TALLINN - The ratings agency Fitch has downgraded the long-term foreign and local currency ratings, as well as the country ceilings, of all three Baltic states.
Fitch announced the downgrade Friday, Oct. 3, citing concerns over the countries' current account deficits as the primary reason for the one-point drop in ratings. Fitch downgraded Estonia and Lithuania's foreign currency ratings from A to A- and Latvia's from BBB+ to BBB.
"The downgrade of the Baltic states reflects the risk that the deterioration in the European economic and financial environment will impose a more costly macroeconomic adjustment in the Baltic countries, given their large bank-financed current account deficits," said Edward Parker, head of emerging Europe sovereigns at Fitch.
Fitch has had longstanding apprehension about the Baltic economies, highlighting significant current account deficits and external financing requirements, rapid bank credit growth and rising external debt ratios as factors weakening ratings.
These concerns manifested when Fitch knocked Latvia's ratings down a peg in August 2007 and again at the turn of the year, when the company shifted the outlook of all three countries from stable to negative due to increased financing risks from the global credit shock.
With continuing deterioration of the European economy and the growing likelihood of recession in the euro area, there are heightened risks for economies with large external financing requirements and dependence on bank financing. This spells bad news for the Baltics as Estonia, Latvia and Lithuania all feature in the top ten economies with the largest gap between outstanding bank credit and deposits relative to GDP and total bank credit.
The announcement has prompted immediate and varied reactions from leading banks in all three Baltic states, signaling the gravity of the drop in ratings.
The revelation has made the most noise in Latvia, where the ratings drop has been put to political ends by fueling arguments against the government's proposed 2009 budget deficit of 1.85 percent of GDP.
Latvia's central bank responded to the news by saying it was a sure sign to Latvian policy makers that the opportunity to borrow at a reasonable cost in the future would be "severely reduced."
"This is a wake-up call to anyone who has been under the impression during the current budget debate that the country can afford to plan a deficit in 2009," said Martins Gravitis, a spokesman for the central bank.
In Lithuania, Gitanas Nauseda, chief economist at the SEB bank in Vilnius, commented that there may hard times ahead. "The chances Lithuania [will] have a recession have greatly increased, and the hard-landing scenario is getting more likely. We think that the economic decline may last till 2010, aggravated by the shutdown of Ignalina Nuclear Power Plant at the end of 2009," he said.
Meanwhile, Estonia's central bank has taken a more relaxed view, saying it would take Fitch's assessment "most seriously" but downplaying the risks of external financing.
"The dependence of Estonia's economy on [an] influx of foreign capital investments has diminished substantially, which is reflected in a very fast-diminishing foreign trade gap, and easing inflationary pressures," said Martens Ross, the vice president of Estonia's central bank.
He said the current volatile situation in the markets and investors' fears were the main reasons for the rating decision.