I was just browsing through a months worth of Economist articles and found this interesting, brief analysis of the Baltics as the rising stars in the EU economic arena…specifically Estonia and Latvia.  I didn’t see that anyone else had posted it, so…  If you go to the bottom of the article there is a link to the article online at economist.com where you can also find sidebars with links to EBRD reports on both countries.  Any thoughts?

THE DYNAMIC DUO
Dec 13th 2006

Europe’s booming Baltic corner

DOUBLING your living standards every six years would seem a breakneck
pace of growth even in east Asia. In Europe it is unheard of. But two
Baltic countries, Estonia and Latvia, are growing at 11.6% and 10.9%,
respectively. This speed is unexpected. Of 13 forecasts looked at last
year by the European Bank for Reconstruction and Development, the
highest for Estonia was 6.4%; even Estonia’s own central bank reckons
that the long-term growth rate is only 7-8%.

The pair’s high growth is an exceptional product of good luck and good
policies. Both countries are stable, business-friendly and cheap, and
lie close to large, rich markets. They have flat taxes, cleanish
government, balanced budgets and stable currencies pegged to the euro.
Foreigners like all this: Estonia is Europe’s biggest recipient per
head of foreign investment.

Consumption is soaring in both countries, as is credit. Estonia will
see money-supply growth of 33% this year; in Latvia mortgage lending
rose by 90% in the year to October, and credit-card lending doubled.
That reflects the rise of a western-style financial industry that lends
in a way yet to develop in most of eastern Europe. “Foreign banking is
a big reason for our success,” says Andres Lipstok, governor of
Estonia’s central bank.

Can the good times last? Signs of a property bubble abound. The
authorities want to tighten banks’ lending. If a crash came, its
effects should be contained by outside ownership of banks (99% in
Estonia, and 80% in Latvia): foreign shareholders, not local taxpayers,
would suffer if loans went bad. Both countries have huge
current-account deficits (17.9% of GDP in Latvia and 12.5% in Estonia).
But for poor economies trying to catch up on 50 years of development
missed under communism, a thirst for imported technology is
commendable. Balance sheets are strong—indeed, Estonia has no net
foreign debt.

The bigger worries are twofold. Even as the Baltic hot rods scorch
across the tarmac towards European living standards, they lack any
brakes. Monetary policy cannot contain inflation (their currency boards
give the two countries no independent control over interest rates).
Fiscal policy works in theory but not in practice: Estonia already runs
a big budget surplus, and Latvia is not far behind.

Wages are spiralling thanks to a boom in labour-thirsty industries such
as construction, retail and tourism. Both countries are struggling to
integrate Soviet-era immigrants, so importing more labour from the east
is hugely unpopular. But tempting back the many locals—especially
100,000-plus Latvians—who have moved to work abroad is tricky.
Latvia’s president, Vaira Vike-Freiberga (herself a returned emigre),
says it is not just the money: Latvians find that foreign bosses and
colleagues treat them more kindly and respectfully than their
compatriots do, and public services such as health care and transport
are better abroad.

So far, soaring productivity growth has masked the labour market’s
tightness. But that will not last. The big task for both countries is
to move to an economy based on brain not brawn. That requires a liberal
immigration regime—at least for skilled foreigners—and a
transformation of the calcified, self-satisfied education system.
Neither is yet in sight: in both countries, smugness rules.

Latvia’s coalition government, closely tied to local big business,
shows little appetite for reform. Estonia, which has a parliamentary
election in March, looks more hopeful. Its star politician, Mart Laar,
is now leading the opposition after a break evangelising for the flat
tax that he introduced when prime minister in 1994. His party slogan is
“happiness does not lie in money”. That would once have been laughable.
Now it sounds quite good.

See this article with graphics and related items at
http://www.economist.com/world/europe/displaystory.cfm?story_id=8417995

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The Economist published a less optimistic article on 12 January: “Latvia’s prospects: the bounding economy may be heading for a fall”—

http://www.economist.com/agenda/displaystory.cfm?story_id=8539864

/P

I am always sceptical of these type of articles. It all depends on who you think this benefits. Gross growth can be interpreted in so many ways. If you are 1000% behind 10% gains don’t amount to much.
And growth in borrowing is always bad in my view. I am alergic to debt. So sez the man who is about to put a $2500 on his credit card for a trip to Phuket. :(

Andrejs

It is the US that is deepest in hock to the rest of the world, and it is still growing.  On the other hand, that reminds me of an old joke:

“If you owe a thousand dollars to a bank, the bank owns you.  If you owe a million dollars the the bank, you own the bank!”

Fun with numbers. Dark clouds on the horizon?

Andrejs

Warnings pour cold water on Latvia’s red-hot economic growth

Mar 1, 2007, 15:03 GMT

Riga - A series of warnings from international economists have cast a chill over Latvia’s economy only a week before the Baltic state is expected to announce record-breaking GDP growth.

On Thursday, the Financial Times ran an article on its website, ft.com, warning of ‘uncomfortable economic imbalances’ in the Latvian economy.

Next Friday Latvia is expected to post its full-year GDP growth figures for 2006, with analysts predicting a figure which could be as high as 12 per cent.

But the FT article adds to warnings from international experts that the economy may now be growing too fast for its own good.

On February 10, economist Morten Hansen of the Stockholm School of Economics in Riga wrote that ‘if Latvian competitiveness keeps being eroded by high inflation it may have to be restored via a devaluation’ in an essay published in leading daily Diena.

