RIGA - A top ratings agency for sovereign debt, Fitch Ratings, has reduced the outlook for Latvia and Estonia from stable to negative due to the two countries' large current account deficits. Bulgaria and Romania were also downgraded.
The news was not unexpected and continues the trend of analysts throwing up warning signs around the Baltic states on the world investment map.
In its announcement Jan. 31, Fitch said that Latvia's current account deficit has risen to levels that are "disconcertingly stretched" and that the risk of a hard landing 's or annual GDP growth plummeting to around 2 percent 's for the economy was still high.
For the past two years Latvia's economy has been the most rapidly expanding in the European Union, though the double-digit growth has come at the expense of macroeconomic imbalances such as high inflation, an overpriced real estate market and excessive wage growth. Estonia has been experiencing the same phenomena, though to a lesser degree.
In Latvia, Finance Minister Atis Slakteris said the rating should give the government the additional incentive to further tighten fiscal policy.
"We cannot yield an inch in working out and implementing a stricter fiscal policy and the economy stabilization plan," he said in a statement.
In the minister's words, "the most important measures in this plan should be government support to entrepreneurs 's support to exports, innovative branches and businesses with high added value, development of the labor market and improving competition."
He said the Finance Ministry would ensure a budget surplus this year and in following years and "revise the tax policy in favor of business and to facilitate development on the labor market."
To be sure, the wind has been taken out of Latvia's property market after the anti-inflation plan was adopted last year, and real estate prices have been falling over the past few months. What's more, the government posted a 1 percent surplus in 2007, largely due to better-than-expected tax receipts.
Inflation, however, remains a severe problem. It reached an incredible 14.1 percent last year on a wave of higher energy and food prices and, analysts agree, will continue to climb.
Economists have warned that any additional measures by the government to reduce borrowing could have a detrimental effect and that ministers should wait until the program put in place last year takes full effect.
In Estonia, central bank officials downplayed the significance of the ratings outlook.
"The main reason for the change in the outlook is the confusion that has reigned on the international financial markets during the past half year," said Marten Ross, deputy governor of the Bank of Estonia.
Indeed, after the sub-prime meltdown in the United States, international banks have less appetite for risk, including East European debt and equity. Baltic stocks have fallen dramatically since their highs last year.
The downgrade of Estonia's outlook to negative means that the probability of a change in the rating in the next one or two years has increased compared with earlier," Ross explained, stressing that investment risks in Eastern Europe, in Fitch's opinion, have risen across the board.
"Fitch believes that a soft-landing is the main economic development scenario for Estonia," he added.
GDP growth fell considerably in the third quarter last year, indicating the soft-landing scenario had started.
He said that growth in domestic demand would slow down this year. "At the same time growth in export keeps strong and the current account and foreign trade shortages are vigorously declining," Ross said.