Update on the development of the Baltic equity markets

  • 1998-09-03
  • By Roberts Idelsons
Stock markets of thethree Baltic countries are similar and different at the same time. The political situation is stable in all three countries, but there are certain uncertainties concerning Latvian - Russian relations. Many Latvian companies are suffering and forced to decrease business activities because of bad political relationships between Russia and Latvia.

Financial markets are not in quite the same condition. Estonian banks suffered more from the stock market crash at the end of 1997. Latvian and Lithuanian banks were implementing a more conservative policy. As a result we see a more favorable situation in these countries.

The insurance sector was also hurt, but in Latvia and Lithuania insurance companies are still experiencing rapid growth compared to Estonia, where growth is slowing down. During the first half of 1998, premium growth in Latvia was about 100 percent, in Lithuania it was 32 percent and in Estonia only 7 percent. Losses from investment portfolios are bringing profits down and Estonian insurance companies are clearly experiencing problems.

Privatization programs are still not finished in Lithuania and Latvia. Latvia will benefit most from completion of the privatization program by the end of 1999. Currency exchange regimes are similar in all three countries; Lithuanian national currency, litas, is pegged to U.S. dollar, Latvian national currency, lats, is unofficially pegged to SDR, a basket of five major currencies, and Estonian kroon is pegged to German mark.

Foreign investors' participation is quite similar in all three markets, but Estonia is getti?additional benefits from Scandinavian investors and speculators holding more than 30 percent of market capitalization. Trading models are almost the same in Lithuania and Latvia (continuous trading based on the public order book), but different in Estonia, where a market-makers system has been introduced.

Impact of the stock market crash

As a result of stock markets' crash in autumn 1997, indexes of all three stock exchanges decreased by more than 50 percent. Estonia suffered most, but continuous confrontation between Latvia and Russia as well as low liquidity of the Riga Stock Exchange and growing pessimism in Lithuania forced investors to post almost the same loses in all three countries.

But the financial sector in Latvia and Lithuania seems healthier than in Estonia. The difference is the Latvian and Lithuanian banks and insurance companies were not so involved in local equities market as their Estonian colleagues. This brought significant problems to the Estonian financial sector and forced banks to search for merger possibilities in order to increase efficiency.

Many stock market related scandals (Tallinn Pharmaceutical Plant, Estonian Savings Bank etc), bankruptcy of Maapank and unclear situation with profit figures for 1998 and profit growth perspectives for following years made the market less interesting for the investors and lenders. As a result interest rates went up twice slowing down growth of economy, decreasing consumption and profits of industrial companies.

Main problems

Outflow of domestic money from the stock markets is a significant problem. Fall of prices and pessimistic perspectives forced local investors to sell shares and withdraw money from the mutual funds. As a result markets are becoming less liquid as significant foreign buying interest are still not seen.

Issuers and intermediaries also suffered from this situation. There are less possibilities for public equity financing (there were no IPOs on the market in 1998 as issuers are waiting for better market conditions) and development of corporate finance sector is slowing down despite growing interest from the companies.

State property privatization programs are not as successful as planned, the market experienced some failed placements (Grindex in Latvia). Slowing down of privatization is affecting market capitalization as some big companies are still waiting to be initially offered to the investors in Latvia and waiting for completion of privatization in Lithuania.

Low liquidity of the markets is one of the main problems as the market is too small to provide foreign institutional investors with investment opportunities. This will improve (especially in Latvia) as largest companies are still not privatized and many private companies are expected to hit the stock market in the coming few years. Consolidation between the three markets in order to create a "Baltic" stock market will also make this region more attractive for foreign investors and boost liquidity.


Liquidity is the key issue for any market. Liquidity in the Baltics suffered from the stock markets turmoil in Asia. Currently the Tallinn Stock Exchange enjoys the best liquidity mainly supported by local banks and Scandinavian investors. Trading system in Tallinn also makes the difference proving the market makers system creates more liquidity on this small market. Some modifications of trading systems in Latvia and Lithuania will probably force dealers to trade more actively and bring more confidence to the investors.
Nevertheless the block market is quite active and there are certain possibilities to trade blocks representing up to 10 percent of the company. This brings us to the low market capitalization problem, which is the primary problem. Without increasing market capitalization it's not possible to speak about significant changes in the liquidity.
Creation of public mutual funds and allowance to sell control stakes in the privatized companies hopefully will also increase liquidity on the Latvian market.

Role of the banks

Banks still have the leading role on Baltic stock markets. At the moment banks are producing the largest part of turnover - about 50 percent in Latvia and Estonia and about 10 percent in Lithuania. Banks are the leading brokers and no changes are expected in the situation despite some strong brokerage companies operating in Estonia and Lithuania.
Banking is still one of the most profitable sectors and there are good possibilities for further development and increasing efficiency. Recent year show that better strategic management and risk management is needed for the banks. Assuming management will improve and taking into account growth of the economies, banks still have much room to grow. Consolidation of the banking sector in Estonia is expected to continue in Lithuania and Latvia accelerated by the Russia financial crisis.

As a result, despite decreasing market share and more companies going public, banks probably will still dominate the stock market.

Issuer's perspectives

There are different perspectives for issuers in the three Baltic countries. Estonia has already gone through the peak of investors' interest while Latvia and Lithuania are still underdeveloped and unexplored.

As interest for equity instruments went down there are good perspectives for the debt instruments. From the issuer's perspective there are certain advantages for securities debt compared to the bank loan and there is a good domestic demand for this type of instrument.

Many public equity placements scheduled for 1998 are postponed and it seems market conditions will not improve till 1999. But growing interest for private equity deals leaves the possibility for companies to raise money not only trough debt but also through equity financing.

Perspectives for development

Despite all the problems there are still good fundamental and interesting stories about the Baltic market. Economies are still on the rise and this is the main factor attracting interest to the region. Companies are becoming more open and there are some big companies to go public shortly.

Quality of brokerage, research and corporate finance services are growing as competition tightens and the financial market is undergoing significant structural changes and consolidation.

Some steps have already been taken toward consolidation into the unified "Baltic" market, which will be more attractive to foreign institutional investors.

Same tight regulations for issuers and intermediaries in all three countries have to be introduced. Cross Baltic registration and settlement should be in place shortly and cooperation between stock exchanges should bring more liquidity. Modifications in legislation should bring Baltic stock markets up to date with those of developed countries.

(Roberts Idelsons is the head of securities department at Trasta Komercbanka.)