Inflation in Latvia has been above 6 per cent ever since it joined the EU in May 2004, while rocketing domestic consumption has driven the current-account deficit above 20 per cent - equal to borrowing 13 million euro per day, Hansen pointed out.

Government and bank officials hastened to reassure the Latvian public that there was no risk of imminent devaluation, but only nine days after Hansen’s essay was published the Standard & Poor’s rating agency downgraded Latvia’s outlook from ‘stable’ to ‘negative.’

‘The Latvian economy is showing clear signs of overheating. Without the introduction of prompt policy measures to curb surging domestic demand, there is an escalated risk of a hard landing,’ the agency said.

And four days later, Danish bank Danske warned that Latvia’s economic dangers were mirrored across the so-called ‘New Europe.’

‘Latvia is not alone in the danger zone. It also includes two other Baltic states, Estonia and Lithuania, and the two south-eastern EU members Bulgaria and Romania,’ the report said.

The Latvian government has promised to develop an action plan for tackling inflation. The plan is due to be announced next week.

But as Latvia’s economy continues its breakneck race ahead, observers are likely to continue pouring cold water on predictions for future red-hot growth.

‘The longer the imbalances in the economy continue to build up unchecked, the more likely it is that the economy will have to go through a painful adjustment,’ Standard & Poor’s said.

There was a scare? Actually the fact that Latvia and China are mentioned in the same paragraph scares me the most. Did Gonzo know and when did he know it?

Andrejs

Markets regain poise after Latvia scare

All Financial Times NewsFinancial markets in central and eastern Europe have regained some poise following the turmoil in the Baltic states sparked by rumours that Latvia was preparing to devalue the lats.

The upheaval has, however, reminded investors of the risks accompanying the hoped-for rewards of putting their money into the fastest-growing economies in the European Union.

It was a scare but a small one. In general, the region has retained investors’ confidence despite the global sell-off in financial markets last month over concerns about China.

While the region’s stock markets are down from their highs for the year, seven out of the 10 bourses in the EU’s new member states remain above their levels at the start of 2007.

Investors are concerned about countries with large economic imbalances, notably Romania, Bulgaria and the Baltic states. But Peter Brezinschek, head of research at RZB Group, the Austrian bank, says countries with problems are identified as isolated risks not as signs of a region-wide problem. “We have seen very few spillover effects,” he says.

Erik Nielsen, chief Europe economist at Goldman Sachs, the US investment bank, also sees no evidence of widespread trouble. He says: “It seems to me that these are hiccups on the road to a market economy.”

However, others disagree. Lars Christensen, an economist at Danske Bank, a Danish bank, which published a bearish report on the region before last month’s Latvian turmoil, says: “We are concerned about the state of economies in central and eastern Europe in general. Countries could become more vulnerable with the ending of easy monetary conditions globally.”

At the heart of the matter is the region’s rapid growth, which has brought with it the risk of overheating as investors have rushed to buy property and other assets while strong domestic demand has, in some countries, put upward pressure on wages and prices. Domestic demand has sucked in imports, generating current account balances. Overall, the current account balances are covered by foreign investment inflows: but the bigger the deficit, the greater the potential danger from changes in foreign investor sentiment.

Countries with fixed exchange rates are particularly exposed because a run on the currency can escalate into a trial of strength between speculators and policymakers. The three Baltic states have pegged their currencies to the euro, as has Bulgaria. Other countries manage their currencies in bands against the euro, except for Slovenia which joined the eurozone this year.

The Baltic states face the extra challenge of sitting aside big trade and investment flows involving Russia, which can have disproportionate effects on the local economies. Latvia last year recorded gross domestic product growth of 11.5 per cent and inflation of 7 per cent – both the highest in the EU. Soaring increases in property prices and credit growth poured fuel on the flames. The current account deficit at the end of 2006 was 18.5 per cent of GDP.

This week, the government announced plans for credit controls and fiscal tightening, going from a 2006 deficit of 0.4 per cent to a balanced budget this year and next. Danske Bank says bluntly: “Too little, too late.”

Lithuania and Estonia are in a better position, with lower growth and inflation rates and smaller current account deficits. But Danske Bank still puts them in the danger zone. So does Fitch, the credit rating agency, which this week issued a report saying there was a risk of “psychological contagion” in the Baltics.

Meanwhile, Romania this week took pride from a 7.7 per cent GDP increase that made the economy bigger than Hungary’s. However, Bucharest was urged by the International Monetary Fund to damp domestic demand and reconsider recent interest rate cuts. IMF officials questioned plans to increase the budget deficit from 1.7 per cent of GDP last year to 2.8 per cent when GDP growth is strong and the current account deficit reached 10.3 per cent of GDP for 2006.

The Bulgarian authorities run a tighter fiscal ship, with a 3.7 per cent budget surplus last year – the EU’s biggest. But soaring investment and strong consumer spending is fuelling high economic growth (6 per cent last year) and pushing the current account surplus to high levels – 16 per cent of GDP for 2006.

Investors are less concerned about Poland, the Czech Republic, Slovakia and Hungary. In Hungary, the government’s deficit-cutting plan, launched last year during a political crisis, is starting to have an effect, easing economic concerns.

Latvia’s turmoil does nothing to advance governments’ plans to join the euro. Riga has abandoned a 2008 target and is now aiming for 2011-13, leaving Estonia and Lithuania targeting around 2010. Slovakia is preparing for entry in 2009 but the rest of central Europe is aiming for 2010-12 and Romania and Bulgaria are considering 2012-14. Recent events demonstrate such dates must remain tentative.

Copyright 2007 Financial Times