Maybe it is because a young friend of mine here in Barcelona has just come back from a holiday in Finland with an Estonian girlfriend, or something similar, but I am pretty sensitive at the moment to the comparisons which are being made between what is happening here and what is happening in Tallinin.
This article in the Baltic Times today about language teaching in Estonian schools (complete text at the end of the post) is typical of what is in my head.
Basically I don't know a great deal about the current language reforms in Estonian schools, but, going by our experience here in Catalonia, intensive teaching in the Estonian language in the schools is vital as a means of integrating the Russian speaking young people into Estonian society and the Estonian labour market.
First off a few facts concerning Catalonia. The population here is 7 million. This breaks down roughly as follows - Catalan speaking families 3 million, Spanish speaking families from the internal migrations of the 1950s and 1960s 3 million, recent - post 2000 immigrants - 1 million. So native Catalan speakers are a minority, yet Catalan is the predominant public language. And Catalonia doesn't even have a state, just regional autonomy, and control over the education system. Sometimes you can do a lot with just a little.
Now all of this becomes very important when you come to think about the economic difficulties facing the Baltic Economies at the present time, difficulties which can be summed up in just two words: labour shortages.
Now Catalonia - despite being a historically relatively low fertility area - has been able to grow into one of the richest and economically most dynamic regions of Europe quite simply by leveraging immigration. Just look at the numbers. It is obvious.
What is also important is that Catalonia has developed an immense capacity for assimilating migrants from a whole variety of different cultures, including those coming from its large Spanish neighbour.
And don't imagine it has been any easier for Catalonia to assimilate Spanish speakers than it will be for the Baltics to assimilate Russian speaking ones. Maybe Russia is associated with authoritarianism and totalitarianism for Baltic citizens, but remember that after nearly 40 years of Franco dictatorship Spain was also associated with precisely these images and feelings in the minds of the Catalans. But they have swallowed their bad feelings, and turned the situation around. And this is what the Baltic states must now do. Their very economic survival is at stake. Latvia, Estonia and Lithuania need to become migrant assimilation machines - a la Catalana. This is the only real way forward to guarantee their citizens the standard and quality of life which they have every right to dream of. Sometimes decisions in life aren't easy, but sometimes you need to bite the bullet.
President of EU Parliament visits Narva, praises language reforms
TALLINN - The President of the European Parliament Hans-Gert Poettering gave tacit support to Estonia’s schoolbased language reforms during an official visit from Aug. 14 - 17. Poettering, a German conservative, veered off the normal diplomatic path by visiting the eastern border city of Narva to talk with residents about language concerns. While he acknowledged the often-leveled claims of discrimination against Russian speaking residents, Poettering said wider study of the Estonian language was the only way forward. He praised the government’s school reforms, which will see one extra class delivered in Estonian at Russian-speaking schools from Sept. 1. Poettering said the program was the key to better integration.
“It will then be possible to move on. It is important that the two communities should communicate with each other,” he said, adding that such communication was only possible through the broader study of the Estonian language. He also called for Russia to deal with its own history, and to adopt a better understanding of Estonia’s misery under Soviet rule. “Life under the communist dictatorship has left a very strong mark on Estonians. It is connected with liberty. That understanding, I think, is not very widespread in Russia,” he said. When meeting with Russian community groups and public figures in Narva, Poettering said it appeared most residents of the border city considered themselves Estonian, no matter what language they spoke.
His working visit also included meetings with President Toomas Hendrik Ilves, whom he invited to address the European Parliament, and Prime Minister Andrus Ansip, who demonstrated Estonia’s highly praised e-government cabinet room. Poettering, who comes from a legal background, was elected president of the European Parliament in January this year.
Tuesday, August 28, 2007
Thursday, August 23, 2007
A Welcome 'Slowdown' in Lithuania?
By Claus Vistesen
Cross Posted From Alpha Sources
Cross Posted From Alpha Sources
The CEE and Baltic economies are interesting; that much I think is certain. This is especially the case in the light of the recent financial market turmoil which have crippled liquidity conditions. As such, my suggestion as it has been in my previous (main previous entry!) notes on Lithuania and the CEE economies in general is to keep a weary eye on these economies since they might very well end being up at the forefront of any kind of rapid unwind of the current economic climate. Before we dig into the recent economic data I should direct your attention to the fact that my coverage of Lithuania forms a small part of a much wider coverage of the Baltic economies which is conducted alongside Edward Hugh who is running his Baltic Economy Watch
which is a poster blog covering the day-to-day evolution of these economies.
It has been while since the statistical office posted its estimate for Q2 GDP growth which came in slightly lower than the previous quarter. Generally, the GDP performance was narrated as a slowdown but in essence it is a very small one at that. In this way, Lithuania is still fairing at very high growth levels relative to the underlying and deteriorating capacity issues which are spelled out in my previous notes linked above. The graph below extents the GDP series to include Q2 2007 where growth nudged down ever so timidly to 8.0% from 8.3% in Q1.
As far as the other economic data which was treated the last time it is difficult to gauge a significant change. Regarding the CPI and PPI index my last figures already included Q2 and as last time we should be noting the steady upwards tick of CPI. Turning to labour costs and construction input prices only the latter seems to be updated relative to the last time we had Lithuania under the loop. The substantial y-o-y uptick in construction input prices suggest that activity in the construction sector by no means have cooled which indicates that the housing sector has not yet lost steam relative to what seems to be an obvious capacity ceiling. This further suggest, at least somewhat, that the risk of a sudden severe slump cannot yet be ruled out.
Another major thread in my analysis of Lithuania has been a rigorous analysis of the labour market as a proxy for assessing just what the underlying capacity issues were. Before we try to extent the analysis from where we broke off last time it serves to remember the inbuilt difficulties with securing adequacy in terms of analysing the human capital situation in Lithuania. The first issue relates to something which I have already briefly touched upon as it pits the data from the official Lithuanian Statistical Department against data from the Vilnius based Labour Exchange Office. The inbuilt downward bias in the data from the Labour Exchange Office suggest that capacity in Lithuania as measured by the unemployment rate and absolute number of unemployed persons is substantially lower than what is cited by Eurostat and the official statistical department. I cannot by no means give any indication as to which number to actually rely on but merely note that it is very difficult to provide a fixed point from which to make general analysis. However, what is very clear is that capacity in Lithuania is indeed declining and from already very low levels. The second point relates to general uncertainties regarding the population census which is well summarised in this small pointer from the Baltic Times.
Lithuania's state institutions do not know how many residents there are in the country, it has been revealed, with different bodies giving significantly differing estimates of the population. There are two offices subordinate to the Interior Ministry of Lithuania - the Migration Department and the Residents' Register Service. The names of the departments may give the impression that they keep track of population levels and how many passports have been issued, but this is not in fact the case, reports the Lietuvos Zinios newspaper. The Head of the Passport Division of the Migration Department,Danute Matareviciene,told the paper that she had no statistics on how many passports have been issued. The Residents' Register Service drew a balnk when asked as well.
The closest thing to an official figure can be found at the Department of Statistics. During the second quarter of 2007, 3,338,000 residents were registered in Lithuania, but only 3,162,879 have citizenship. Further confusion is created by data on official and unofficial emigration levels. Officially the number who left the country between 2003-2006 was 54,400. Unofficially the department puts the figure at 76,700, though other institutions suggest the number is actually as high as 500,000. Given the large number of Lithuanians working in other parts of Europe, and particularly the UK and Eire, this last figure seems far more realistic.
Apart from the obvious feedback mechanism with general labour market analysis this uncertainty also strongly affects my previous notes on net migration. Clearly, there can be no doubt that the trend is negative but when we think about this number of 500.000 cited as an unofficial estimate of net outward migration between 2003-2006 we also need to remember the inbuilt uncertainty relating to citizenship. More generally relating to the graphs I fielded in my previous main note the data is still more or less up to date. According to Eurostat the total amount of persons unemployed basically held steady in July at 75.400 compared to June's 75.300. This also translates into an unchanged unemployment rate at 4.7% in July 2007.
Lastly, and in connection with Edward's recent note on how Fitch downgraded Latvia foreign currency issuer default rating (IDR) to ‘BBB+’ from ‘A- as well as also downgrading the currency IDR to ‘BBB+‘ from A-. In this respect, Lithuania is still set on A and A+ respectively which reflects the fact that Latvia is showing stronger signs of overheating than its neighbour to the South. However, the recent move by Fitch on Latvia might be the first tentative sign that the current market turmoils will be followed by a more wide re-appraisal of risk. Especially in this light I will be looking closely at Lithuania and indicators such as labour costs, core inflation, and capital inflows since these indicators will be certain to raise the red lights quicker than they would have just a few weeks ago. Also, and since the genie now is pretty much out of the bottle in terms of coupling the current situation with the rumblings of 1998 the recent credit and capital inflows into the CEE economies should cause more than a few raised eyebrows.
As a final note I want to sketch out a bit where I am going from here on in my coverage of Lithuania and more generally the global economy. As such, I am thinking and collecting noted regarding a longer note on the rating agencies and their role in this whole debacle. On Lithuania, I will also try to look more closely at previously neglected areas in my analysis such as a detailed look at the balance of payment situation (i.e. source of funding) as well as the FDI stock which by no means is trivial. All this of course should be closely tied to the pegged currency and the strains this situation is set to be put in if the economy stays in its current high growth trajectory.
So in short, stay tuned.Wednesday, August 22, 2007
Migration and Latvia
Is Inward Migration A Solution To Latvia's Labour Shortages?
As has been repeatedly argued on this blog, given that a strategy of relying exclusively on fiscal tightening and strong deflation to address Latvia's overheating problem is fraught with risk, and may even in the best of cases fail to deliver the results anticipated, another possibility which could be be put under serious consideration would be the application of a determined policy mix involving both decreasing the pace of the present economic expansion and increasing the economy's capacity for expansion by loosening labour market constraints somewhat via the use of an open-the-doors policy towards inward migration. This would involve the active promotion and encouragement of a flow of migrants from either elsewhere in Eastern Europe or from points further afield. Such a move would seem sensible, and even viable given the fact that Latvia is a pretty small country. However, as Claus Vistesen notes here, this can only be thought of as an interim measure, since, as the World Bank has recently argued, all the countries in Eastern Europe and Central Asia are effectively condemned to face growing difficulties with labour supply between now and 2020 (so in this sense what is currently happening in the Baltics may be thought of as an extreme harbinger of the shape of things to come).
But given this proviso it is clear that a short-term inward migration policy may help Latvia escape from the vice within whose grip its immediate future seems condemned to lie. Such short term advantage may be important, since longer term solutions like increasing the human capital component in the economy and moving up to higher value activity, whilst important, need much more time to be able to have any noteable effect. You simply cannot take a 20 year old with a basic school leaving certificate and turn him or her into a high value technician overnight, and especially if you don't have that many twenty (or 15) year olds to play around with in the first place.
What is at issue here is transiting a fairly small economy from being locked onto an unsustainable path over onto a sustainable one.
