Friday, February 23, 2007

A Bursting Baltic Bubble?

Are the Baltic states facing an impending economic crisis? So seems to be the case, due to the current overheating of both Estonian and Latvian economies. Earlier this week, Standard & Poor's as well as Deutsche Bank warned that Latvia's economic imbalances might cause a currency devaluation. Estonia risks a similar fate in the runup to its 4 March parliamentary elections. Only Lithuania seems to be getting off scot free.

In January, Standard & Poor declared Latvia Europe's "most dynamic economy in 2007" with a GDP growth of 8.9%, and with neighbouring Estonia coming in second, with a 7.5% growth. Estonia and Latvia - along with Slovakia - are the fastest growing economies in Europe.

Growth, however, has a price. Both economies are facing an inflationary spiral with most economic indicators going wild. In the battle over customers, Latvian banks have lended money to consumers at an interest lower than the inflation rate, and Estonian banks have followed suit.

However, Latvia's problems are the most acute. Since January, economic growth has risen to 11%, by far exceeding the 6-7% that are long-term economically sustainable. High domestic demand and corporate investment rates add to the problems. The increase in imports - clearly over what the country exports - has also created a worryingly negative balance of trade.

As for the labour market, supply cannot meet demand as many Latvians work abroad. The annual wage-rises of an average 10% have so far been compensated by a corresponding growth in productivity, but this year the tendency is towards an impassable 20% rise.

What may really topple the economy, however, is the negative real interest rate combined with a high rate of public lending - largely in euro-loans. According to some sources, this has caused prices of real estate to double in recent years.

All in all, if Latvia were now to devalue its currency - the Lat - banks would be forced to compensate themselves by a drastic increase in interest rates. With loans largely in foreign currency, consumers would face acute solvency problems, potentially with a consequent crisis for the banking system. As it appears, recession seems to stand at the door.

So, what has the Latvian government done to curve inflation and battle economic overheating? Precious little, one must admit. Already last spring, Standard & Poor predicted several years' delay for Latvia's inclusion into the eurozone, postponing it for 2009-2010 at the earliest. Prognosis was based on sustained price growth, driven by demand and rising inflationary expectations. This, in itself, should have been a clear stop-sign for the Latvian government.

All the same, the Latvian economy is basically in good shape. The country's foreign debt is low and the state economy is under control. And, obviously, economy is booming. So, why waste a winning concept, seems to have been the reasoning of the government. Some measures have been made, but they have either failed or been dubious as for their effects.

Also, it is quite obvious that the government had had more reasons to be content. In October, the government coalition, led by conservative People's Party (Tautas Partija) leader Aigars Kalvītis, was the first to be re-elected since the country regained independence in 1991. No wonder the government had a laid back attitude to developments, wanting to enjoy its honeymoon with the voters as long as possible.

However, now the government has come to a rude awakening, as the situation has quickly gotten out of hand. The question is if it will dare to challenge the banking and financial sector, which - as in Estonia - belongs to its key support groups. It is questionable if the Kalvītis cabinet can rise to the challenge. In the meantime, the fear that the Baltic bubble bursts will linger on.


Raffi Aftandelian said...

Thank you for the warm encouragement! Ever since moving back to the US I was wondering about keeping up the blog. And seeing a comment in MNG the day after posting a message is delightful.

We'll be in touch! On another radio show? I have to say, I was afraid that I was a wee bit misunderstood on the show...


p.s. I'm also reviving another blog-

p.p.s. It'll take some time to catch up on my favorite Russian blogs, but at first glance really like the layout of your blog. Have you changed it?

Michelle said...

I would be really interested in reading a post about Ukraine's economy.....

nopsam said...

Vilhelm, I'd love to hear / read your view on the Kaliningrad Oblast in the light of the economic situation in the Baltic region.

Sincerely yours


Vilhelm Konnander said...

Dear Raffi,

Don't mention it. I'm happy to have you back in the blogospehere, and you deserve all encouragement you can get. As I wrote: "Keep on blogging!"

As for our Open Source Radio show, I can't recollect that you said anything strange, though the reporter seemed distraught and posed some rather peculiar questions to you. Such things happen, and one should not be bothered by them - either as an interviewee or as a reporter. Mind you, it was a live broadcast.

