I was truly convinced that Mr. Zatlers virtually already was Latvia’s next President. However, I must confess I became very happy with the latest news about the uncertainty of the process, giving chances to Mr. Endziņš. Although I cannot say anything bad against Mr. Zatlers – I believe he is a good man and a good doctor, his proximity with Tautas Partija (he was one of that signing the manifesto founding this party) make me feel uncomfortable. However, the question is not the fact that he sympathises with Tautas Partija as he has the right to freely express his political believes, but rather that the coalition is trying to sell the image that he is apolitical. This is a naïve try to hide the fact that, probably, Mr. Zatlers as President would be a marionette.
The way the coalition is leading the economic (under)development of Latvia through a very interesting form of populistic policies (I’ll discuss this in the next days), very permeable to dark private interests is, to be gentle, very irresponsible. To have a President very influenciable by these forces is not a big deal. Is better to have some contraposition in order to assure a more pluralistic government and avoiding the “Aha, uhu, the State is our, let’s do whatever we want”. If monopoly is not an efficient model in Economics, in Politics is the same.
Anyway, what would be an easy victory, showing the unit and strength of the coalition, is turning in a more complex scenario. Jaunais Laiks is supporting Saskaņas Centrs’ Mr. Endziņš and there is no consensus between TB/LNNK’s deputies to support Mr. Zatlers. In this case, the result may be that both candidates will not receive the sufficient amount of votes to be elected and a new election will have to occur, with new political arrangements. In this case, it would be demonstrated that the basis of the coalition is not too strong, as it could be. Although discordances are perfect normal in democracies, in a country where the politicians are capable to stop urgent matters to discuss a mere question of synonymity as, for example, happened in the case of the support of the Latvian Parliament to Estonia, this may have unpleasant repercussions to the stability of the government. In Estonia’s matter, fortunately the Ministry of Foreign Affairs, Mr. Artis Pabriks, declared the support of the Latvian government immediately.
Let’s wait the next days. May be we’ll have some surprises.
Popularity: 3% [?]
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Popularity: 2% [?]
Some people affirm that one image may say more than 1000 words. In some cases it’s true. In relation to the Latvian economy, I have to agree. Click to enlarge.
Popularity: 4% [?]
The text below is a previous version of an article I wrote in may, 2006, published by Komersanta Vestnesis in 28, June, 2006, alerting to the structural problems of the Latvian economy. I brought up to date the statistics.
The pseudo-development of the Latvian economy: some points to be considered
Jānis Bērziņš
The rising inflation in Latvia is a problem worrying not only the government, but also the academic community and people in general. Although the inflation rate is a good indicator of a country’s economic health in such a way that low rates are always welcomed, the presence of some inflation also shows the economy is growing and, in sometimes, developing, as Lord Keynes has already shown, but some economists forgot. As the GDP shows, the Latvian economy is presenting a strong growth in the last years, obviously pressuring the inflation rate to higher levels. The problem facing the Latvian economy is not only the way the country is growing, but rather other macroeconomic aspects. In this way, there are some fragilities at the national accounts that should be taken into account to understand that inflation is not the biggest problem of the national economy, but rather the persistent deficits of the Balance of Payments, the External Debt, the way these deficits have been financed and, last but not least, the way the Latvian economy is (under)developing.
The first thing to be considered is the chronic deficit of the Current Account. This occurs due the very profound disequilibrium of the Current Account, consequence of the negative results of the Commercial Balance. As may be observed in the table 1, the results of both Current Account and Commercial Balance are presenting deepening deficits in the last years, result of the idiosyncrasies of the Latvian economy. As the country has experienced a process of deindustrialisation since the beginning of the 1990’s, most of the non-durable goods consumed internally are imported. Also, there is a repressed demand of durable goods and, as people want to get rid of the old soviet stuff, with the increase of the available income naturally there is a growing consumption of these goods. In this way, as the economy is growing fast and developing slow, what may be seen in the results of the components of the Payment Balance – first, the increasing deficit of the commercial account shows that although the exports are growing, the imports also and more intensively, second, the Service Account is stagnated since 2001, showing this sector could develop faster and, third, the growing deficits of the Income Account, and forth the Current Transfer Account’s erratic behaviour – the tendency of the deficits of the Current Account is to become deeper and deeper. The table 1 shows these treads. Click in the image to enlarge it.