As Claus notes in this post, Estonia has already taken some tentative steps in the direction of making access easier for external workers, and Estonian Economy Minister Juhan Parts is busy working on a set of proposals - which he is to put before the Estonian Parliament by November - which will attempt to address Estonia’s growing shortage of skilled workers. The quota of foreign workers will be doubled to about 1,300 and the bureaucratic paperwork is to be significantly reduced . Now it is true that Parts is still to bite the bullet of accepting the need for unskilled workers too, but in the present situation a start is a start.
Poland has recently being making more sustained efforts to attract workers from Russia, Ukraine and Belarus, but also from more distant lands like India, while the Czech Republic, which has already decided to introduce a kind of green card system for workers from other East European countries has representatives out in Vietnam. In this sense if Eastern Europe is to overcome the looming crisis, then she must certainly be imaginative, and be prepared to offer incentives and advantages to migrants, and not only to skilled ones, since if you have only a few children what do you really want them to do, the most menial jobs?
The last IMF staff report(September 2006) already drew attention to the fact that a number of Latvian economic analysts had been calling for an expansion in inward migration in an attempt to alleviate shortages and to dampen wage pressures. However, it seems that local policymakers generally have been taking the view that this would only have the effect of replacing domestic low-cost workers with imported ones, thereby holding down wages and promoting further emigration. The problem is that if the current wage-cost driven inflation continues then a hard landing will become inevitable, and with a hard landing their will most probably be another exodus of people driven out in search of work, so this is really no solution.
The IMF was, in fact, cautiously positive on the need to open up the labour market:
However being realistic, we need to note that Latvia certainly faces significant difficulties in introducing any kind of pro-migrant policy. One of these is evident, since any broad opening of the labour market may ultimately simply serve to put downward pressure on unskilled workers wages in a way which only sends even more of the scarce potential labour Latvia has out to Ireland or the UK or elsewhere. A recent report by the US Council of Economic Advisers made some of the issues involved relatively clear. The report cited research showing immigrants in the US on average have a “slightly positive” impact on economic growth and government finances, but at the same time conceded that unskilled immigrants might put downward pressure on the position of unskilled native workers. Now in the US cases these US workers are unlikely to emigrate, but in Latvia they may do.
Another difficulty which arises is the lack of availability of accurate data on the actual scale of either inward or outward migration in Latvia (this difficulty is noted by both the IMF staff team and the Economist Intelligence Unit).
As the IMF staff team note in IMF Selected Issues (2006) official statistics show that Latvia's population has declined markedly over the past 15 years, owing to both net outward migration and to a birthrate which has been well below reproduction rate since the early 1990s.
According to Latvian government data, Latvia had nearly 400,000 fewer residents in 2005 than it had in 1990. And according to the IMF calculations the population decrease is about equally explained by net outward migration (71 per 1,000) and by natural population decrease (births minus deaths, 75 per 1,000).
As the IMF comment:
"The fall in the population due to natural causes.......is also quite worrisome, as it continues unabated and will begin to exacerbate a shrinking labor market in a few years’ time."
According to the most recent estimate from the Bank of Latvia some 70,000 Latvians, or around 6% of the labour force, are currently working abroad - mostly in the UK and Ireland - but the true number is very likely considerably higher (IMF Selected Issues Latvia 2006, for example, put the figure at that point at nearer 100,000).
One of the difficulties that anyone trying to make an assessment of the labour shortage situation in Latvia faces is that official statistics measure only long-term migration, and, following the practices of Latvia’s Citizenship and Migration Board, long-term migration refers to "individuals who leave Latvia with the intent of settling in a new country for at least one year and who report this intention to an appropriate authority". As a consequence most of the data do not capture several important categories of migration:
a) illegal migrants who move permanently to another country without proper authorization from the receiving country,
b) permanent migrants to another EU country who do not report their change of residency, and
c) temporary migrants to another EU country who are not required to report their arrival in the receiving country.
The latter two categories would seem to be especially important in Latvia’s case, given that since EU accession, many Latvians have been moving to Ireland and the U.K. - either permanently or temporarily - to seek and obtain work.
On the other hand, if we look at the situation the other way round, in terms of arrivals in the UK or Ireland - as Latvian Abroad has in this post here (and this one) - then we may be better able to get a better idea of the numbers involved due to a difference in the quality of the statistics maintained. As Latvian Abroad points out, the numbers we actually find are somewhat below the normal headline-making level, but still substantial:
As Latvian Abroad also notes the numbers leaving for the UK and Ireland have been dropping steadily since 2006 (although in the Irish case it is not clear to what extent the slowdown in the Irish economy, and in particular in its construction sector, is responsible for this, in any event the Irish data can be found here, and the UK data here).
Several recent surveys also suggest that the potential for outward migration remains substantial. For example, a survey conducted by SKDS (Public Opinion on Manpower Migration: Opinion Poll of Latvia’s Population) in January 2006 revealed that about 22 percent of Latvian residents see themselves as being either “very likely” or “somewhat likely” to go to another country for work “in the next two years”. Based on the current estimated population, this translates into between 350 and 450 thousand residents (between 15 and 20 percent of the 2005 population). The survey also indicated that these respondents were significantly skewed toward the relatively young (15-35), which would significantly reduce the working-age population and labor force in the near future. These respondents were also slightly more likely to be male, less educated, low-income, employed in the private sector, or non-Latvian.
But the biggest problem which arises in the context of projected in-migration as a partial solution to Latvia's present difficulties is a cultural one, and is associated with the historic legacy arising from years of unwilling participation in the old USSR, namely the presence in Latvia of large numbers of Russophone Latvian residents who are non-citizens. The scale of the situation can be seen from the table below.
(please click over image for better viewing)
Essentially out of a total Latvia population of 2,280,000, only 1,850,000 are Latvian (and hence EU) citizens. Of the remainder the majority (some 280,000) are Russians. And these Russians are not recent arrivals, but live in Latvia as part of a historic Russophone population which build up inside Latvia during the period that the country formed part of the Soviet Union.
In fact, if we look at the chart below, we will see that during 2003 the rate of out migration from Latvia seems to have increased substantially, as membership of the European Union loomed.
(please click over image for better viewing)
But what happened in 2003/4 wasn't simply an increase in the volume of migration, it was also a change in the direction of migration, away from the CIS and towards the EU. The majority of the pre 2004 out-migration was actually towards the CIS - official Latvian statistics suggest that over half of the Latvian residents who left Latvia between 1990 and 2005 emigrated to CIS countries - and it is reasonable to assume that many of these migrants came from the Russian speaking population.
So obviously any attempt to revert the flows will confront Latvians with some awkward and difficult cultural decisions, but then these are in-principle no more complex than those which would be posed by following the Polish example and attempting to establish a significant Indian community, or the Czech one and looking to bring in Vietnamese. As I say, Latvia is a small country, and the numbers involved are not necessarily huge, but perhaps the leap in the mindset which is required in fact is. As such the sustained exit of Russophones back into the CIS may only have served to delay, and make more difficult, a process of reconciliation which now, above all, has become economically expedient for everyone concerned.
As has been repeatedly argued on this blog, given that a strategy of relying exclusively on fiscal tightening and strong deflation to address Latvia's overheating problem is fraught with risk, and may even in the best of cases fail to deliver the results anticipated, another possibility which could be be put under serious consideration would be the application of a determined policy mix involving both decreasing the pace of the present economic expansion and increasing the economy's capacity for expansion by loosening labour market constraints somewhat via the use of an open-the-doors policy towards inward migration. This would involve the active promotion and encouragement of a flow of migrants from either elsewhere in Eastern Europe or from points further afield. Such a move would seem sensible, and even viable given the fact that Latvia is a pretty small country. However, as Claus Vistesen notes here, this can only be thought of as an interim measure, since, as the World Bank has recently argued, all the countries in Eastern Europe and Central Asia are effectively condemned to face growing difficulties with labour supply between now and 2020 (so in this sense what is currently happening in the Baltics may be thought of as an extreme harbinger of the shape of things to come).
But given this proviso it is clear that a short-term inward migration policy may help Latvia escape from the vice within whose grip its immediate future seems condemned to lie. Such short term advantage may be important, since longer term solutions like increasing the human capital component in the economy and moving up to higher value activity, whilst important, need much more time to be able to have any noteable effect. You simply cannot take a 20 year old with a basic school leaving certificate and turn him or her into a high value technician overnight, and especially if you don't have that many twenty (or 15) year olds to play around with in the first place.
What is at issue here is transiting a fairly small economy from being locked onto an unsustainable path over onto a sustainable one.
As Claus notes in this post, Estonia has already taken some tentative steps in the direction of making access easier for external workers, and Estonian Economy Minister Juhan Parts is busy working on a set of proposals - which he is to put before the Estonian Parliament by November - which will attempt to address Estonia’s growing shortage of skilled workers. The quota of foreign workers will be doubled to about 1,300 and the bureaucratic paperwork is to be significantly reduced . Now it is true that Parts is still to bite the bullet of accepting the need for unskilled workers too, but in the present situation a start is a start.
Poland has recently being making more sustained efforts to attract workers from Russia, Ukraine and Belarus, but also from more distant lands like India, while the Czech Republic, which has already decided to introduce a kind of green card system for workers from other East European countries has representatives out in Vietnam. In this sense if Eastern Europe is to overcome the looming crisis, then she must certainly be imaginative, and be prepared to offer incentives and advantages to migrants, and not only to skilled ones, since if you have only a few children what do you really want them to do, the most menial jobs?
The last IMF staff report(September 2006) already drew attention to the fact that a number of Latvian economic analysts had been calling for an expansion in inward migration in an attempt to alleviate shortages and to dampen wage pressures. However, it seems that local policymakers generally have been taking the view that this would only have the effect of replacing domestic low-cost workers with imported ones, thereby holding down wages and promoting further emigration. The problem is that if the current wage-cost driven inflation continues then a hard landing will become inevitable, and with a hard landing their will most probably be another exodus of people driven out in search of work, so this is really no solution.
The IMF was, in fact, cautiously positive on the need to open up the labour market:
The mission saw a role for targeted temporary immigration of high-skilled workers to relieve growth bottlenecks, and cautioned that Latvia’s current labor shortages may be short lived if growth were to slow at home or in those countries where Latvians are currently working. To boost domestic labor supply while moderating demand, the mission recommended easing the pace of economic growth, improving productivity in the public sector to free up labor, and further increasing labor force participation by raising the untaxed minimum under the PIT.
However being realistic, we need to note that Latvia certainly faces significant difficulties in introducing any kind of pro-migrant policy. One of these is evident, since any broad opening of the labour market may ultimately simply serve to put downward pressure on unskilled workers wages in a way which only sends even more of the scarce potential labour Latvia has out to Ireland or the UK or elsewhere. A recent report by the US Council of Economic Advisers made some of the issues involved relatively clear. The report cited research showing immigrants in the US on average have a “slightly positive” impact on economic growth and government finances, but at the same time conceded that unskilled immigrants might put downward pressure on the position of unskilled native workers. Now in the US cases these US workers are unlikely to emigrate, but in Latvia they may do.
