Soft landing begins for Latvia, Estonia

  • 2007-08-01
  • Staff and wire reports
RIGA - The Estonian and Latvian economies are settling into the eagerly awaited "soft landing," as Estonia's growth in the first quarte of this year eases off a rapid 9.8 percent year-to-year increase, and Latvia's slows from 11.2 percent, says a new report released by Hansabank Markets. Estonia is clearly experiencing a slowdown in its economy, while Latvia is taking its first steps, the report states.
The Estonian economy is to grow approximately 8.6 percent this year and drop to around 6.9 percent in 2008, which would be within "an optimal level," say the analysts. The respective growth rates for Latvia are forecast at 9.0 percent and 7.0 percent, and for Lithuania 8.0 percent and 7.0 percent.

The main risk highlighted by the report is if governments continue expansionist policies, and in the process fuel ongoing consumer spending growth. Global economic developments are considered as still favorable in driving export demand, particularly in exports within the EU.
Suggestions of a calm and orderly slowdown come as welcome news, considering the repeated warnings from international observers that the Baltic states were at risk from overheating economies. Commenting in an AP article in March of this year on the Latvian government's anti-inflation plan, senior analyst at Danske Bank in Copenhagen Lars Christensen said that "At this point it seems pretty difficult to avoid a hard landing in the Latvian economy, especially in the property market."

Anxiety this spring of a possible devaluation of Latvia's currency due to the rapidly deteriorating balance of trade figures has subsided as well. Chief Economist at Hansabank Martins Kazaks says, "The risk of devaluation is minor at the moment. Due to our very thin and virtually sealed-off financial markets, external speculative attacks are very unlikely to be of any important volume, but with no improvements in macro imbalances the current situation is not sustainable."
Hansabank Markets believes that economic developments in Estonia and Latvia are following the scenario of a so-called soft landing, in which the fast economic growth of the past several years slows to a more sustainable pace easing inflationary pressures but not causing a big jump in employment numbers. Analysts foresee the possibility that Lithuania could fend off the problems characteristic in Estonia and Latvia by revising its economic structure more rapidly. Lithuania is set to see accelerating economic growth this year, they say.
Estonia is experiencing rapid deceleration of domestic demand and investment growth despite households' continued strong spending, which is fueled by growing employment levels but brings with it higher inflation numbers. Coupled with these developments has been the expected slowdown in loan growth in the face of rising interest rates.

Domestic demand pressures have likewise been reported as weakening for Latvia, and that after 1st quarter imbalances between strong local demand in retail and wholesale trade growth, at 15.3 percent, which far outstripped manufacturing growth of 2.4 percent, "A turnaround came in the 2nd quarter as the government's anti-inflation plan" started to take effect, the report says. Kazaks adds that "The role of the governments is largely the key to the success of the soft landing scenario. Regarding Latvia, currently the key short-term measures have been implemented and so far they seem adequate."
Although inertia carries the economy along, with core inflation still rising, retail trade growth rates in Latvia are shrinking, residential real estate price growth stalled in May, followed by a 3.6 percent month-on-month drop in June, and consumer and business confidence levels have moderated, and a slowdown for the 2nd half of 2007 is increasingly evident, say the analysts.

Kazaks says that the full effect of the government's plan "will be seen in the following few months, and that the measures so far address only demand issues, while supply issues still have not been adequately addressed."
The demand side of the economy, he says, can be quickly brought under control by government policies, but it's a more difficult assignment to affect the supply side, i.e. exports. "If supply measures, comprising labor markets, costs (inflation), export growth and innovation are too slow to be implemented, or to yield results, the risk is that domestic demand sectors rapidly contract while exports do not boost [fast] enough to compensate for the decrease in domestic demand sectors," he says.

Dienas Bizness however reported on July 30 that though the two largest banks in Latvia, Hansabanka and SEB Unibanka, have pulled back on their credit growth, other banks are stepping in to fill the gap. Latvian banks that can take out large syndicated loans from abroad find it difficult to pass up the opportunity to lend this money locally, at high-paying consumer loan rates.
Kazaks adds that so far we have only seen the first steps; there are still many things to be done to ensure a return to a sustainable growth path, which include addressing issues of emigration and immigration, reducing state pressure on the labor market via its very high vacancy rates and wage growth; export support programs, and changing incentives by taxing consumption more and income less.