Economy of Baltic Sea Region

In search of growth

The region’s growth suffers from lacklustre and patchy global demand, Russia-driven geopolitical uncertainty, and its own structural imbalances. The region’s growth forecast for 2014 has been repeatedly lowered during the year and now stands at only 1.2%, i.e., only half of what we expected a year ago. In 2015, growth will dip to 0.9%. In 2016, the region is forecast to expand by 1.9%, driven by better growth in the euro area and an expected stabilisation of the Russia-Ukraine conflict around mid-2015, which should restore Russia to very pale growth. It will be the fourth year in row of growth below the region’s long-term average. There are structural reasons for growth to slow permanently, e.g., demographics. Growth will increasingly rely on investments and productivity growth, which would benefit from closer regional integration.

Baltic Sea index: the region’s structural qualities have improved, but still much to do

The Baltic Sea index points to improvements in the region’s structural qualities and competitiveness – it has risen to 7.6 from 7.4 last year. Improvement has been across the board, with that in logistics and infrastructure improving most. Only three of the ten subindices – entrepreneurship, tax policy, and foreign trade – have retained their last year’s ranking. The region overall ranks above the EU (7.1), but below the US (8.4). Russia and Latvia have seen the steepest improvements, but notable gains are seen also in Estonia, Lithuania, Norway, and Poland. Finland has seen a little slippage in its rank. The key weakness comes from the region’s uneven structural quality – bringing up those countries lowest ranked would generate the largest gains in the region’s competitiveness. This is happening, but the current reform agenda seems to be weak. Another negative trend for the region’s growth is Russia’s drifting away, driven by political actions that override its structural improvements. Developments in Russia are the main risks to the region’s growth. To reduce the negative impact of such risks, the rest of the region must strengthen its mutual integration and use its competitive advantages to integrate with other expanding economies.

FDI in the Baltics: weaker inflows, but growing investments abroad

Foreign direct investment (FDI) flows in the Baltics have weakened over the last couple of years, as in the EU overall. Meanwhile, with the Baltic economies maturing, outward investments have risen. The Baltics keep attracting FDI with somewhat higher returns and lower costs than the EU’s average; however, returns are likely to decline due to slower convergence with the EU average, while costs will continue to rise. Geopolitical risks due to the Russia-Ukraine conflict will affect FDI flows. Business investments (especially in R&D) are vital to boost the productivity and competitiveness of the Baltics, and FDI is critical. The option of transferring operations to lower-cost countries might become increasingly attractive, going forward. To strengthen competitiveness and boost growth, companies should (i) keep raising efficiency, (ii) find new markets and innovate, and (iii) get out of the grey economy. To support businesses, policymakers can (i) ease the tax burden, (ii) support innovations and R&D, (iii) keep improving institutional environment, (iv) address demographic and labour market challenges.

Source: Swedbank

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