Another difficulty which arises is the lack of availability of accurate data on the actual scale of either inward or outward migration in Latvia (this difficulty is noted by both the IMF staff team and the Economist Intelligence Unit).
As the IMF staff team note in IMF Selected Issues (2006) official statistics show that Latvia's population has declined markedly over the past 15 years, owing to both net outward migration and to a birthrate which has been well below reproduction rate since the early 1990s.
According to Latvian government data, Latvia had nearly 400,000 fewer residents in 2005 than it had in 1990. And according to the IMF calculations the population decrease is about equally explained by net outward migration (71 per 1,000) and by natural population decrease (births minus deaths, 75 per 1,000).
As the IMF comment:
"The fall in the population due to natural causes.......is also quite worrisome, as it continues unabated and will begin to exacerbate a shrinking labor market in a few years’ time."
According to the most recent estimate from the Bank of Latvia some 70,000 Latvians, or around 6% of the labour force, are currently working abroad - mostly in the UK and Ireland - but the true number is very likely considerably higher (IMF Selected Issues Latvia 2006, for example, put the figure at that point at nearer 100,000).
One of the difficulties that anyone trying to make an assessment of the labour shortage situation in Latvia faces is that official statistics measure only long-term migration, and, following the practices of Latvia’s Citizenship and Migration Board, long-term migration refers to "individuals who leave Latvia with the intent of settling in a new country for at least one year and who report this intention to an appropriate authority". As a consequence most of the data do not capture several important categories of migration:
a) illegal migrants who move permanently to another country without proper authorization from the receiving country,
b) permanent migrants to another EU country who do not report their change of residency, and
c) temporary migrants to another EU country who are not required to report their arrival in the receiving country.
The latter two categories would seem to be especially important in Latvia’s case, given that since EU accession, many Latvians have been moving to Ireland and the U.K. - either permanently or temporarily - to seek and obtain work.
On the other hand, if we look at the situation the other way round, in terms of arrivals in the UK or Ireland - as Latvian Abroad has in this post here (and this one) - then we may be better able to get a better idea of the numbers involved due to a difference in the quality of the statistics maintained. As Latvian Abroad points out, the numbers we actually find are somewhat below the normal headline-making level, but still substantial:
It's actually Lithuanians who have been the quickest to leave their country. 3.3% of Lithuania's population has ended up working in UK or Ireland. (Since UK only registers those foreigners who work there, the percentage of working-age Lithuanians who have left is probably 5-6%.) Latvia is second, with 2.5% of population gone. Slovakia is third and Poland is fourth. That surprised me a bit, because there are so many newspaper stories about Poles in UK and hardly any about Slovaks. Estonia is fifth. The emigration rates from Hungary, Czech Republic and Slovenia are much smaller.
As Latvian Abroad also notes the numbers leaving for the UK and Ireland have been dropping steadily since 2006 (although in the Irish case it is not clear to what extent the slowdown in the Irish economy, and in particular in its construction sector, is responsible for this, in any event the Irish data can be found here, and the UK data here).
Several recent surveys also suggest that the potential for outward migration remains substantial. For example, a survey conducted by SKDS (Public Opinion on Manpower Migration: Opinion Poll of Latvia’s Population) in January 2006 revealed that about 22 percent of Latvian residents see themselves as being either “very likely” or “somewhat likely” to go to another country for work “in the next two years”. Based on the current estimated population, this translates into between 350 and 450 thousand residents (between 15 and 20 percent of the 2005 population). The survey also indicated that these respondents were significantly skewed toward the relatively young (15-35), which would significantly reduce the working-age population and labor force in the near future. These respondents were also slightly more likely to be male, less educated, low-income, employed in the private sector, or non-Latvian.
But the biggest problem which arises in the context of projected in-migration as a partial solution to Latvia's present difficulties is a cultural one, and is associated with the historic legacy arising from years of unwilling participation in the old USSR, namely the presence in Latvia of large numbers of Russophone Latvian residents who are non-citizens. The scale of the situation can be seen from the table below.
(please click over image for better viewing)
Essentially out of a total Latvia population of 2,280,000, only 1,850,000 are Latvian (and hence EU) citizens. Of the remainder the majority (some 280,000) are Russians. And these Russians are not recent arrivals, but live in Latvia as part of a historic Russophone population which build up inside Latvia during the period that the country formed part of the Soviet Union.
In fact, if we look at the chart below, we will see that during 2003 the rate of out migration from Latvia seems to have increased substantially, as membership of the European Union loomed.
(please click over image for better viewing)
But what happened in 2003/4 wasn't simply an increase in the volume of migration, it was also a change in the direction of migration, away from the CIS and towards the EU. The majority of the pre 2004 out-migration was actually towards the CIS - official Latvian statistics suggest that over half of the Latvian residents who left Latvia between 1990 and 2005 emigrated to CIS countries - and it is reasonable to assume that many of these migrants came from the Russian speaking population.
So obviously any attempt to revert the flows will confront Latvians with some awkward and difficult cultural decisions, but then these are in-principle no more complex than those which would be posed by following the Polish example and attempting to establish a significant Indian community, or the Czech one and looking to bring in Vietnamese. As I say, Latvia is a small country, and the numbers involved are not necessarily huge, but perhaps the leap in the mindset which is required in fact is. As such the sustained exit of Russophones back into the CIS may only have served to delay, and make more difficult, a process of reconciliation which now, above all, has become economically expedient for everyone concerned.
Tuesday, August 21, 2007
Hard Or Soft Landing in Latvia?
The Batic Times had an article during last week giving a summary of a recent report from Hansabank Markets (full text available here in event of link rot).
Now as Latvian Abroad points out in comments, neither the article nor the report it summarises really add anything new to the the extensive airing that this topic has already received in the economic and financial press. In this context see, for example, the Financial Times here and here, the Economist here, here and here, and EU Business here. EU Economy Commissioner Joaquim Almunia has also joined in the act, although he explicitly avoided direct reference to the hard landing possibility, as did the IMF staff economists in their last IMF "Mission to Latvia" statement. The same essentially goes for the widely quoted BICEPS report (caution pdf). Carsten Valgreen, who puts his finger on one part of the present problem judiciously avoids voicing an opinion about what exactly the future might have in store for Latvia.
Hansabank, however, is rather more explicit than most, and this explicitness isn't too hard to understand, since they come down on the more optimistic side of the fence.
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.
Perhaps this optimistic tone is not all that surprising, given the amount of money Hansabank have invested in the happy ending scenario. The report also touches on the rather more delicate issue of the currency peg, and what might happen to it. Again they are pretty positive.
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.”
The last phrase, we might note. does cover virtually any possible eventuality.
But, more to the point, what exactly are these macro imbalances they refer to? Well as I have tried to argue at some length here, they stem from a virtually unique set of circumstances (historically unique I mean, at the present time the underlying dynamic across all the East European EU member states is remarkably similar, with the possible exception of Hungary). In brief Latvia is facing, at one and the same time, a massive inflow of external funds, and a massive outflow of people. Put another way, demand side factors are increasing rapidly, while supply side capacity not only is unable to keep pace, it is actually shrinking (if we think about the number of people of working age).
So there are two problems to correct here, and they are both large and important. Essentially Latvia needs:
a) more labour supply, both skilled and unskilled
b) a lower rate of inflow of structurally distorting funds, whether these be bank credit, remittances, or even (possibly, this needs investigating further) EU funding for projects which Latvia cannot reasonably expect to carry through in the time horizon outlined.
c) more Foreign Direct Investment to create value creating jobs, especially in manufacturing and services areas with export potential
d) increased spending on education and training projects to upgrade the human capital of the existing population
In this sense the Hansabank statement that:
"The main risk.....is if governments continue expansionist policies, and in the process fuel ongoing consumer spending growth."
is not really to the point, since it is not government policy which is fueling the overheating, and indeed the government is already aiming for a budget surplus this year. In this sense the Hansabank report only reiterates what the IMF staff economists stated after their Article IV consultation discussions back in May 2007, to the effect that the Latvian government should aim for a 4% of GDP budget surplus in 2007, an order of magnitude which the Latvian government has so far resisted. So the Latvian government may be blamed for excessive complacency. The March 2007 measures (summarized by the Finance Ministry here, and by the National Bank here) certainly fall short of what is needed, but at the same time it needs to be understood that many of these problems are not of the Latvian governments own making, and even under the best possible package of policy options, Latvian would still be having major problems, as the BICEPS report authors indicate when they state that Latvia has more problematic parameters than policy instruments available. This is simply a technical way of saying that they are really rather at the mercy of events, and not their master.
The central point here is that the fiscal surplus proposal really a form of positive policy, it is a last line of defence move, implemented as a result of the fact, as the BICEPS report makes clear, that given the fact that the major imbalance issues (shortages of suitably educated and qualified working population, and inflow of remittances and bank funds) are de facto outside of the control of conventional monetary policy instruments, neither the central bank nor the government have adequate policy instruments available. This is the real issue, and this is the longer term problem we all need to be thinking about, not only in Latvia but far more generally.
But the measures mentioned above are longer term and structural, what about the present situation, is it manageable? This is a very difficult question to answer. It depends on what they call the "global conditions". The financial markets, as is now well known, are currently in turmoil, and it is hard to know where the snowball which has been put in motion will actually come to rest. But to really decide whether or not the Baltic states will have a hard landing we really do need to know, as a prior, the answer to this question. Meanwhile, we must simply bide our time, and watch and wait.
My general feeling is that while there are no easy or immediate solutions to Latvia's long term problems, Latvia on its own won't "unwind". Nor is it likely to precipitate a more general unwind. In part this is to do with what the Economist rather impertinently calls the "pipsqueak" factor.
But then we need to think about the general global risk appetite. Certainly this has been somewhat volatile of late. And for the time being it seems set to remain volatile.
The issue really is that the global economy may be reaching(or even we may now have passed) the peak of the current growth cycle. Signs of a slow-down are evident everywhere (except of course in Eastern Europe, although obviously the Baltics and Hungary are clearly slowing now, and the others may not be too long in following depending on how "hard" the global landing actually is). From the US to the eurozone and Japan it is clear that GDP growth rates in 2007 will be lower than those in 2006, and even China is giving some indication that she will need to pause for breath at some point (especially if the rapid growth rates of exports to the EU and the US cannot be maintained), and while India may well be on the development launch ramp, she is not sufficiently large (in GDP terms), or sufficiently integrated in the global economy at this point, to make any decisive difference.
The decline in the value of the dollar is also a factor which needs to be considered here. In Europe we are not especially noticing the oil price effect, but in the US it is surely now a drag. Add to this the US housing woes, and the fact that almost a majority of the population *believe* that the US is headed for a recession ("animal spirits" do matter here). As a result I think it is not unreasonable to imagine that the US will gradually (I hope gradually) slow in the second half of 2007.
If we reach a recession call point in the US then Bernanke will undoubtedly unlease all that ammunition he has been storing up, and start to lower interest rates (Of course the surprise move by the Federal Reserve last Friday is now an early indication of this possibility). This in and of itself will present the ECB with a big headache, given the "normalisation" course they have been trying to steer. Any attempt to continue the upward march in Eurozone interest rates will only send the euro once more sharply upward, and with the euro, of course, the Lat.