With a persistent deficit in the payment balance, which has increased 108,9% in one year, there is other matter to concern, which is the way this deficit has been financed. As shown in the table 1, in 2006 the sum of the positive results of the Balance of Payments was only, nearly, 21,7% of the negative results, meaning that the deficit has been financed by the influx of external capital. If this external capital influx was in the form of Foreign Direct Investment, directed to competitive sectors, it would be very good to the national economy, helping to develop the country. Instead of that, the influx of Foreign Direct Investment, which could finance the deficit of the Payment Balance, in relative terms, are nearly in the same level in the last four years, both to the GDP and to the deficits of the Payment Balance. See the Table 2. Click in the image to enlarge it.
 If Latvia is not financing its external deficit with Foreign Direct Investment, it has been doing in another way. The answer to this question may be found in the passive of the Financial Account, precisely in the item “loans of banks”. Due the lack of internal savings in Latvia and the high spread level, with the development of the credit market, there is a strong growing influx of foreign capital to Latvia to be offered as credit to the general public. As already very well discussed in the economic literature, credit is a very powerful way to promote economic development, if directed to the correct sectors. However, credit in Latvia is not directed to promote economic development, but to consolidate a very dangerous speculative scenario in the Real Estate sector and to stimulate the consumption of durable goods, both indirectly pressuring the inflation index as a collateral effect.
With the prices of Real Estate still booming and going to surreal levels – is not feasible an apartment of the soviet times in a distant neighbourhood to cost more than some well-located property in Paris or London only because the professionals of the Real Estate want to receive bigger commissions and there is available credit – probably there will be a moment that the bubble will explode. In Finland, for example, the prices of Real Estate felt down 40% in some months in the beginning of the 1990’s. The problem is not only the socioeconomic problem of people having a debt of something that devaluated due the consequences of speculation, in other words, paying for something which actual value is very lower than the time it was bought, but the financing of the external debit of Latvia. The credit market, as every market, has a point of stagnation due the natural barriers, for example the population of a country, which usually cannot be easily transposed. Even if the Real Estate’s bubble won’t explode, there will be a time when the banks will start to repatriate their capital to theirs mothers, resulting in strong pressures to the national accounts and deepening the deficits.
Although, for one side, it will not be entirely bad diminishing the external debt of Latvia that already is more than the national GDP, the result may be the incapacity of Latvia to finance its external debt
, which would lead the country to a very profound external crisis. In other way, there are measures to avoid this situation, by planning the development of the economy. The analysis of the GDP’s structure shows that the dynamic of the Latvian economy rests mainly on the service sector, witch responded for about 75% of the Latvian 2006’s GDP, following the changes in the world’s economy. In the same way, an analysis of the structure of the Latvian service’s account shows that nearly 49% of the GDP depends of three sectors: Real Estate operations (14,8%), wholesale, retail trade, repair of motor vehicles, motorcycles, personal and household goods (20,9%), and transport and storage (13%), while manufacturing and agriculture represents only 15,4% of GDP.
The problem is that the performance of the Latvian economy is based in three sectors that, by their own idiosyncrasy, may appear very dynamic but after some time completely lose their capacity of development. Besides the question of speculation in the Real State sector, as already explained before, the demand for autos in general and personal and household goods is increasing as the growing incomes permits to people to attend their repressed demand related to this goods. After a growing period, the repressed demand tends to disappear, turning to normal levels. The transport and storage sector, by its side, depends of the production and commerce of material goods. As Latvia’s manufacturing sector is shrinking, besides the inevitable decrease of the commerce of durable goods, the transport and storage sector also may experiment a dynamical reduction. In this way, half of the Latvian GDP remains in a very fragile basis.
