The Latvian Economy

Monthly newsletter from Swedbank’s Economic Research Department

by Dainis Stikuts and Mārtiņš Kazāks No. 1 • 10 February 2010

Foreign direct investment inflows return to pre-boom levels

• Foreign direct investment started to recover in 2010, approaching 5% of GDP.
• Foreign direct investment inflows are concentrated around Riga and cities with good
infrastructure. Improving infrastructure could attract FDI to other regions and will help
to increase employment and improve regional development.
• Before the crisis, foreign direct investment was concentrated in the financial and real
estate sectors. Now, foreign direct investment primarily goes to manufacturing
because of its improved competitiveness and increasing export possibilities.
Meanwhile, significant part of investments into real estate is due to operations of
bank’s owned companies.

Foreign direct investors retained interest in Latvia –
according to the Bank of Latvia, on average foreign
direct investment (FDI) inflows were 4% of GDP in
the last decade, and continue to increase. Only
during the recession, FDI inflows temporarily
became negative in some quarters mostly due to
overheated sectors. With the economic recovery,
foreign investors’ interest in the Latvian economy
has renewed. This is confirmed also by various
sources, including industry associations; the
interest is being expressed by both current and new
investors. Of course, investors have different
interests – some look for geographical expansion of
their business, and some want to take advantage
from lower prices and benefit from an asset price
increase in the future. While most current investors,
particularly in manufacturing, want to gain
momentum from increased external demand and
expand their production.
Latvia is strongly integrated into the
northern European market
FDI is one of the regional integration indicators.
Current statistics show that investments from
Estonia currently dominate in Latvia. However, data
on the origin country for FDI are sometimes
misleading: they show the last country from which
investment has come, but, because of complicated
business ties and globalisation, the true investor
country is hard to guess. For instance, most
Estonian FDI in the banking sector (e.g.,

Cumulative FDI in Latvia by country, Q3 2010

Cumulative FDI in Latvia, 2000-2010
7000 60 others EE
22.0% 14.4%
6000 50
SE
5000 AT
40 13.4%
2.2%
4000 LU
30 2.5%
3000
LT DK
20 6.7%
2000 2.6%

1000 10 DE
NO
2.8% US 6.2%
0 0 3.2% NL
2000 2002 2004 2006 2008 2010* FI CY RU 6.2%
IE
m LVL % of GDP (r.s.) 4.3% 4.3% 4.5% 4.6%
Source: Bank of Latvia
* 3Q 2010 Source: Bank of Latvia

Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46 8 5859 1000.
E-mail: ek.sekr@swedbank.com www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46 8 5859 7720.
Mārtiņš Kazāks, +371 6744 5859. Lija Strašuna, +371 6744 5875. Dainis Stikuts, +371 6744 5844.
 The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 1 • 10 February 2010
Swedbank), actually originates in Sweden. Thus, it
is Sweden rather than Estonia that is the true FDI
leader.
Meanwhile, investments from other, mostly northern
European, countries, are quite evenly distributed
across the economy. In the third quarter of 2010,
the largest FDI inflows apart from Sweden came
from the Netherlands (mostly in transport) and
Finland (in real estate), while investment from
Cyprus (in manufacturing) most likely is related to
offshore business.
FDI is concentrated in Riga region
Infrastructure is a very important factor for FDI
inflows. Naturally, FDI is concentrated around Riga,
where about two-thirds of value added is created
and where most of the real estate is located. Riga’s
central position and its developed infrastructure
(airports, seaports, and railway connections) make
it a natural location for business headquarters.
However, for balanced regional development large
centres are necessary linked by appropriate
infrastructure – this is the task for the government
and municipalities, which would also foster job
creation and tax revenues.
Cumulative FDI in Latvia, 2010
Other
9%
Daugavpils
2%
Riga city
Ventspils
79%
3%
Riga
district
7%
Source: Lursoft
FDI was accumulated in overheated sectors
After Latvia’s EU accession in 2004, development
of FDI inflows had three distinct periods – largely
following GDP dynamics. The first was the boom
period from 2004 to 2007, during which almost half
of FDI was accumulated in financial intermediation.
This was one of the most dynamic sectors, fostering
credit expansion in the economy. Real estate and
other commercial services were also important,
promoting construction. Only half as much
2 (3)
investment was made in wholesale and retail trade
and in manufacturing.
Cumulative FDI in Latvia by sector, Q3 2010
Other
20.1% Financial
inter-
mediation
Transport 27.2%
and com-
munication
6.9%
Real estate
Manufac- and
turing business
11.7% activities
Domestic 22.1%
trade
11.9%
Source: Bank of Latvia
The second period is recession of 2008 and 2009 –
this caused FDI inflows to slow significantly in all
sectors, but in some sectors, they even became
negative, reflecting losses. More than half of the
losses in 2009 were in the banking sector, but large
losses appeared also in businesses related to
transit and trade. Banks were required to raise
additional capital to meet the capital requirements –
this comprised almost 90% of FDI inflows.
Meanwhile, FDI inflows into manufacturing and real
estate remained positive. Furthermore, in 2010,
investments first started to increase in these latter
sectors.
The third period is recovery that started in the first
quarter of 2010. Strong export growth renewed FDI
flows into manufacturing. Most investments are
going into traditional activities, e.g., food, wood,
non-metallic minerals, and textiles. Evidently, most
of these investments are coming from current
investors. However, some new investors are
looking to take over the assets of companies that
have closed their businesses but would still be able
to restart operations quickly.
Foreign investors in the real estate sector are
largely interested in good property in the city centre
or in newly built housing projects. A significant part
of transactions is made by banks’ owned
companies that take over insolvent clients’ property.
These transactions, though, do not create new
activity in construction. Very few investors intend to
start new projects on their own.
 The Latvian Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued

No. 1 • 10 February 2010

Cumulative FDI in Latvia, 2000-2010, (millions of lats) Current asset prices are favourable for real estate
1200 Other sector to continue to attract FDI, but the amounts
Transport and communication will be below that of 2006-2007. Current FDI inflows
1000 Manufacturing are largely being determined by repossessing
Domestic trade already built projects and projects in the building
800 RE & oth.business process, but, perhaps, gradually interest will shift
Construction towards new projects. Most likely, these will be in
600
Financial intermediation commercial premises because demand for
400
Agric ulture & fishing residential property will be restrained due to the
weak labour market and low incomes and because
200 people have become more fastidious. Meanwhile,
FDI inflows into the banking sector will be subdued
0 because banks have accumulated very large
capital: the capital adequacy ratio has reached
-200 15%, while the requirement is 8%.
2000 2002 2004 2006 2008 2010*
* 3Q 2010 Source: Bank of Latvia We forecast that FDI inflows will amount to 4-5% of
GDP in coming years, i.e., they will largely return to
1200 the pre-boom level. The result depends on some
factors that are hard to control, e.g., investment
800 conditions abroad (Estonia has joined the euro
zone). However, some factors can be influenced
400 making Latvia more attractive for FDI, e.g., the
business environment, infrastructure, labour costs,
0 credit ratings, and tax policy. The government must
make improvements in these areas – it would also
-400 hasten employment and income growth, as well as
New capital
increase tax revenues.
Reinvested earnings
-800
FDI inflow Dainis Stikuts
-1200
Mārtiņš Kazāks
2000 2002 2004 2006 2008 2010*

* 3Q 2010 Source: Bank of Latvia

Exporting sectors will drive FDI inflows

We expect that FDI inflows will be mostly
concentrated in sectors related to goods and
services exports. These sectors have very good
preconditions – increasing external demand and
improved competitiveness due to lower labour
costs. They currently have very good cash flows
and profit margins, but their capacity utilisation is
rapidly approaching the maximum. Thus, for further
development, they need new investments financed
by either reinvested profits or new equity capital.

Swedbank
Economic Research Department
Swedbank AB. SE-105 34 Stockholm.
Legally responsible publisher
Cecilia Hermansson, +46 8 5859 7720
Martiņš Kazāks, +371 6744 5859
Dainis Stikuts, +371 6744 5844
Lija Strašuna, +371 6744 5875
Swedbank’s monthly newsletter is published as a service to our customers. We believe that
we have used reliable sources and methods in the preparation of the analyses reported in
this publication. However, we cannot guarantee the accuracy or completeness of the report
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