But it is more what will happen in financial markets at this point we need to be thinking about.
Once the ECB moves away from rate "normalisation" as a discourse (as I feel it will now have to), and once we get into the area of possibile rate reductions again, then the global financial system will enter a "delicate moment", simply because what financial markets like best is a consistent story, and this is what we have been having, up to now. In the last few years everything has been all about relative yield and the search for the differential. But when we get a change in the "zeitgeist", then there is always the risk of increased problems, if for now other reason than that market participants don't really know how to respond. This, I think is the worry in the back of the Economist's Buttonwood's mind in the recent articles (here, and here). As he says in the most recent installment - Cold Turkey - "WHEN investors get twitchy, developing countries are usually the first to pay the price."
So what can the Latvian government do? Well beyond tightening up credit regulations (which it has already done, but there are limits to this process in an era of financial deregulation) and being more aggressive on the fiscal tightening side, there is precious little they can do. Obviously steps need to be taken to try and facilitate the return of some of those migrants who are in the UK and Ireland (mightn't some of the EU funding be better used for this purpose?), and evidently it would be very positive to follow in the initial footsteps of Estonia and open the labour market up to migrants from elsewhere (indeed they need to be actively encouraged to come, and not subtly resisted), and of course the underlying fertility situation which is fueling the problem needs to be addressed (once more a leaf can be taken from Estonia's book). But all these measures are longer term in nature. In the short term we now have little remedy but to sit it out and wait, and oh yes, to keep our fingers crossed that the current problems associated with the US sub-prime mortgage market don't turn into a globalised and general "credit crunch".
Now as Latvian Abroad points out in comments, neither the article nor the report it summarises really add anything new to the the extensive airing that this topic has already received in the economic and financial press. In this context see, for example, the Financial Times here and here, the Economist here, here and here, and EU Business here. EU Economy Commissioner Joaquim Almunia has also joined in the act, although he explicitly avoided direct reference to the hard landing possibility, as did the IMF staff economists in their last IMF "Mission to Latvia" statement. The same essentially goes for the widely quoted BICEPS report (caution pdf). Carsten Valgreen, who puts his finger on one part of the present problem judiciously avoids voicing an opinion about what exactly the future might have in store for Latvia.
Hansabank, however, is rather more explicit than most, and this explicitness isn't too hard to understand, since they come down on the more optimistic side of the fence.
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.
Perhaps this optimistic tone is not all that surprising, given the amount of money Hansabank have invested in the happy ending scenario. The report also touches on the rather more delicate issue of the currency peg, and what might happen to it. Again they are pretty positive.
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.”
The last phrase, we might note. does cover virtually any possible eventuality.
But, more to the point, what exactly are these macro imbalances they refer to? Well as I have tried to argue at some length here, they stem from a virtually unique set of circumstances (historically unique I mean, at the present time the underlying dynamic across all the East European EU member states is remarkably similar, with the possible exception of Hungary). In brief Latvia is facing, at one and the same time, a massive inflow of external funds, and a massive outflow of people. Put another way, demand side factors are increasing rapidly, while supply side capacity not only is unable to keep pace, it is actually shrinking (if we think about the number of people of working age).
So there are two problems to correct here, and they are both large and important. Essentially Latvia needs:
a) more labour supply, both skilled and unskilled
b) a lower rate of inflow of structurally distorting funds, whether these be bank credit, remittances, or even (possibly, this needs investigating further) EU funding for projects which Latvia cannot reasonably expect to carry through in the time horizon outlined.
c) more Foreign Direct Investment to create value creating jobs, especially in manufacturing and services areas with export potential
d) increased spending on education and training projects to upgrade the human capital of the existing population
In this sense the Hansabank statement that:
"The main risk.....is if governments continue expansionist policies, and in the process fuel ongoing consumer spending growth."
is not really to the point, since it is not government policy which is fueling the overheating, and indeed the government is already aiming for a budget surplus this year. In this sense the Hansabank report only reiterates what the IMF staff economists stated after their Article IV consultation discussions back in May 2007, to the effect that the Latvian government should aim for a 4% of GDP budget surplus in 2007, an order of magnitude which the Latvian government has so far resisted. So the Latvian government may be blamed for excessive complacency. The March 2007 measures (summarized by the Finance Ministry here, and by the National Bank here) certainly fall short of what is needed, but at the same time it needs to be understood that many of these problems are not of the Latvian governments own making, and even under the best possible package of policy options, Latvian would still be having major problems, as the BICEPS report authors indicate when they state that Latvia has more problematic parameters than policy instruments available. This is simply a technical way of saying that they are really rather at the mercy of events, and not their master.
The central point here is that the fiscal surplus proposal really a form of positive policy, it is a last line of defence move, implemented as a result of the fact, as the BICEPS report makes clear, that given the fact that the major imbalance issues (shortages of suitably educated and qualified working population, and inflow of remittances and bank funds) are de facto outside of the control of conventional monetary policy instruments, neither the central bank nor the government have adequate policy instruments available. This is the real issue, and this is the longer term problem we all need to be thinking about, not only in Latvia but far more generally.
But the measures mentioned above are longer term and structural, what about the present situation, is it manageable? This is a very difficult question to answer. It depends on what they call the "global conditions". The financial markets, as is now well known, are currently in turmoil, and it is hard to know where the snowball which has been put in motion will actually come to rest. But to really decide whether or not the Baltic states will have a hard landing we really do need to know, as a prior, the answer to this question. Meanwhile, we must simply bide our time, and watch and wait.
My general feeling is that while there are no easy or immediate solutions to Latvia's long term problems, Latvia on its own won't "unwind". Nor is it likely to precipitate a more general unwind. In part this is to do with what the Economist rather impertinently calls the "pipsqueak" factor.
But then we need to think about the general global risk appetite. Certainly this has been somewhat volatile of late. And for the time being it seems set to remain volatile.
The issue really is that the global economy may be reaching(or even we may now have passed) the peak of the current growth cycle. Signs of a slow-down are evident everywhere (except of course in Eastern Europe, although obviously the Baltics and Hungary are clearly slowing now, and the others may not be too long in following depending on how "hard" the global landing actually is). From the US to the eurozone and Japan it is clear that GDP growth rates in 2007 will be lower than those in 2006, and even China is giving some indication that she will need to pause for breath at some point (especially if the rapid growth rates of exports to the EU and the US cannot be maintained), and while India may well be on the development launch ramp, she is not sufficiently large (in GDP terms), or sufficiently integrated in the global economy at this point, to make any decisive difference.
The decline in the value of the dollar is also a factor which needs to be considered here. In Europe we are not especially noticing the oil price effect, but in the US it is surely now a drag. Add to this the US housing woes, and the fact that almost a majority of the population *believe* that the US is headed for a recession ("animal spirits" do matter here). As a result I think it is not unreasonable to imagine that the US will gradually (I hope gradually) slow in the second half of 2007.
If we reach a recession call point in the US then Bernanke will undoubtedly unlease all that ammunition he has been storing up, and start to lower interest rates (Of course the surprise move by the Federal Reserve last Friday is now an early indication of this possibility). This in and of itself will present the ECB with a big headache, given the "normalisation" course they have been trying to steer. Any attempt to continue the upward march in Eurozone interest rates will only send the euro once more sharply upward, and with the euro, of course, the Lat.
But it is more what will happen in financial markets at this point we need to be thinking about.
Once the ECB moves away from rate "normalisation" as a discourse (as I feel it will now have to), and once we get into the area of possibile rate reductions again, then the global financial system will enter a "delicate moment", simply because what financial markets like best is a consistent story, and this is what we have been having, up to now. In the last few years everything has been all about relative yield and the search for the differential. But when we get a change in the "zeitgeist", then there is always the risk of increased problems, if for now other reason than that market participants don't really know how to respond. This, I think is the worry in the back of the Economist's Buttonwood's mind in the recent articles (here, and here). As he says in the most recent installment - Cold Turkey - "WHEN investors get twitchy, developing countries are usually the first to pay the price."
So what can the Latvian government do? Well beyond tightening up credit regulations (which it has already done, but there are limits to this process in an era of financial deregulation) and being more aggressive on the fiscal tightening side, there is precious little they can do. Obviously steps need to be taken to try and facilitate the return of some of those migrants who are in the UK and Ireland (mightn't some of the EU funding be better used for this purpose?), and evidently it would be very positive to follow in the initial footsteps of Estonia and open the labour market up to migrants from elsewhere (indeed they need to be actively encouraged to come, and not subtly resisted), and of course the underlying fertility situation which is fueling the problem needs to be addressed (once more a leaf can be taken from Estonia's book). But all these measures are longer term in nature. In the short term we now have little remedy but to sit it out and wait, and oh yes, to keep our fingers crossed that the current problems associated with the US sub-prime mortgage market don't turn into a globalised and general "credit crunch".
Estonian Producer Price Index Continues To Rise
Estonian producer prices rose in July at their fastest annual pace in 9 1/2 years, led by rising food and timber costs, a sign the country's competitiveness is under severe pressure.
According to the latest release from the Estonian Statistics Office producer prices rose in July 2007 at an annual rate of 8.7%, up from an 8.3% rate in June. As can be seen from the chart below, the annual rate of increase has been accelerating continuously over the months:
There is a small piece of good news if we look at the evolution of the index itself, since despite the large year on year increases registered recently the pace of increase seems to be slowing down, as can be seen in the chart below. Indeed over the last two months the annualised rate has been only something like 3.6%.
But this is of little comfort if we look at the export producer price component - export prices rose 0.9 percent in July from June and 9.1 percent from a year earlier, again see chart below - which has clearly been going steadily on its upward path:
Since domestic demand is now evidently slowing substantially, the need to obtain growth from exports is stronger than ever, but with these rates of increase in export prices this is going to be a very difficult matter indeed.
Estonia's economy is struggling to handle the dramatic increase in wage costs the growing labour shortage is causing - wages and salaries were up over 20 percent year-on-year in the first quarter of this year. And companies are cutting jobs, like Boras Waefveri AB, a Swedish textile company, who said in April they will cut at least 800 jobs, or a quarter of the staff, at its plant in Narva, Estonia, due to competition fromlow-cost imports from Asia.
Other companies, such as Elcoteq Network Oyj, a Finnish contract manufacturer for mobile-phone makers such as Nokia Oyj, have attempted to address the problem by cutting production and trying to move over to higher value-added production.
Others again, such as Nolato Telecom, a Swedish contract manufacturer of mobile phone components are simply packing their bags and leaving. Nolato Telecom announced in its second-quarter earnings report last month that it plans to close production at its Tallinn unit in the second half of 2007, but gave no reasons for the move.
If all of this continues the outlook will become grave indeed. This problem needs a much more extensive response, not only from the Estonian government, but from the European Commission itself.