As for your other blog, I will take a closer look at it as soon as possible.

As for my own blog, I am happy you like its appearance. I change it gradually as I go along and learn more about programming it.

What is a nuisance is that templates have changed considerably in the new blogger version, why I have only done a partial update, keeping the old template for now. I prefer to blog rather than keep hours reprogramming everything to get it back to what it already is, viz. if I were to do a complete update to new blogger.

Obviously though, even when opting for the partial solution, all blogs displayed in the new version of Internet Explorer are distorted. (Yes, I belong to the many unfortunate stuck with IE due to compatibility reasons). Also, the blog is disastrously displayed by Mac browsers. As I am no longer a Mac user, I cannot adapt the templates to all browsers, why it does not appear as I would like it for all users.

With new Google blogger, one also cannot login when e.g. visiting an arab-speaking country, as Google generates an arabic script login default. I imagine that the same problem goes for most countries with alphabets other than the Latin.

All in all, new blogger is confronted with a lot of problems, which makes it much more difficult to have and use an individualised blog, departing in any way from the basic templates provided by blogger.

Thus, if you have any special features on your current blogs, my advice would be to be careful with the new blogger version, or else you might end up reprogramming the lot. However, if not so, new blogger allows for much easier handling of your blog layout - provided you are willing to have a blog that appears like most other blogger weblogs.



Vilhelm Konnander said...

Dear Sergej,

I haven't really thought about this a lot lately, why I would have to furter contextualise the issue of Kaliningrad in the Baltic Sea regional context. Let me think about it, and I will see if I might have something to add to what is already common knowledge. Thus, I can't promise any specific piece on the subject. What I do promise is to think it over, to see if I at all can offer any interesting perspective.

Perhaps, you might be more of an "expert" on the subject than I am, and that it really should be the other way around, i.e. that I would need to learn something from what you might write on Kaliningrad in a regional context? One never knows...



Vilhelm Konnander said...

Dear Michelle,

How nice to hear from you again. How are things in Kyiv? I hope your important work with streetchildren is getting along fine.

As with Sergej's request, I must confess, I do not spontaneously know what to write on the subject - whether or not I can present any interesting perspective.

I haven't been to the Ukraine for over a year, so I'm not up to date on many issues.

I was hoping to meet and discuss Ukraine with an EBRD-associate next month, but now the meeting doesn't seem to materialise.

So, I would not at the moment know what I might have to offer on current Ukrainian economy besides what is in the news. I will though see if I might come up with something.

What I can promise, though, is that I will write a piece on Ukraine shortly.

I have been pondering on a theme concerning the country's foreign policy for quite some time now, so that might perhaps interest you, if I actually get down to writing it eventually.



Vilhelm Konnander said...

Dear fellow bloggers,

Coming to think of it, I'm overwhelmed by your faith in me, that I might have something to add to such a wide variety of issues.

A few years back, I worked as analyst for strategic security planning, trying to look 10-20 years into the future. Of course, it was mission impossible, and one might as well have used a crystal bowl instead of the scenarios we applied to various situations.

The thing was though that I was expected to know or have an opinion on next to anything that might happen in the future. No matter how much I tried, people simply could not understand that what I, at the most, could offer was an educated guess. In the end, I succeeded in defusing such expectations by starting to refer to myself as "Marjory the Trash Heap" - a character of Muppet Show sequel "Fraggle Rocker."

Actually, having people not taking me so seriously made them start to think and reason by themselves, and in the end most of them had as much to contribute with as I had.

The lesson was that when not taking each other's knowledge too seriously, we could all start questioning things that were self-evident now, but might not be all that relevant in a longer perspective of time. It all turned out quite well. We gained greater mutual respect for each other's expertise and also got to challenge our own views and perspectives. It was a very useful exercise. After all, knowledge is for a purpose, and if it isn't satisfactorily applicable, it must be challenged.

Without engulfing myself in an epistemological discussion, what I want to say is that next to anyone's knowledge and perspectives might be as relevant as mine.



nopsam said...

Vilhelm writes: “Perhaps, you might be more of an "expert" on the subject than I am, and that it really should be the other way around, i.e. that I would need to learn something from what you might write on Kaliningrad in a regional context? One never knows...”