The only chance to Latvia is a well coordinated action by the government, stimulating the development of real dynamic activities in the service and in the manufacturing sectors, as also re-orienting the agriculture to high value-added activities, promoting a real development of the economy. The responsibility to develop the country in a sustainable way remains with the politicians. However, as the politicians in Latvia live in a world full of adventure, lyrism and magic, and the reality doesn’t even touch their souls, unfortunately this situation may turns in reality, and the adoption of very orthodox economic policies and the creation of a strong recession will be the only solution with very unpleasant consequences to the business climate and the population.
Popularity: 3% [?]
It is a curious and disturbing fact of current financial life that a message tapped into a mobile phone one morning in Riga, the capital of Latvia, can within hours trigger a run on the country’s currency amid rumours it is to be devalued.
Latvia’s security police say the SMS came from fewer than 10 sources and appeared to be based on a newspaper article arguing, but not stating, the currency could be devalued via an adjustment of its peg to the euro. The message spread virally, urging people to sell the Lats, the currency, and to buy euros or dollars instead. Queues formed at Riga’s foreign exchange bureaux, which ran out of euros, intensifying a sense of crisis.
The peg to the euro held fast, but the uncertainty caused three-month inter- bank rates to spike at 9 per cent from a previous range of 3.5-4 per cent. The central bank has intervened to support the Lats and raised interest rates.
The security police say they have hauled in “bankers and workers from the money exchanges” for interrogation amid claims they perpetrated an attempt to destabilise the currency for personal profit. The results of the investigation will emerge after Easter.
This quirky, high-tech, rumour-driven saga highlights the increasing nervousness surrounding Latvia’s incredible 12 per cent economic growth in 2006, and by extension the similarly high-octane performances of its Baltic neighbours, Estonia and Lithuania, up 11 per cent and 8 per cent respectively.
The anxiety is readily explained by a heady combination of high growth, rising inflation, tightening labour markets, spiralling credit growth and large current account deficits in all three countries.
Latvia’s current account deficit was 21.8 per cent in 2006; Estonia’s was 14.3 per cent; and Lithuania’s 12 per cent. Credit growth last year in Latvia was 57.6 per cent; Estonia 35 per cent; and Lithuania 56.6 per cent.
Unsurprisingly given these numbers, the world’s leading credit rating agencies – Moody’s, Standard & Poor’s and Fitch – have stepped up their analysis of the Baltics and reached the same broad conclusion: they are showing signs of serious overheating and, as a result, the possibility of hard landings has escalated.
More aggressive interpretations of the facts drew comparisons between the Baltics and the Asian economies before their crisis in 1997, reasoning that a hard landing in Latvia could trigger a contagion across the Baltics into countries such as Romania and Bulgaria.
While nobody dares rule this out, current thinking on this vibrant corner of northern Europe is more benevolent. The rating agencies have inhaled the pungent mix of ingredients pointing to a crash, but have chosen a more subtle dish dubbed by Moody’s “Baltics – a la Portuguese”.
The chosen comparison is with pre-euro Portugal, which experienced high growth, a pro-cyclical fiscal policy, rising inflation, a large current account deficit and rapid credit growth. When the cycle turned Portugal did not crash, but went into prolonged stagnation as overextended private sector balance sheets slowly adjusted.
The ratings agencies argue that the reason this is a more likely scenario for the Baltics is that all three economies have shown fiscal discipline with low levels of public debt and strong government finances. The amount of local currency debt held by foreigners is low and the banking system is almost entirely controlled by foreign banks, mainly Swedish.
Moody’s emphasises that all three economies are members of the European Union and pending euro members. “The comparison with Asia 1997 is misleading. It ignores the nature of EU integration, which lends support to a realistic real income convergence scenario and reduces considerably the risk of a sudden halt to external financing.”
Associated with this is a pressing need for euro membership for all three countries. Adopting the euro would “make the risk of external financing and currency crises negligible and as such is an exit strategy from their exchange rate regimes”, argues Fitch.
Lithuania’s bid to join in 2007 failed as its inflation rate was 0.06 per cent above Maastricht criteria and it has not announced a new concrete target. Estonia has abandoned its target of 2008 and hopes to make it by 2010, as does Latvia.