According to the latest release from the Estonian Statistics Office producer prices rose in July 2007 at an annual rate of 8.7%, up from an 8.3% rate in June. As can be seen from the chart below, the annual rate of increase has been accelerating continuously over the months:
There is a small piece of good news if we look at the evolution of the index itself, since despite the large year on year increases registered recently the pace of increase seems to be slowing down, as can be seen in the chart below. Indeed over the last two months the annualised rate has been only something like 3.6%.
But this is of little comfort if we look at the export producer price component - export prices rose 0.9 percent in July from June and 9.1 percent from a year earlier, again see chart below - which has clearly been going steadily on its upward path:
Since domestic demand is now evidently slowing substantially, the need to obtain growth from exports is stronger than ever, but with these rates of increase in export prices this is going to be a very difficult matter indeed.
Estonia's economy is struggling to handle the dramatic increase in wage costs the growing labour shortage is causing - wages and salaries were up over 20 percent year-on-year in the first quarter of this year. And companies are cutting jobs, like Boras Waefveri AB, a Swedish textile company, who said in April they will cut at least 800 jobs, or a quarter of the staff, at its plant in Narva, Estonia, due to competition fromlow-cost imports from Asia.
Other companies, such as Elcoteq Network Oyj, a Finnish contract manufacturer for mobile-phone makers such as Nokia Oyj, have attempted to address the problem by cutting production and trying to move over to higher value-added production.
Others again, such as Nolato Telecom, a Swedish contract manufacturer of mobile phone components are simply packing their bags and leaving. Nolato Telecom announced in its second-quarter earnings report last month that it plans to close production at its Tallinn unit in the second half of 2007, but gave no reasons for the move.
If all of this continues the outlook will become grave indeed. This problem needs a much more extensive response, not only from the Estonian government, but from the European Commission itself.
Sunday, August 19, 2007
Fitch downgrades Latvia to BBB+
Fitch ratings agency has downgraded Latvia’s foreign currency issuer default rating (IDR) to ‘BBB+’ from ‘A-. It has also downgraded the Latvia's currency IDR to ‘BBB+‘ from A, –‘both of these ratings with a stable outlook. In defence of its decision Fitch argues that the Latvian economy is severely overheating (and who can disagree about that) whilst considering the policy reaction of the Latvian government to be insufficient to restore the economy to a sustainable growth path (again it is hard to disagree, although it would be simply unjust to pour all the blame on the Latvian government here, since there are important structural factors at work which are to some considerable extent beyond the control of the Latvian government”. For a fuller analysis of this see this post, and this one.
At the end of the day it is hard to disagree with Fitch and the downgrade should as such not have come as a surprise, especially since Standard & Poor’s earlier this year also made a similar downgrade, and we are still only waiting to hear from Moody's (who still maintain an A2 investment grade on Latvian sovereign deb). Should Moody's also revise their rating then Latvia would be without a single investment grade rating from a ratings agency, and their would be consequences from this since the ECB have earlier signalled that they are no longer prepared to accept paper from countries in this position as collateral (more on this below).
But there is another issue which arises here, and that is the actual role of credit ratings agencies in protecting both investors from serious financial risk, and citizens of sovereign states from the profligate practices of their political leaders.
This issue has recently been getting some coverage in the case of Italy, where of course public debt has over the last decade spiraled upwards almost out of control (to 107% of GDP) and the European Commission has proved itself to be completely incapable of rising to the challenge which this situation presents in the context of Italy's rapidly ageing population. (For more analysis of the role of the credit agencies in the Italian context see this post).
The ratings agencies question has also been entering particularly muddied waters in recent days due to the insistance of some EU Commissioners and the French President Nicolas Sarkozy on holding an investigation into the role of these self same agencies in the US sub-prime mortgages problem.
Now why am I pointing the finger especially at Nicolas Sarkozy here? Well, according to the Financial Times:
Now obviously, in general terms, there may be little to disagree with here. A nice theoretical discussion of transparency, and the role of the ratings agencies (which could also be extended to the role of the EU Commission and the ECB when it comes to the tricky question of the sovereign debt ratings of some delicate EU member states, including unfortunately the Baltic ones) may well be in order. But, I ask you, is now, precisely now, the moment to be airing all this. Isn't the number one priority for everyone right now to settle the global financial markets down, and to try and pass through this storm without incurring any excess damage?
But no, we need a scapegoat for our problems apparently, and the scapegoat it would seem is to be the ratings agencies, forgetting conveniently in the process that only last week they were being regarded as the last firewall of our collective defence.
So what do you expect, the agencies themselves hit back, at least to cover themselves. On Thursday it was Chris Mahoney, vice chairman of Moody's who responded in kind:
Then on Friday it was the turn of Fitch:
Now I really don't see that you can expect the ratings agencies to respond in any other way. You suggest you want to criticise them for being insufficiently vigilant, and so naturally they respond by starting to be "extra-vigilant". You can hardly blame them for this.
But as I indicate above, this decision by Fitch also begins to put the ECB in an interesting situation. Let us go back to November 2005, and the ECB decison to only accept bonds with at least a single A- rating from one or more of the main rating agencies as collateral in its financial market activities (and the original article here).
Well technically Latvia still has an A2 rating from Moody's, and this is equivalent to an A- (as has Italy in the case of Moody's), so the ECB will in theory continue to accept Latvian paper, but at this pace it would only seem to be a matter of time before Moody's downgrade too, especially with Sarkozy loading on the pressure. This will, apart from making it much more difficult for the Latvian government to raise credit, effectively take away the guarantee which underpins the present structural distortion in the Latvian economy, put even more distance between Latvia and membership of the euro, and complicate the task of the Latvian government in trying to steer the economy forward. Bottom line: is all of this a good idea. Answer: what you ask for is what you get, so my advice in future is to think first before opening your mouth.
The principal point I want to make here is that while in the normal course of events such downgrades - or the threat of them - may serve a useful purpose by putting pressure on governments to change course, in the current climate these very same downgrades may only serve to provoke the very situation which they are intended to avert, and that is the danger now. Let us remember what Buttonwood wisely, and possibly presciently, said:
At the end of the day it is hard to disagree with Fitch and the downgrade should as such not have come as a surprise, especially since Standard & Poor’s earlier this year also made a similar downgrade, and we are still only waiting to hear from Moody's (who still maintain an A2 investment grade on Latvian sovereign deb). Should Moody's also revise their rating then Latvia would be without a single investment grade rating from a ratings agency, and their would be consequences from this since the ECB have earlier signalled that they are no longer prepared to accept paper from countries in this position as collateral (more on this below).
But there is another issue which arises here, and that is the actual role of credit ratings agencies in protecting both investors from serious financial risk, and citizens of sovereign states from the profligate practices of their political leaders.
This issue has recently been getting some coverage in the case of Italy, where of course public debt has over the last decade spiraled upwards almost out of control (to 107% of GDP) and the European Commission has proved itself to be completely incapable of rising to the challenge which this situation presents in the context of Italy's rapidly ageing population. (For more analysis of the role of the credit agencies in the Italian context see this post).
The ratings agencies question has also been entering particularly muddied waters in recent days due to the insistance of some EU Commissioners and the French President Nicolas Sarkozy on holding an investigation into the role of these self same agencies in the US sub-prime mortgages problem.
Now why am I pointing the finger especially at Nicolas Sarkozy here? Well, according to the Financial Times:
In a letter to Angela Merkel, the German chancellor and acting president of the group of eight industrialised nations, which includes the G7, Mr Sarkozy highlighted his concerns over the weaknesses of the international financial system revealed by the present crisis.
He called for G7 finance ministers to draw up proposals for their meeting in Washington in October to address transparency and risk awareness among market participants and regulators.
He said the G7 should join the European Commission in investigating the role played by credit ratings agencies in the crisis, and said that bank involvement in credit markets should also be addressed.
Now obviously, in general terms, there may be little to disagree with here. A nice theoretical discussion of transparency, and the role of the ratings agencies (which could also be extended to the role of the EU Commission and the ECB when it comes to the tricky question of the sovereign debt ratings of some delicate EU member states, including unfortunately the Baltic ones) may well be in order. But, I ask you, is now, precisely now, the moment to be airing all this. Isn't the number one priority for everyone right now to settle the global financial markets down, and to try and pass through this storm without incurring any excess damage?
But no, we need a scapegoat for our problems apparently, and the scapegoat it would seem is to be the ratings agencies, forgetting conveniently in the process that only last week they were being regarded as the last firewall of our collective defence.
So what do you expect, the agencies themselves hit back, at least to cover themselves. On Thursday it was Chris Mahoney, vice chairman of Moody's who responded in kind:
Moody's Investors Service fueled concern that the global credit crisis is worsening by speculating that a hedge fund collapse on the same scale as Long-Term Capital Management LP in 1998 is possible.
Hedge funds face potential losses on collateralized debt obligations, securities packaging bonds, loans and other assets, Chris Mahoney, vice chairman of Moody's, said on a conference call today. The funds are unable to agree on prices to sell riskier assets, causing the market to seize up, Mahoney said.
Then on Friday it was the turn of Fitch:
Latvia's long-term sovereign rating was cut to BBB+ from A- by Fitch Rating Service as government plans to keep the economy from overheating are ``insufficient.''
Now I really don't see that you can expect the ratings agencies to respond in any other way. You suggest you want to criticise them for being insufficiently vigilant, and so naturally they respond by starting to be "extra-vigilant". You can hardly blame them for this.
But as I indicate above, this decision by Fitch also begins to put the ECB in an interesting situation. Let us go back to November 2005, and the ECB decison to only accept bonds with at least a single A- rating from one or more of the main rating agencies as collateral in its financial market activities (and the original article here).
Well technically Latvia still has an A2 rating from Moody's, and this is equivalent to an A- (as has Italy in the case of Moody's), so the ECB will in theory continue to accept Latvian paper, but at this pace it would only seem to be a matter of time before Moody's downgrade too, especially with Sarkozy loading on the pressure. This will, apart from making it much more difficult for the Latvian government to raise credit, effectively take away the guarantee which underpins the present structural distortion in the Latvian economy, put even more distance between Latvia and membership of the euro, and complicate the task of the Latvian government in trying to steer the economy forward. Bottom line: is all of this a good idea. Answer: what you ask for is what you get, so my advice in future is to think first before opening your mouth.
The principal point I want to make here is that while in the normal course of events such downgrades - or the threat of them - may serve a useful purpose by putting pressure on governments to change course, in the current climate these very same downgrades may only serve to provoke the very situation which they are intended to avert, and that is the danger now. Let us remember what Buttonwood wisely, and possibly presciently, said:
As central banks lose authority, might credit-rating agencies play the watchdog role? By acting swiftly to downgrade debt, they would constrain companies (and countries) from borrowing too much. But the agencies tend to lean with the wind, rather than against it. They upgrade debt when the economy is booming and downgrade it when recession strikes. If the central banks do eventually slam on the brakes, therefore, the rating agencies will only exacerbate the downturn. As asset ratings fall, investors will be forced to sell their holdings and credit will be withdrawn from the system. Thanks to the financial markets, central banks now struggle to police the economy. But this may imply that the bust, when it comes, is as hard to control as the boom that preceded it.
Will The Lat Come Under Pressure Again?
