Optimism overheating Estonia, Latvia's economy

  • 2006-12-13
  • By Gary Peach
RIGA - The Baltics' economic euphoria shows no sign of abating, as Latvia and Estonia's gross domestic product growth for the third quarter remains in double-digit territory. The Latvian Statistics Bureau reported on Dec. 8 that economic expansion in the July to September period increased 11.9 percent compared to the same period last year.

The stunning rate even surpassed Estonia's, which posted an 11.6 percent jump in GDP growth during the third quarter, and placed Latvia at the front of the EU25 in terms of economic expansion.
Economic activity was led by trade, which soared 18.9 percent, construction (14.8 percent) transport and communications (9.8 percent) and manufacturing (6.8 percent).

On the flip side, inflation remains high, and with energy prices set to rise next year there are no signs that it will relent. Consumer prices rose 1 percent on a monthly basis from October to November, and annual inflation amounted to 6.4 percent. The statistics bureau said the price-rise was mainly sparked by increases in food and heat.
Analysts said annual inflation for the year 2006 would likely come in around 6.5 percent, slightly below last year's level, and that 2007 would see a similar boost in consumer prices.

With such high macroeconomic results, the discussion of economic overheating was raised anew.
"If you look at specific issues, then the market has been overheated for quite some time," said Martins Kazaks, chief economist at Hansabanka, in a recent interview.
"For instance, if you look at the labor market, unemployment is decreasing, and at the same time unemployment in Riga is around 4 percent, so the market has already overheated," he explained, adding that two-thirds of Latvia's GDP comes from economic activity in the capital.

As Kazaks went on to explain, the crux of Latvia's problem is that the gap in wage growth is outpacing the increase in productivity. Judging by 2005 data, the wage growth-productivity situation was stable, he said, but the numbers for the first half of 2006 point to a diverging trend, with wages significantly outpacing advances in productivity.
However, the current government has so far preferred to stress growth, particularly for the sake of catching up to the rest of Europe. Finance Minister Oksars Spurdzins told reporters on Dec. 8 that the government wanted to maintain annual GDP growth in the 7 's 10 percent range.

"If we don't maintain the rate of growth, then we will not reach the average EU living standard soon 's and we may never reach them at all," he said.
In Latvia, real wages have grown by about 14 percent in the first six months of the year, while the average productivity has increased only by 8 percent, Kazaks said. "So if you look at the labor market, it is not just a matter of overheating risks 's the overheating is already there."

In Estonia, third quarter GDP growth amounted to 11.6 percent, the nation's statistical office reported on Dec. 4, fuelled by trade, transport, manufacturing and construction. First and second quarter growth were both 11.7 percent. Annual inflation at the end of November was 4.6 percent in Estonia.
Estonia continues to lead the Baltics in terms of wealth per capita, with average annual economic growth over the past 10 years amounting to 7 percent, compared with 6.2 percent for Latvia and 6.1 percent for Lithuania. In the eurozone, the average annual growth in the 1995 's 2005 percent was 2 percent.

Last month Eurostat reported that GDP per capita in Estonia 's in terms of purchasing power parity - would reach that of Portugal's in 2007.
The Postimees daily reported last week that the average monthly salary in Estonia would reach 10,000 kroons (640 euros) in the fourth quarter. As in Latvia, Estonian wages are skyrocketing 's some 15 's 16.5 percent annually 's and there is no sign of the pressure letting up.

Analysts stressed that the government needs to tighten the reins. "The best thing for the government to do would be to slow down the real estate market because it is spilling over into other sectors," Kazaks said.
As he explained, optimism is driving the Baltics' economies. And one of the sectors fuelling the optimism is real estate: consumers take on cheap loans, buy apartments and houses, and then, basking in the illusion of endless wealth, go right on spending.

Economists have argued that by taxing capital gains on property sales, the Latvian government could take some of the speculative steam out of the real estate market and slow the current borrow-and-spend cycle.
Meanwhile, in Lithuania the economy continues to be robust but without the alarming intensity in the other two Baltic states. Third quarter growth was 6.4 percent, and annual average inflation at the end of November amounted to 3.6 percent. Year-on-year inflation has been rising steadily in Lithuania and reached 4.4 percent by the beginning of December.