Baltic Tiger: In the Eye of the Storm
By Oleg K. Temple, October 2009.
Unemployment, defaults, foreclosure and bankruptcy have become the bywords of our time. The domino effect that hit the rest of Europe in 2008 was but a glancing blow to some countries such as Norway. The country domestically contained the crisis largely, by virtue of being outside the EU and continued full sail in true Norse fashion. Currency Expert Chuck Butler* comments that the Norwegian krone is HSBC's preferred G10 currency where the bank expects a sustained appreciation over the next 18 months. Whereas the crisis wasn't as kind to Latvia, Lithuania and Estonia, countries that were much more vulnerable, colliding with the recession maelstrom head-on. Indeed, the Baltic countries were caught off-balance in their 3rd stage of transition to the Economic Monetary Union of Europe. After a decade of unprecedented growth without foundations and safety measures, the inexorable economic law kicked in and the Baltic house of cards built on the shifting marsh of inexperience imploded with a bang. Today, the dust is beginning to settle and it is time to look to the future.
EU Ascension to Rapture | Macroeconomics | New Money | Less Bitter Pill
| Everyone has taken a licking, the rampaging recession has been kicking tail and taking names around the globe, ravaging the rich and the poor alike (well, almost). In April 2009 many news outlets reported that the recession in one year hit the wealthiest people in the UK collectively for over 155bn pounds and smacked the British Billionaire down on the endangered species list, culling their number from 75 to just 43 persons. |  |
It chills the cockles of my heart to think that this dreadful crisis scythed the questionable fortunes of the Russian oligarchs, forcing many of them down to their knees, from billionaires to the status of simple, plain millionaires. The plight of Donald Trump is a particularly entertaining epistle to behold, as he continues his attempts to cajole the courts and Deutsche Bank into accepting that the recession should be considered as force majeure and thus, his 40m debt should be dropped. How nice it would be if the little people could petition to get their little loans dropped or at least subsidised. I bet if the banks dropped 40 thousand from the credits of 1000 households with kids to raise, the world would be a better place, but nooo, by all means, give more money to "Scrooge McDonald" so he can buy another plane with golden plumbing.
Ok, enough ranting (for the moment), time to get serious, I will now review the various theories as to what caused the Baltic Backlash of the recession to sting so much. What could we have done better and how do we safeguard ourselves against a repetition of the tragic events of the past year.
Latvian Economy: The Road from EU Ascension to Rapture
From 2003 - 2007 the Latvian economy exhibited tremendous growth patterns and was dubbed the Baltic Tiger by many. Gross domestic product (GDP) soared by 12.2% in 2006 and 10.3% in 2007. Inevitably, the backlash came and predictably, it hurt - GDP crashed by 19.6% in Q2 of 2009. The sting of the recession was made that much more acute by a collimation of the following factors which tipped the trade balance and ultimately, culminated in the recession:
1) Wage and price inflation accelerated in early 2007, with core inflation rising to almost 10% by mid-2007. The CPI-based real effective exchange rate appreciated by 15% from EU accession to end-2007.
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2) Latvia's real estate prices hiked more than 60% in 2005 and 2006 and the annualized growth rate of the credit was over 50%. 3) An explosion in domestic demand, especially, private consumption and investment in real estate, as a result, the current account deficit peaked in late 2006 at over than 25% of GDP. |
These forces combined with secondary factors to smother the charging Tiger until nothing remained, but a meek, trembling cub.
Recent Macroeconomics of Latvia
Actually, the GDP began to plateau already in Q4 of 2007, and fell by 4.6% in 2008 as a result of a slowdown in lending that was struck in early 2007. The decline was sparked by foreign banks' concern about their overexposure and overextension to the Baltic countries. As the banks began to stone-wall loan applications and pull the plug on business, the rubber band keeping a lid on things snapped and a chain reaction began that ultimately brought the banking system to a virtual standstill.
The economy of Latvia now enters a phase of correction desperately needed to restore competitiveness and create an environment conducive to sustainable economic growth in the future.
1) In 2008 export grew by 8.7% and import dropped by 4.1%, as a result, current account deficit decreased from 23.8% of GDP in 2007 to 13.8% in 2008, and it is predicted to shrink down to 7.3% this year.
| 2) Inflation ebbs due to decreasing domestic demand and further wage cuts and low commodity prices are expected to wrestle it down to as low as 3.3% by the end of the year – a stark contrast from the crest of 15.4% in 2008. |  |
3) The economic downturn and resultant layoffs brought on a spike in unemployment, predicted to hit 12.7% by the end of the year, quite an increase from the 7% witnessed at the end of December 2008.