Well we all know about the turmoil that is taking place in the financial markets at the moment. Last Friday the Federal Reserve surprised everyone by suddenly lowering the discount rate. This has lead to all sorts of speculation about the future direction of interest rate policy in the major economies. It is now extremely unlikely that the Bank of Japan will now proceed with a quarter point raise later this month, and it is very doubtful in my mind that the ECB will raise in September. It is pretty much a foregone conclusion that the next move by the Federal Reserve will be down, the only outstanding question really is when.
Obviously we need to wait and see how the financial markets respond to the latest move from the Fed, but my feeling is that the so called "credit tightening" isn't over yet (and not by a long stretch), and that even were the "crunch" to come to an end soon the consequences for the real economy are going to be important, since credit - both corporate and private, and possibly even sovereign - will be harder to come by. What this "harder to come by" really means is that you will have to pay more for it, especially if your credit valuation is not of the highest (as was the case with the US sub-prime home purchasers). As I say this will hit at all levels, since the banking sector has clearly had a big shock, and will involve individual, companies and even governments. Just how it will affect them is what we are now waiting to see. But it is important to bear in mind that this impact on new credit will occur regardless of the extent to which central banks lower their base rates, since what has happened is that the lending environment has deteriorated, and this deterioration is likely to influence conditions in new lending (or rollover credit) for years rather than months.
Obviously existing mortgage holders on variable rate mortgages can get some fresh air from any loosening in the base rates, but it is the demand for new mortgages, and activity in the construction sector, and not locally but globally, that we need to be thinking about here. Clearly construction growth can slow, as lenders become more choosy about who - and under what conditions - they lend to. This becomes important for the real economy when we come to consider the importance which construction activity shares have had in economic growth in some major economies - the US, the UK, Spain, Australia etc - since the turn of the century, and the impact which the so-called wealth effect has had on the rate of growth of private consumption in this self same economies. So clearly, in some developed economies, economic growth is now likely to be rather weaker, and for some time to come.
But the "credit crunch" is likely to affect the so called "risk appetite" (that is the willingness to invest in riskier areas or activities) and the place where this is most likely to be felt is in the emerging market area. Those emerging markets which are considered to be most vulnerable will undoubtedly have the hardest time of it, and this brings us directly to the Baltics, who must be considered to be in one of the riskiest situations of all. To quote the Economist's Buttonwood, "WHEN investors get twitchy, developing countries are usually the first to pay the price."
And investors are definitely twitchy right now, as Danske Bank Senior Analyst Lars Christensen commented last Wednesday (pdf link) the markets are beginning to see signs that pressures on the lat are re-emerging. In his research note Christensen argues that while the atmosphere surrounding the Lat calmed down in May,after having experienced significant pressure during February-April period (as reflected in this speech from Latvikas Banka governor Ilmārs Rimšēvičs back in February, which was an irate response to an article in the pages of Diena by the Swedish Economist Morten Hansen, who was arguing that the Lat/euro peg needed to be broken, more on all this in another moment).
Basically Christensen sees this pressure re-emerging, largely for three reasons:
Firstly there is the above mentioned worsening of global credit conditions, which will make it much harder to fund the large current account deficits in Latvia and the other Baltic states. Scandinavian banks naturally are also showing less willingness to fund the Baltic credit boom with global credit conditions worsening and concerns are mounting about the vulnerability of over-leveraged households and investors across the Baltics.
Secondly there are clear signs that the property markets are coming under fairly strong selling pres-sure in all three Baltic states. Christensen suggests that property prices have dropped nearly 10% in Estonia over the last two quarters, while Latvian property prices have declined 5%-8% over the last two months. Meanwhile, Lithuanian property prices are no longer rising. In addition to this he mentions anecdotal evidence that property developers in the Baltics are freezing property projects that have already been initiated.(Latvian Abroad is covering the unwinding of the Latvian property boom here, and here).
Thirdly, there is the fact that the Baltic economies are now clearly slowing. As I argued yesterday, the Estonian economy is now showing very significant signs of a fairly sharp slowdown with the rapid second quarter GDP screech to a halt (only 0.2% growth in the quarter) marking the lowest rate of growth in seven years on a quarter-on-quarter basis.
On the property market angle, Christensen has a separate report (again pdf), and he makes a number of important points here:
So basically, and the bottom line here, the Baltic economies are extremely vulnerable to any sudden turn in investor sentiment. We are in the middle of a major sea change in global sentiment even as I write, so at the end of the day all I can say is, do watch out.
Obviously we need to wait and see how the financial markets respond to the latest move from the Fed, but my feeling is that the so called "credit tightening" isn't over yet (and not by a long stretch), and that even were the "crunch" to come to an end soon the consequences for the real economy are going to be important, since credit - both corporate and private, and possibly even sovereign - will be harder to come by. What this "harder to come by" really means is that you will have to pay more for it, especially if your credit valuation is not of the highest (as was the case with the US sub-prime home purchasers). As I say this will hit at all levels, since the banking sector has clearly had a big shock, and will involve individual, companies and even governments. Just how it will affect them is what we are now waiting to see. But it is important to bear in mind that this impact on new credit will occur regardless of the extent to which central banks lower their base rates, since what has happened is that the lending environment has deteriorated, and this deterioration is likely to influence conditions in new lending (or rollover credit) for years rather than months.
Obviously existing mortgage holders on variable rate mortgages can get some fresh air from any loosening in the base rates, but it is the demand for new mortgages, and activity in the construction sector, and not locally but globally, that we need to be thinking about here. Clearly construction growth can slow, as lenders become more choosy about who - and under what conditions - they lend to. This becomes important for the real economy when we come to consider the importance which construction activity shares have had in economic growth in some major economies - the US, the UK, Spain, Australia etc - since the turn of the century, and the impact which the so-called wealth effect has had on the rate of growth of private consumption in this self same economies. So clearly, in some developed economies, economic growth is now likely to be rather weaker, and for some time to come.
But the "credit crunch" is likely to affect the so called "risk appetite" (that is the willingness to invest in riskier areas or activities) and the place where this is most likely to be felt is in the emerging market area. Those emerging markets which are considered to be most vulnerable will undoubtedly have the hardest time of it, and this brings us directly to the Baltics, who must be considered to be in one of the riskiest situations of all. To quote the Economist's Buttonwood, "WHEN investors get twitchy, developing countries are usually the first to pay the price."
And investors are definitely twitchy right now, as Danske Bank Senior Analyst Lars Christensen commented last Wednesday (pdf link) the markets are beginning to see signs that pressures on the lat are re-emerging. In his research note Christensen argues that while the atmosphere surrounding the Lat calmed down in May,after having experienced significant pressure during February-April period (as reflected in this speech from Latvikas Banka governor Ilmārs Rimšēvičs back in February, which was an irate response to an article in the pages of Diena by the Swedish Economist Morten Hansen, who was arguing that the Lat/euro peg needed to be broken, more on all this in another moment).
Basically Christensen sees this pressure re-emerging, largely for three reasons:
Firstly there is the above mentioned worsening of global credit conditions, which will make it much harder to fund the large current account deficits in Latvia and the other Baltic states. Scandinavian banks naturally are also showing less willingness to fund the Baltic credit boom with global credit conditions worsening and concerns are mounting about the vulnerability of over-leveraged households and investors across the Baltics.
Secondly there are clear signs that the property markets are coming under fairly strong selling pres-sure in all three Baltic states. Christensen suggests that property prices have dropped nearly 10% in Estonia over the last two quarters, while Latvian property prices have declined 5%-8% over the last two months. Meanwhile, Lithuanian property prices are no longer rising. In addition to this he mentions anecdotal evidence that property developers in the Baltics are freezing property projects that have already been initiated.(Latvian Abroad is covering the unwinding of the Latvian property boom here, and here).
Thirdly, there is the fact that the Baltic economies are now clearly slowing. As I argued yesterday, the Estonian economy is now showing very significant signs of a fairly sharp slowdown with the rapid second quarter GDP screech to a halt (only 0.2% growth in the quarter) marking the lowest rate of growth in seven years on a quarter-on-quarter basis.
On the property market angle, Christensen has a separate report (again pdf), and he makes a number of important points here:
Property price statistics are fairly unreliable and hard to compare from country to country in the Baltics, but most sources now point to fairly heavy declines in property prices – at least in the three capital cities. Property prices have dropped most in Estonia’s capital, Tallinn, where official statistics and anecdotal evi-dence indicate that property prices have dropped around 10% this year. Latvia’s capital, Riga, is also ex-periencing falling property prices – down 5-8% over the last couple of months and most indicators suggest-ing an acceleration in the rate of decline.
There are also signs of slowing property prices in Lithuania’s capi-tal, Vilnius, but it is still too early say that property prices are actually declining. There are a number of rea-sons why property prices are now declining in the Baltic States. In our view the primary reason is simple – prices have simply risen far too much relative to fundamentals. Furthermore, a number of negative shocks have hit the Baltic property markets. Most importantly, interest rates have gone up in line with European rates over the last year. Furthermore, the banks have tightened credit standards on the back of rising con-cerns about the large imbalances in all three countries. Hence, it looks like the boom in the Baltic property market is coming to an end. It is very difficult to assess how far property prices in the Baltics could potentially fall, but given the large imbalances in the Baltic economies we think the downturn could be quite severe and long-lasting. It is debatable whether there has been a Baltic property bubble, but there is no doubt in our view that property price growth has been exces-sive, and therefore property prices should be expected to slide further going forward.
So basically, and the bottom line here, the Baltic economies are extremely vulnerable to any sudden turn in investor sentiment. We are in the middle of a major sea change in global sentiment even as I write, so at the end of the day all I can say is, do watch out.
Thursday, August 16, 2007
Emerging Markets and Safe Havens
Danske Bank's Lars Christiansen had another research note last week which is of some interest for Latvia's current situation (see this post for his earlier research note). Entitled "Emerging Markets: Looking for the safe haven" (watch out pdf), and published last Thursday, Christiansen accepts that there is a global credit crunch, and that it is now spreading to Emerging Markets (EM), with many of the high-risk EM currencies (the Turkish Lira, the Hungarian Forint, etc) now coming under heavy fire. As to the question what countries may be most at risk, he answers the following:
That would seem to put Eastern Europe pretty generally on the map I would have thought. Chrisiansen seems to accept the arrival of the credit crunch as now a fact:
Furthermore:
This is really code language for speaking about Hungary (although there may be more) since in Hungary around 80% of the mortgages which have been taken out in recent times have been Swiss Franc denominated (via Austrian banks I should mention, so the Austrian banking sector is also partially at risk, although the Austrian Central Bank think they can withstand the shock if you look at the "Stress Testing the Exposure of Austrian Banks in Central and Eastern Europe" paper presented here.