Oh Vilhelm, you know that I am no expert. There's absolutely nothing you could learn from me as I am only a humble contributor to blogosphere and my blog is all about self-expression and has absolutely no nutritional value in what sense ever. I do not take my blogging serious, why should anybody else ?

I like your entry on the Baltic states and this is why I think that your view on Kaliningrad will be interesting, particularly form the viewpoint of a Scandinavian, not a Russian.


Vilhelm Konnander said...

Dear Sergej,

Would not the world be a much better place if anyone willing could join the blgogosphere of self-proclaimed experts? ;)

Thanks for you encouragement to write something about Kaliningrad! I shall see what I can do.



nopsam said...


blogosphere is so easy to join. A few clicks with your mouse and woooops ... you have a blog. But I don't think the world would be a better place if it were inhabited by self-proclaimed experts only. The real experts cause too much chaos already.

A few more professionals wouldn't do any harm though. Unfortunately there are too few of them around.

So, I will snap to attention now and wait for your Kaliningrad Prophecy'. ;-)


Pēteris Cedriņš said...

An excellent overview of Latvia's imperiled economy, Vilhelm! The only thing I would add is that the devaluation rumors appear to have been started intentionally. TBT/BNS: "Authorities have already tracked down the mobile phone numbers of several people who sent text messages about the devaluation.
Bank of Latvia president Ilmars Rimsevics said rumors on the possible devaluation of the lat were intentionally launched on Fri. Jan 16 ahead of the weekend, when financial markets were closed. Rimsevics said currency exchangers might benefit from such a fuss."

Vilhelm Konnander said...

Dear Pēteris,

Thank you for this update!

When I wrote the piece, it was still unclear which were the sources of this rumour. However, one must always assume that someone tries to benefit from doing things like this.

Still, the situation is as it is - rumours or not - so the question was not whether they were real or not, but if there was substance to the overall picture. I believe the latter is the case.

Now, what has to be determined is who stood to gain from destabilising the Lat.

In my recent piece "Estonia: Battle by Bronze Proxy pinpointing the "culprits" was quite easy.

The question is if one may find a parallel in Latvia or if it simply was an initiative by minor entrepreneurs.

Perhaps, you may have something insightful to add.



Anonymous said...

There's a keynesian confusion that equates inflation with price increases. If demand for estonian labor force increase that causes wages to rise, but money supply stay the same, then it's not inflation. Eesti Pank started out 1992 adopting sort of full-reserve banking with D-mark as the reserve that later turned into Euros. Can anyone tell me if Eesti Pank have abolished this supreme principle? I am skeptic when I hear about Estonian economy overheating.

Pēteris Cedriņš said...

Dear Vilhelm,

The Financial Times ran an article yesterday that gives the latest; whether nefarious texting took place following Valgreen's Danske Bank analysis I don't know; as I understand it, the security services in Latvia are looking into the authors of the SMS messages. But I agree with you completely -- whether there was substance to the overall picture is what matters most (whether there was substance to the devaluation rumors is another matter, and there seems to be no substance there, at least not in the near term).

The overall picture is definitely troubling. The Government quickly established a working group, as described, but the key phrase at the FT is "doubts remain about the government's ability or desire to implement changes." Not a few people have warned about overheating for quite some time -- but it took the recent S&P report to get the Fin. Min. off its duff, and their first release consisted mostly of spin (to the point that one had difficulty discerning whether they were actually talking about the S&P report, which was quite gloomy).

The deeper problem is that Latvia's parties are primarily top-down structures sponsored by rather oligarchical business interests doing back room deals we'll likely never really find out about -- the impetus for the rush with the Border Agreement, for example, has never been properly explained, at least not to my satisfaction (see my blog for some notes on that, though my musings haven't much material on economics). It's worth noting, too, that there's a major horse coming up for trade in the very near future -- the President's term ends in four months, and as you know the President is not directly elected but chosen by our parliament. The strength of the current coalition was just crudely exhibited by the decision of parliament to override the President's veto of the "emergency" security law.

Warm regards,

Dr. J said...

Hello Vilhelm Konnander,

I would like to exchange links with your blog. I posted your blog to my "Partners" links. My page is dedicated to Estonian Housing Bubble. The page is in Russian, however my visitors do speak English.

Thank you!