LONDON - Moody's Investors Service downgraded both Estonia's and Latvia's long-term foreign and local currency debt ratings Sep. 12 in a move likely to increase investor worries about the economic prospects of the Baltic region.
Both ratings were switched from 'positive' to 'stable'. The changes were prompted by "worsening macroeconomic imbalances that have eroded the upside potential for the sovereign ratings of both countries in the foreseeable future," Moody's said, adding that persistently high inflation makes it "unlikely" that either country will win accession to the European Monetary Union in the next few years.
Moody's local and foreign currency government bond rating for Estonia is currently A1. The local and foreign currency government bond rating for Latvia is A2. The countries' Prime-1 short-term foreign and local currency ratings were unaffected by the change in outlooks.
"Latvia's economy is currently expanding at a very rapid rate, while economic growth in Estonia has recently slowed but remains high," explained Kenneth Orchard, Moody's Vice-President and Senior Analyst for the Baltic region. "Very fast growth has brought many benefits, but the risk is that a slowdown could be somewhat sharper than previously thought."
Moody's notes that macroeconomic imbalances in the Latvian and Estonian economies have worsened in conjunction with the acceleration in growth. Large-scale foreign borrowing by the private sector has fuelled household consumption and investment in property, which have been the primary drivers of economic growth over the past few years. The rating agency believes that property markets are exhibiting bubble-like characteristics, although prices have started to decline. Current account deficits, as a percentage of GDP, are now amongst the highest in the world.
Following the European Commission's refusal to allow Lithuania's entry to EMU in May 2006, Latvia and Estonia have deferred adoption of the Euro indefinitely. The major concern for both countries is the inflation rate, which, at around 6% in Estonia and over 10% in Latvia, stands far above the required ceiling for EMU accession.
The move from Moody's echoes similar predictions by numerous other analysts in recent weeks.
But Orchard did have a few words of comfort. "The governments of Estonia and Latvia remain solid 'A' credits, and Moody's does not expect a material deterioration in the governments' underlying creditworthiness," he said.
"Despite increased external debt, Moody's believes that the Latvian and Estonian banking systems are resilient to both liquidity and external trade shocks," he concluded.