So here are Danske Banks recommendations. The countries you are told to avoid are in red:
One bright spot - or potential safe haven - does exist in Eastern Europe however: the Czech Republic:
In case any of you notice some inconsistency in this view of the Czech Republic, since of course Czechia is also one of the "reds" (though to a much lesser extent than some of the others), I think it needs to be pointed out that other factors beyond the CA deficit need to be taken into account when evaluating the situation (the value content of exports would be one of these, what the deficit is based on would be another - ie are you importing machinery and equipment which can subsequently be used for exports - and the openness of the labour market to immigration would be another - there is of course an acute labour shortage in the Czechia , but they are they are actively attempting to address this and they are even out trying to recruit in Vietnam). Essentially the Czech economy seems to be on pretty solid ground (as may also be the Slovenian one), and you do need islands of tranquility in Oceans of tempest. So some countires will for this very reason prove to be win-win, while others may well, by the same token, prove to be lose-lose. Unfortunately historic reality is seldom just.
I also would be much more cautious than Christiansen is about Russia, political instability is evident, as are labour shortages. We need to see what happens next to oil and other commodity prices before sticking our necks out on Russia I think.
In a situation where liquidity is tightening there is no doubt that the most liquidity-“hungry” countries are those with large current account deficits and large external debt. In this category we find Turkey, South Africa, Hungary, and Iceland. Furthermore, risks are heightened in the Baltic states, Romania, and Bulgaria.
That would seem to put Eastern Europe pretty generally on the map I would have thought. Chrisiansen seems to accept the arrival of the credit crunch as now a fact:
For the last couple of weeks, we have warned that the global credit crunch could spread to Emerging Markets. This has now clearly happened, but given the major moves in the global credit and equity markets there clearly is potential for even more contagion to Emerging Markets. Therefore, there is also reason to start looking for safe havens within Emerging Markets. Here external funding needs will be the key.
Furthermore:
The credit crunch has triggered a strengthening of the yen and to a lesser extent, the Swiss franc. We would in particular watch the Swiss franc as many households in Central and Eastern Europe have funded their property investments with Swiss franc loans. Hence, if the Swiss franc strengthens further then it could put additional pressures on the CEE markets mostly exposed tothe Swiss franc.
This is really code language for speaking about Hungary (although there may be more) since in Hungary around 80% of the mortgages which have been taken out in recent times have been Swiss Franc denominated (via Austrian banks I should mention, so the Austrian banking sector is also partially at risk, although the Austrian Central Bank think they can withstand the shock if you look at the "Stress Testing the Exposure of Austrian Banks in Central and Eastern Europe" paper presented here.
So here are Danske Banks recommendations. The countries you are told to avoid are in red:
One bright spot - or potential safe haven - does exist in Eastern Europe however: the Czech Republic:
Finally it should be noted that the Czech koruna (CZK) – unlike most other CEE currencies – should be expected to strengthen in the present environment due to unwinding of CZK-funded carry trades. That said, the CZK is fundamentally not undervalued and the Czech central bank should be expected to keep interest rates below the ECB rate – especially if the CZK strengthening accelerates. That will limit the potential for strengthening of the CZK.
In case any of you notice some inconsistency in this view of the Czech Republic, since of course Czechia is also one of the "reds" (though to a much lesser extent than some of the others), I think it needs to be pointed out that other factors beyond the CA deficit need to be taken into account when evaluating the situation (the value content of exports would be one of these, what the deficit is based on would be another - ie are you importing machinery and equipment which can subsequently be used for exports - and the openness of the labour market to immigration would be another - there is of course an acute labour shortage in the Czechia , but they are they are actively attempting to address this and they are even out trying to recruit in Vietnam). Essentially the Czech economy seems to be on pretty solid ground (as may also be the Slovenian one), and you do need islands of tranquility in Oceans of tempest. So some countires will for this very reason prove to be win-win, while others may well, by the same token, prove to be lose-lose. Unfortunately historic reality is seldom just.
I also would be much more cautious than Christiansen is about Russia, political instability is evident, as are labour shortages. We need to see what happens next to oil and other commodity prices before sticking our necks out on Russia I think.
Is Estonia Heading For A Soft Landing?
Earlier in the week I read a number of reports in the press which seemed to be suggesting that the recent (2nd quarter 2007) decline in the Estonian growth rate was an indication of the fact that a "soft landing" was now to be expected there. This article from Bloomberg more or less typical of the reception with which the data release was greeted:
Now I was intrigued by all of this since in the first place I don't think any decision on hard and soft landings is something you can take on the basis of a simple quarterly GDP reading (leaving aside for the present time the question of what exactly we mean by hard and soft landings in this context, a topic which I have attempted to address in this post), and in the second place I don't think you can even begin to address the issue in an emerging markets context (and yes, the Eastern Europe EU 10 are in the sense that counts here still "emerging markets")without taking some account of the final landing the financial markets will have when the current bout of turmoil ends. But still, as I say, I am intrigued by the way people can make such assertions, and what they think the grounds for making them are. So I started to dig a little deeper. And here is what I found.
In the first place it may be useful to take the arguments as they are being presented one at a time, since the way people justify their opinions is important, and I do think there is some confusion abroad about is being talked about here.
What is being asserted is:
1) That the year on year growth as measured by quarters has slowed in Estonia (this is certainly true, it has).
2) That the growth rate needs to slow further to "get out of the woods".
3) The Finance Ministry consider the slowdown greater than expected, but still "welcome".
4) The data is consistent with the possibility of Estonia having a soft landing.
Points (2) to (4) seem to me to be misleading, and now I'll try and explain why. (Incidentally, here is the original Estonia statistical office release which lies behind the report. It is worth noting that what we have here is only a "flash release", the complete initial data will only be available in September, together with what promises to be a complete overhaul of recent Estonian GDP data, so we well may be in for some surprises yet awhile, but still, if we want to decide whether or not we face a possible hard or soft landing at this point we have to work with the data we have, such as it is).
One of the difficulties about measuring economic growth is that you are never sure just which numbers to look at. You could look at GDP evolution (by quarters, lets stay with quarters here) in straight current money terms, a process which for some strange reason we economists refer to as viewing the data in "nominal" terms. So lets start here, and to do this here's a chart for Estonian GDP at current prices and non-seasonally adjusted since the start of 2006.
Well this chart is reasonably easy to interpret, and there is no big mystery here, in the sense that it is clear that the Estonian economy is, and has been, growing. So, lets dig-down a little deeper: here's a chart for Estonian GDP at current prices and non-seasonally adjusted since 2000.
Now the interesting thing to notice, is that in these "raw", non-adjusted, figures, you can see a clear decline in GDP in Q1 each year when compared with Q4 in the previous one. So the annual data have a rather irregular flavor, and this will be important when we get to what is happening in 2007.
Ok, so now let's look at the data from 2005 on a seasonally adjusted and constant (2000) price basis, ie what we economists call in "real GDP growth" terms.
Here what we can see here is that while the Estonian economy has been growing, the rate of growth has been slowing for some quarters now. This slowing becomes even clearer if we look at the quarterly growth in real terms.
Here it becomes apparent that the Estonian economy probably peaked somewhere between the 3rd quarter of 2005 and the 1st quarter of 2006. But what stands out even more is what happened in Q2 2007 (with a quarterly growth rate of only 0.2% according to my calculations). This is almost - in Baltic economy terms - to grind to a halt. Indeed since the Q1 2007 figures are seasonally corrected, and it is not clear to what extent the "correction" being used is valid during such a sudden slowdown, the deceleration may be more equally distributed over the two quarters than it seems, but still, the drop is real and evident enough.
The issue is however compounded by one additional factor, which only adds to our difficulties: the bronze soldier factor. Back in April Estonian authorities exhumed the remains of 12 Soviet soldiers and moved the associated bronze statue to a military cemetery on the outskirts of Tallinn. This move provoked significant protests in Tallinn and other Estonian cities, disturbances which lead to the detention of over 1,000 people, to dozens injured and to the death of one Russian national.
Predictably the Russians have responded in kind, by taking administrative economic measures against Estonia.
Tiit Vahi, Estonia's former prime minister and owner of the Silmet plant, is quoted in the Estonian press as saying the downturn was predictable, given that the economy was bound to be negatively affected by any worsening in relations with Russia.
"Russia has used administrative measures, scaling down rail service and limiting exports to Estonia and imports from Estonia," he is quoted as saying.
This view is also shared by Tiit Tammsaar, head of Baltic Panel Group, who said his company, which produces plywood, has been experiencing a shortage of raw materials from Russia.
The state-controlled railway Eesti Raudtee has also indicated that the volume of rail shipments fell 35% in July, year-on-year, to 2.5 million metric tons, while the volume of oil shipments in July fell 34%, year-on-year, to 1.55 million metric tons, and coal shipments declined 60% in July, year-on-year.
As a result of this Eesti Raudtee has had to lay off 200 employees due to a fall in the volume of freight traffic to Russia.
So what can we conclude from all this? Well in the first place the obvious point would be that it is very important when you enter a critical economic period as Estonia has, not to shoot yourself in the foot. But then this is exactly what Estonia seems to have done.
Clearly the dispute with Russia has produced a dramatic screech of the brakes in Estonia. Does this mean that a hard landing is now inevitable? Well, not necessarily, since to know the answer to this question we need to know what happens next in the financial markets, but what we can say is that the possibility of a hard landing has risen considerably, while what we most definitely can't say is that this slowdown is positive (or "welcome" even, given its scale) or that it provides evidence of a soft landing. Au contraire and caveat emptor.
Update
Someone who seems to have some clear idea about what happens in the world is Danske Bank Senior Analyst Lars Christensen. Last week he published a research report (pdf link) which I pretty much agree with, and in particular he says this:
By-the-by he also makes this point:
Estonia's economy grew at its slowest pace in two and a half years in the second quarter, as manufacturing output ebbed and oil shipments from Russia declined.
The $15.1 billion economy grew an annual 7.3 percent, compared with 9.8 percent in the first three months of the year, the Tallinn-based statistics office said on its Web site today. ``The number takes out the worst fears about overheating,'' said Mika Erkkila, a senior analyst with Nordea Bank in Helsinki in an e-mailed comment.``However, 7.3 percent is still above the long-run sustainable rate and hence it will still take a quarter or two with further slowing growth before we can conclude that we are out of the woods.''
The central bank said the data was in line with its previous forecasts the economy will make a ``soft landing.'' Trade data also indicated the current-account deficit has stopped growing, it said in an e-mailed statement.
The finance ministry said growth should slow further in the third quarter, citing weaker business and consumer confidence. The slowdown in the second quarter was more than expected, but still ``welcome'' after prolonged growth above potential, the ministry said in an e-mailed statement.
Now I was intrigued by all of this since in the first place I don't think any decision on hard and soft landings is something you can take on the basis of a simple quarterly GDP reading (leaving aside for the present time the question of what exactly we mean by hard and soft landings in this context, a topic which I have attempted to address in this post), and in the second place I don't think you can even begin to address the issue in an emerging markets context (and yes, the Eastern Europe EU 10 are in the sense that counts here still "emerging markets")without taking some account of the final landing the financial markets will have when the current bout of turmoil ends. But still, as I say, I am intrigued by the way people can make such assertions, and what they think the grounds for making them are. So I started to dig a little deeper. And here is what I found.
In the first place it may be useful to take the arguments as they are being presented one at a time, since the way people justify their opinions is important, and I do think there is some confusion abroad about is being talked about here.