4) Remuneration has significantly subsided in all work sectors, an integral part of the correctional process, as real wages should stem from gains in productivity;
Presently, the LVL is riveted to the Euro and the Bank of Latvia flexes its reserve muscle in a complicated balancing act, buffering the LVL/EUR exchange rate, endeavouring keep all fluctuations within the 1% bracket.
Will "new money drive out old"?
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The private sector is salivating in anticipation of the Euro euphoria prophesized by the Latvian government for 2012, the Maastricht requirements are finally within Latvia's grasp. However, many experts still consider this deadline preposterous, as there are too many bones to sweep out of the system's closet. Latvian experts are holding their breath to see the "Euromorphosis" of Estonia in the coming months. |
We find empirically that despite the fact that the LVL is skewered to the Euro, people no longer trust in the Lat, viewing it as a high-risk currency. The vast majority of loans issued in the past few years have been in Euro and local traders (selling cars, real estate, advertising media, etc.) and employers prefer to cite figures in "hard" currency, usually Euro and convert to the LVL on the day of the transaction. From the above we may surmise that an unofficial, underground transition from the LVL is already in progress The lack of confidence in the domestic currency has been instigated by persistent rumours about hungry wolves of devaluation being afoot that have haunted the merchant flock for since 2006. Indeed, in the years gone by, economists and politicians flirted with the idea of devaluation, but never had the need to wed it, now the pros and cons must be seriously tallied...
International financial rescue of Latvia was not easily won, stringent control and tough structural reforms have been demanded to ensure future economic health and stability. Latvia has secured a loan amounting to EUR 7.5 billion from international financial donors to be released in measured chunks upon evidence of outlined adjustments over the next three years. Late last year, the IMF conceded to pick up about 20% of the tab to bridge Latvia's budget deficit gap from 2009 to 2011, the remaining budget hole is to be patched up by other international donors such as the European Bank for Reconstruction and Development (EBRD) and the World Bank. The EBRD is still involved in about 30 serious projects in Latvia, including infrastructure expansion (roads and RIX airport) and the April 2009 acquisition of a 25% stake in the then vulnerable and somewhat notorious Parex Bank. Despite these investments, the EBRD is determined to stick to its 2008 strategy and see Latvia graduate from its influence by the end of 2010.
Choosing the less bitter pill:
As the constricting deficits and debts asphyxiated the economy, Latvia was faced with two choices for salvation: devaluation of the currency or internal devaluation (i.e. drastic grounding of domestic costs). Both these options would be tough pills for the population to swallow, but it was clear that the economy was not going to be revived without strong medicine and a fair share of tough love. The real estate market has stalled and the tourism industry is stagnating as a result of the unjustifiably high currency indicator, something has to be done. A devaluation of the currency may quickly patch things up on the surface, but would not address the deep-rooted structural inadequacies and absurdities which would continue to undermine the system and exacerbate economic problems in the future.
Latvia has chosen to maintain course for the Euro transition in 2012 and slash domestic expenditure in an effort to regain sustained competitiveness. Gunnar Ljungdahl of the Stockholm School of Economics in Riga told Swedish business newspaper Dagens Industri in June this year that a devaluation would be detrimental to the system, despite short-term stabilization, as it would give the Latvian politicians an excuse to continue to overlook the glaring structural problems that plague the country. Government overspending is clearly illustrated by the medical and educational sectors, for instance the overabundance of village schools, some of which are keeping a full staff to cater for less than 10 pupils.
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Anchors have dropped on nearly all governmental spending fronts and the consumers have hidden in their burrows only popping out for an occasional quick forage for basic necessities, as a result prices for non-essentials have been melting like snow on a mid-spring afternoon. If shopkeepers wish to shift goods from their shelves and secure a turnover, they must bow to the wishes of the consumer and now that the tables are turned, the consumers have become ruthlessly frugal. However, on the 19th of September, the headline of the Diena and Dienas Bizness newspapers proclaimed that Latvian citizens are going to shop in Poland where prices are between 30 to 45% lower than in Latvia, so obviously, there is still room for prices to drop. |
* Chuck Butler is a Currency Expert and Editor of The Currency Capitalist and the free daily FX University Daily
Sources: Wikipedia, Ashurst Weekly Economic Update, Latvian Institute, Eurostat, The World Economic Forum.
© Oleg K. Temple, CornerstonesWorld.com, 2009.
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