RIGA - A recent report by Nordea shows a mixed, yet all-round upbeat picture for the Baltic states' further economic development, predicting that higher ECB interest rates will help create a soft landing for the region's stellar, if not "irrationally exuberant," growth.
The recent growth in the Baltics has been credit-driven, and thus reflected in real estate and large-item purchases. As a result, in all three countries inflation has reared its ugly head. The Baltics have the highest rates of GDP expansion in the EU (and the world), as well as some of the steepest increases in consumer prices. Inflation has pushed back the countries' chances of joining the eurozone in the near future.
According to Nordea, the Baltic economies may be headed toward a situation where wages rise due to inflation and not productivity, causing export-based manufacturing and competition to suffer.
In Latvia, Nordea writes, "The signs of a slowdown are still weak and partly contradictory, and they are presently confined only to manufacturing. Confidence surveys have pointed to a continuation of the current expansion, particularly in consumption and construction."
The report gave Estonia and Latvia the distinction of having the largest lending portfolios in the Baltic states, reaching up to 80 percent of GDP. Importantly, 75 percent of Latvia's loans are denominated in euros.
According to Nordea, housing in Latvia seems to be overvalued, and the gap between wages and real estate prices continues to grow. Current prices are 10 times higher than Latvia's average annual income. Rents have not kept pace with housing prices - renting a flat will become cheaper than buying, signaling a market based slow down in the works for the housing sector.
Labor issues are particularly gloomy. The lack of working hands has taken much of the wind out of the current building/real estate boom, causing an increase in construction prices. Inflation in the construction sector stands at 26.5 percent in Latvia, 10 percent in Lithuania and 11.2 percent in Estonia.
Indeed, labor issues in the Baltic states will most likely put a crimp on real estate-driven growth. The combination of negative demographic trends, low wages at home and the right to work elsewhere in the EU has resulted in a mass exodus of much-needed professionals. Even if building and engineering are some of the most popular subjects studied at trade schools and universities, there will be at least a five-year gap before new workers are trained and experienced enough to meet the minimum requirements of the construction sector.
Is there a solution? Importing qualified labor from abroad is a politically sensitive issue. Due to the Baltics' cultural and linguistic legacy, migrant labors would originate from Russia or the former Soviet republics, a process that Baltic independence movements hoped to reverse in the early '90s. To be sure, construction markets in Russia and the Ukraine are growing as well, creating labor shortages of their own.
Estonia and Lithuania have both ruled to keep their doors open to Romanian and Bulgarian workers once the latter two become EU members in 2007. Latvia is considering the same. However, comparatively low wages and high housing prices will likely put the Baltics last on the list for EU opportunity seekers.
In spite of these challenges, Nordea sees a bright future for the Baltic economies.
"The Baltic countries and Poland will become the economic center of tomorrow in Western Europe. There is no need to look for economic tigers in Asia - they are at our very threshold," says Mikka Erkkila, senior analyst and specialist with Nordea Poland.
The exodus of workers from the Baltic states may have a boomerang effect on the economy. As labor migrants from new EU countries bring down average salaries in more developed countries, inflation at home pushes domestic wages up.
Some migrants, having gained valuable economic experience and contacts abroad, will no doubt return, and their experience abroad will direct the infant "Baltic tiger" countries toward new export markets and business opportunities.
