higher employment, the Lithuanian unemployment rate drooped to 5.8%, 1.3 p.p lower year-over-year.

The situation in Latvia in 2022 was completely determined by the war waged by Russia in Ukraine, the termination of trade with aggressor states, the acceptances of refugees fleeing the war in Ukraine, and a surge in the price of energy fuels.

The impact of the war could be seen most pronouncedly in the energy fuel market, where the rapid price increase and limited availability of resources caused the prices of gas and electricity to rise several times. In the second half of the year, when food prices also started to surge, inflation in Latvia reached levels unseen since the mid 1990s. In September 2022, it amounted to 22.2%, but became stabilized in the following months below 22%. In 2022, the average inflation was 20.8%.

In the first half of the year, economy was still rather effectively recovering from the restrictions imposed due to the COVID-19 pandemic; the service industries were showing high growth rates, but the second quarter was already marked by the effects of war and growing energy fuel prices. A GDP increase of 0.3% year-over-year was observed in Q4 2022. The construction sector played a large role in the change in GDP, being the the first of the large sectors to be affected by rising prices, rising construction costs and delays in completing work works. At the same time, growth was recorded in crop production, livestock and in the manufacturing industry.

Figures of Statistics Estonia show that GDP following Q3 2022 was 1.8% lower than in the previous quarter and 2.4% lower year-over-year. This means that the Estonian economy was shrinking rather rapidly for the second quarter in a row. However, despite the sudden price increase, consumption grew. Society was prepared for high inflation thanks to its savings accrued throughout the COVID-19 pandemic and resources withdrawn from the second pillar of the pension system. High consumption levels allowed companies to grow their profits, even with rapidly increasing costs

Year-over-year, compared to the average value in 2021, consumer prices grew by 19.4%. The costs of household utilities rising had the greatest effect on the consumer price index. Compared to 2021, the price of electricity grew by 94.4%, gas by 123.8%, whereas heat by 49.1%. High inflation was having an ever greater impact on economic growth. The lower purchasing power and shrinking savings point to a potential fall in consumption at the end of 2022 and the first half of 2023.

The war instigated by Russia on 24 February 2022 against Ukraine made most risks for both the people and the business materialize. The loss in human resources and destruction of infrastructure due to Russian terrorist attacks an military action caused the economic situation to be substantially worse. Following an unprecedented fall in the first half of 2022, the Ukrainian economy started to gradually recover in the second half of the year; however, damage to critical infrastructure brought this process to a halt. In light of the foregoing, in line with the figures from the Ukrainian Ministry of Economy, the GDP of Ukraine fell by 30.4%, the largest decline in more than 30 years.

The accelerated inflation in 2022, which according the figure of the National Bank of Ukraine amount to 26.6%, results primarily from the effects of the Russian aggression on Ukraine. The most substantial of these effects are destructions of enterprises and infrastructure, disruptions to production and supply chains, increase in production costs, and temporary demand for some goods and services (the main driver for price increases is food). Importantly, despite such strong economic disruptions, the expectations concerning inflation on the part of economic activities (banks, corporations, household, analysts) have stabilized. Price pressure was stopped by the reference rate raise in June and its subsequent maintenance, as well as by low demand and fixed utility rates.

Disruptions in energy, water, and heat supplies, as well as problems regarding mobile and Internet networks caused by the regular mass attacks on critical infrastructure in Q4 2022 were one of the primary challenges and obstacles for business.

The December AmCham study showed that 31% of companies reported office or production plant damage; only 59% said that all employees were safe throughout the ten months of war; in turn, 98% of respondents supported the humanitarian movement or volunteerism in various ways.

Since the start of the war, the rating agency S&P Global Ratings has on numerous occasions updated its long-term and short-term foreign currency credit rating for Ukraine, and on 19 August raised the rating to “CCC +/C” with stable outlook thanks to debt restructuring and stable international financial support.