While there are reasons to be cautious, the strangely good news for the booming economies of Latvia, Estonia and Lithuania is that if their politicians fail to implement proper policies to cool growth, they will probably face a Portuguese- style period of slow and painful economic adjustment – hardly an enticing scenario, but better than a full blown crash.
Copyright The Financial Times Limited 2007
Popularity: 2% [?]
Henrys Leja exudes the kind of confidence only possible for a real estate agent in one of the world’s hottest property markets. He works in Riga, the historic capital of the former Soviet state of Latvia, where property prices are booming, up a heady 40 per cent between July and September last year.
Mr Leja is part of a new generation of fast talking entrepreneurs growing rich on Latvia’s year-on-year economic growth of 12 per cent. It is the first economic boom he has experienced since the country freed itself from Soviet control and “it just keeps going and going,” he says.
His boundless optimism is understandable, but goes against the grain of economic history. Booms are generally followed by busts, and late last week there was an ominous hiccup in Mr Leja’s confident sales patter about Latvia’s never ending growth.
It started with research report from Standard Poor’s, the credit rating agency, which downgraded its outlook for Latvia to negative from stable, saying there were “clear signs of overheating” and an “escalated risk of a hard landing” if no corrective action was taken.
The report was shrugged off until Danske Bank, a Danish Bank, issued a more disturbing analysis which claimed a bust in Latvia could trigger contagion across the fast growing Baltic states of Estonia and Lithuania into Eastern Europe, reminiscent of the Asian crisis of 1997.
“We are worried about no one else being worried,” said Carsten Valgreen, Danske’s chief economist. “All the macro indicators are flashing even more red than they were in Asia.”
For Danske, Latvia is “warning sign” for other central and eastern European countries, many of which have similarly high rates of growth, soaring inflation, large current account deficits, rampant credit expansion and runaway property prices.
“Latvia is clearly not the only central and eastern European economy showing signs of overheating and where the risks of a hard landing are high and increasing,” Danske concluded.
In Latvia, the reaction was swift. The Danske report triggered rumours – some spread by SMS messages on mobile phones – that the country’s currency, the Lat, which is pegged to the Euro, was going to be devalued. The Lat fell to a low of 0.7073 to the Euro from the 0.696 level adopted since January 2005 when the peg was adopted.
The air of mild panic was exacerbated by the fact that Mr Valgreen’s name is a familiar one in northern Europe. He attracted considerable attention last year after writing a chilly piece of research on Iceland which almost triggered an economic crisis there.
“We don’t have anything against small European countries,” he insists.
The situation in Latvia has since stabilised, but the affair lifted the mask on Latvia’s booming economy and revealed some uncomfortable economic inbalances across the Baltics and eastern Europe. In turn, this has prompted a debate about how politicians in the region plan to tame their booming economies.
Senior policy makers in Latvia insist action is on the way. Olegs Baranovs, director of the Department of Economic Policy, agreed the economy was overheating but said the release of an “inflation action plan” next week should reassure the markets.
He said this plan would involve “new taxes on real estate speculation” to cool the market as well as fiscal measures that will generate “a budget surplus or at least a small deficit”. Other unspecified measures should also be expected, he said.
Despite these calming words, doubts remain about the government’s ability or desire to implement the changes. Helmuts Ancans, head of the macro economics department of the Bank of Latvia, the central bank, warned next week’s “plan” was merely a working paper and that the government had a problematic track record implementing cooling measures. “We will see if it is just more window dressing or real measures,” he said.
“Fiscal policy has to do the trick, but if there is an absence like last year, an election year, it will do no good. Fiscal policy should go against the cycle and not be pro the cycle,” he added.
Eileen Zhang, the author of the S&P report that started the affair, concurs: “A soft landing needs urgent policy measures that must be implemented,” she said. Lack of implementation could trigger a full downgrade of the country’s credit rating, she warned.
But back in Riga, Mr Leja’s confidence is untouched by the recent events. “It was all just rumours,” he shrugged. “I am sure the banks doing the lending would not make mistakes regarding their own future.”
Copyright The Financial Times Limited 2007
Popularity: 2% [?]
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