What is being asserted is:
1) That the year on year growth as measured by quarters has slowed in Estonia (this is certainly true, it has).
2) That the growth rate needs to slow further to "get out of the woods".
3) The Finance Ministry consider the slowdown greater than expected, but still "welcome".
4) The data is consistent with the possibility of Estonia having a soft landing.
Points (2) to (4) seem to me to be misleading, and now I'll try and explain why. (Incidentally, here is the original Estonia statistical office release which lies behind the report. It is worth noting that what we have here is only a "flash release", the complete initial data will only be available in September, together with what promises to be a complete overhaul of recent Estonian GDP data, so we well may be in for some surprises yet awhile, but still, if we want to decide whether or not we face a possible hard or soft landing at this point we have to work with the data we have, such as it is).
One of the difficulties about measuring economic growth is that you are never sure just which numbers to look at. You could look at GDP evolution (by quarters, lets stay with quarters here) in straight current money terms, a process which for some strange reason we economists refer to as viewing the data in "nominal" terms. So lets start here, and to do this here's a chart for Estonian GDP at current prices and non-seasonally adjusted since the start of 2006.
Well this chart is reasonably easy to interpret, and there is no big mystery here, in the sense that it is clear that the Estonian economy is, and has been, growing. So, lets dig-down a little deeper: here's a chart for Estonian GDP at current prices and non-seasonally adjusted since 2000.
Now the interesting thing to notice, is that in these "raw", non-adjusted, figures, you can see a clear decline in GDP in Q1 each year when compared with Q4 in the previous one. So the annual data have a rather irregular flavor, and this will be important when we get to what is happening in 2007.
Ok, so now let's look at the data from 2005 on a seasonally adjusted and constant (2000) price basis, ie what we economists call in "real GDP growth" terms.
Here what we can see here is that while the Estonian economy has been growing, the rate of growth has been slowing for some quarters now. This slowing becomes even clearer if we look at the quarterly growth in real terms.
Here it becomes apparent that the Estonian economy probably peaked somewhere between the 3rd quarter of 2005 and the 1st quarter of 2006. But what stands out even more is what happened in Q2 2007 (with a quarterly growth rate of only 0.2% according to my calculations). This is almost - in Baltic economy terms - to grind to a halt. Indeed since the Q1 2007 figures are seasonally corrected, and it is not clear to what extent the "correction" being used is valid during such a sudden slowdown, the deceleration may be more equally distributed over the two quarters than it seems, but still, the drop is real and evident enough.
The issue is however compounded by one additional factor, which only adds to our difficulties: the bronze soldier factor. Back in April Estonian authorities exhumed the remains of 12 Soviet soldiers and moved the associated bronze statue to a military cemetery on the outskirts of Tallinn. This move provoked significant protests in Tallinn and other Estonian cities, disturbances which lead to the detention of over 1,000 people, to dozens injured and to the death of one Russian national.
Predictably the Russians have responded in kind, by taking administrative economic measures against Estonia.
Tiit Vahi, Estonia's former prime minister and owner of the Silmet plant, is quoted in the Estonian press as saying the downturn was predictable, given that the economy was bound to be negatively affected by any worsening in relations with Russia.
"Russia has used administrative measures, scaling down rail service and limiting exports to Estonia and imports from Estonia," he is quoted as saying.
This view is also shared by Tiit Tammsaar, head of Baltic Panel Group, who said his company, which produces plywood, has been experiencing a shortage of raw materials from Russia.
The state-controlled railway Eesti Raudtee has also indicated that the volume of rail shipments fell 35% in July, year-on-year, to 2.5 million metric tons, while the volume of oil shipments in July fell 34%, year-on-year, to 1.55 million metric tons, and coal shipments declined 60% in July, year-on-year.
As a result of this Eesti Raudtee has had to lay off 200 employees due to a fall in the volume of freight traffic to Russia.
So what can we conclude from all this? Well in the first place the obvious point would be that it is very important when you enter a critical economic period as Estonia has, not to shoot yourself in the foot. But then this is exactly what Estonia seems to have done.
Clearly the dispute with Russia has produced a dramatic screech of the brakes in Estonia. Does this mean that a hard landing is now inevitable? Well, not necessarily, since to know the answer to this question we need to know what happens next in the financial markets, but what we can say is that the possibility of a hard landing has risen considerably, while what we most definitely can't say is that this slowdown is positive (or "welcome" even, given its scale) or that it provides evidence of a soft landing. Au contraire and caveat emptor.
Update
Someone who seems to have some clear idea about what happens in the world is Danske Bank Senior Analyst Lars Christensen. Last week he published a research report (pdf link) which I pretty much agree with, and in particular he says this:
It is still too early to say whether there will be a hard or a soft landing in the economy – and we will probably not know this for a couple of quarters yet. The signs of overheating in the Estonian economy have been very clear, and therefore it should not be any great surprise that growth is beginning to slow now.
By-the-by he also makes this point:
The breakdown of the national accounts numbers for GDP has not yet been published, but other data indicate that the slowdown in the economy is fairly broad-based. The major change is probably that consumer and investor sentiment have turned more negative, and private consumption and particularly fixed capital investment – mostly in the construction sector – is now beginning to slow decisively. That said, the numbers are still mixed, but overall we do not think there is any doubt that growth has peaked and a slowdown in the economy is under way. Anecdotal evidence seems to indicate that a slowdown in construction activity, in particular, is leading the general slowdown in the economy.
Thursday, August 9, 2007
Latvian Fertility
Well, while we are looking at the economic straights which Latvia is now in, it may also be useful to see how we got to where we are. Basically the Latvian economy is growing very rapidly, in all probability too rapidly even in the best of cases. But Latvia does not have the best of cases. If there were a plentiful and adequate supply of fresh labour, growth rates near the present one might not be unthinkable (remember China's GDP is currently growing at around the 11% annual rate, and India may well soon overtake this - over say a 5 to 10 year window). So why not Latvia? Well you have to look at the fertility and migration situation, that is why not.
Latvian Abroad had a post over the weekend which gave some details of the numbers of Latvians in the UK and Ireland (which must surely be the principal destinations since 2005), while Latvijas Statistika offered us some useful information on Latvian fertility earlier in the week.
But before we get into some of the more recent details, I've compared a simple chart showing live births in Latvia since the late 1980s (and in the process, documented the natural population decline by making a comparison with deaths, as can be seen the crossover point is around 1992).
And before going any further I think it important to point out that, from an economic point of view, it is live births and not the Total Fertility Rate statistic which matters, since these births are what regulate the actual flow of new people into the working age groups. As can be see there was a very dramatic decline after 1987 (ie 20 years ago). The decline steadied after 1999, and the number of births has risen slightly, but it is important to point out here (and even forgetting for the moment about the impact of migration) that the number of births will surely soon start to fall again.
This is principally for two reasons:
In the first place there is the fact that the median age of first birth for Latvian mothers at around 25.5 is still comparatively low by West European standards (in Western Europe the numbers normally are approaching the 30 mark). Let's have a look at a chart from Latvijas Statistika:
So we can see that mean ages at first birth have been steadily rising. This process is known as birth postponement, and produces what is known as a "birth dearth" as women delay having children. This process also produces artificially low readings on period based fertility indicators (like the standard Total Fertility Rate), but this, as I say, is largely irrelevant from an economic point of view, since what we are interested in is how many people will be arriving in the labour market in the years ahead. And as I say, since postponement has only run approximately half its probable course, we should expect more from the "birth dearth effect".
But there is a second reason why births are likely to go down with time rather than up, and this is known as the population momentum effect. If we look at the number of children born in 1999 (just under 20,000), then even assuming that Latvia achieved that magical 2.1 perfect reproduction fertility number, they would only produce 20,000 children, not the old level of 40,000 or so. And we can be pretty sure that these 20,000 children born in 1999 won't do this even under the best of circumstances (which, of course, we aren't) since even being optimistic they are only likely to have completed cohort fertility of somewhere in the 1.5 - 1.7 region if other countries examples are anything to go by. So these 20,000 children will produce say 16,000 or 17,000 children.
Latvian Abroad had a post over the weekend which gave some details of the numbers of Latvians in the UK and Ireland (which must surely be the principal destinations since 2005), while Latvijas Statistika offered us some useful information on Latvian fertility earlier in the week.
But before we get into some of the more recent details, I've compared a simple chart showing live births in Latvia since the late 1980s (and in the process, documented the natural population decline by making a comparison with deaths, as can be seen the crossover point is around 1992).
And before going any further I think it important to point out that, from an economic point of view, it is live births and not the Total Fertility Rate statistic which matters, since these births are what regulate the actual flow of new people into the working age groups. As can be see there was a very dramatic decline after 1987 (ie 20 years ago). The decline steadied after 1999, and the number of births has risen slightly, but it is important to point out here (and even forgetting for the moment about the impact of migration) that the number of births will surely soon start to fall again.
This is principally for two reasons:
In the first place there is the fact that the median age of first birth for Latvian mothers at around 25.5 is still comparatively low by West European standards (in Western Europe the numbers normally are approaching the 30 mark). Let's have a look at a chart from Latvijas Statistika:
So we can see that mean ages at first birth have been steadily rising. This process is known as birth postponement, and produces what is known as a "birth dearth" as women delay having children. This process also produces artificially low readings on period based fertility indicators (like the standard Total Fertility Rate), but this, as I say, is largely irrelevant from an economic point of view, since what we are interested in is how many people will be arriving in the labour market in the years ahead. And as I say, since postponement has only run approximately half its probable course, we should expect more from the "birth dearth effect".
But there is a second reason why births are likely to go down with time rather than up, and this is known as the population momentum effect. If we look at the number of children born in 1999 (just under 20,000), then even assuming that Latvia achieved that magical 2.1 perfect reproduction fertility number, they would only produce 20,000 children, not the old level of 40,000 or so. And we can be pretty sure that these 20,000 children born in 1999 won't do this even under the best of circumstances (which, of course, we aren't) since even being optimistic they are only likely to have completed cohort fertility of somewhere in the 1.5 - 1.7 region if other countries examples are anything to go by. So these 20,000 children will produce say 16,000 or 17,000 children.
July 2007 Latvia Inflation
Well, not unexpectedly the July inflation reading came in on the high side (9.5% year on year). This is not especially surprising given all the inflation there must be in the pipeline after all the wage rises. Things will have to get worse before they get better on this front. The first sign that inflation pressures are easing would come from the Q2 wages data, assuming these have improved.
Of course coupled with the Q2 GDP data (see next post), there are few signs that Latvia is slowing anything like quickly enough (in order to avoid having a very dramatic deceleration later), so this must raise question marks about the effectiveness of the policy measures introduced so far.
For the record, here are the time series graphs for the consumer price index and the yaer on year inflation rate.
Of course coupled with the Q2 GDP data (see next post), there are few signs that Latvia is slowing anything like quickly enough (in order to avoid having a very dramatic deceleration later), so this must raise question marks about the effectiveness of the policy measures introduced so far.
For the record, here are the time series graphs for the consumer price index and the yaer on year inflation rate.
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