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Sunday, December 9, 2007

Estonia Q3 2007 Real Estate Contracts

According to data from Statistics Estonia, there were 11,400 real estate purchase-sale transactions - with a total value of 12.7billion kroons - during the 3rd quarter. Both the number and the total value of transactions decreased when compared with the previous quarter, and with the corresponding quarter of the previous year.

The total number of notarised purchase-sale contracts decreased by 25% as compared to the 3rd quarter of the previous year, and by 17% as compared to the previous quarter. The last time that less than 12,000 contracts were notarised was in the 1st quarter of 2004.

Also the total value of contracts decreased 25% when compared to the previous quarter and to the corresponding quarter of the previous year. Although the average value of contracts has decreased during last quarters as well, the decline has not been as drastic as in case of the number and total value of contracts.

The recession in the number of contracts is mainly caused by the decrease in the number of contracts for dwellings. Compared to the 3rd quarter of 2006 the number of contracts for dwellings decreased by a quarter and compared to the previous quarter by a fifth. In the 3rd quarter of 2007, 55% of the purchase-sale contracts were concluded for the transfer of dwellings, 23% for unimproved registered buildings, 14%for residential buildings and 7% for non-residential buildings. The decrease in the number of contracts notarised in Tallinn was greater than in the rest of Estonia. A dead fish, as they say, starts to stink from the head.

50% of real estate contracts were notarised in Tallinn in Q3 2007. The value of these contracts accounted for almost three quarters of the total value of purchase-sale contracts. The share of the number and the total value of contracts notarised in Tallinn has been decreasing since the beginning of 2006.

According to Statistics Estonia, the more conservative loan policies of the banks and the increase in interest rates (ie the credit crunch) have been the main factor influencing the slowdown of real estate market. If at the beginning of 2006 the interest rates on housing loans granted to individuals were still below 4% (these loans are largely, remember, denominated in euros), by September 2007 they had already reached 5.9% (although please note, if we look at the inflation rate - 9.1% in November - these are still extraordinarily negative), and of course, in Estonia, unlike the United States, there is no mega-conduit rescue proposal on the table to come to the aid of those paying the interest. If (or rather when) the value of the currency moves (as it surely has to if Estonian GDP is not to go into straight decline at some point) and more realistic interest rates (ie ones which bear some relation to the level of risk involved) come into effect, then distress among households will become severe. Basically a rescue package will need to be put together, and the capital (book) value of all these outstanding loans will have to be adjusted down according to the actual level of distress produced. Essentially, all those who from the sidelines - the EU Commission, the IMF, the ECB, the World Bank, the Economist, etc - have had a hand in all this with their constant stream of policy recommendations, recommendations which have been by-and-large followed (ie leaving out the odd 'detail' of excess here, too much government spending there, I mean here that policy needs to be realistic, humans, and even more to the point governments, are never perfect, so this part should be factored in from the start, by allowing a margin.....) - will need to accept their share of the responsibility for the mess which has been produced as a result. As Oscar Widle put it "to lose one parent might be considered a misfortune, but losing two, that has to be carelessness". Well the ECB has lost three plus (The Baltics, Bulgaria, Romania, possibly now Poland, and Russia is now definitely wobbling- this latter is not the direct responibility of the ECB I know, but is certainly is in the policy sphere of the World Bank and the IMF).

These institutions cannot, like Pontius Pilate, simply wash their hands of all this (well they can, but they should at least be ashamed of themselves if they do), having aided and abetted it during the upswing by recommending policy proposals which quite simply failed to take account of the quite unique demographic characteristics of this whole region. You cab incant the mantra that Demography Doesn't Matter till you are blue in the face, but unfortunately it does, and I will tell you how we know it does, we know it does by looking at the macroeconomic data, in which (plagiarising Solow's famous dictum) we may not be able to discern the presence of the computer, but we can certainly see the impact of fertility, and especially of decades of below replacement fertility. As I say in my recent analysis of Russia's burgeoning inflation problem:

Well it seems to be the case that this sudden acceleration in growth and inflation is intimately related to the very specific and unusual demographic profile which most of Eastern Europe has inherited from its recent past. So one of my central arguments is that what we have here is certain a kind of mis-match. A mis-match between a basically third world. “developing-country-type” income level (for this reason they tend to be called “emerging economies”) and a very-first-world-type age structure - in the sense that many of these societies have now had below replacement fertility for decades, and in some cases several decades, with the working age group entry level cohorts (15 to 24) down to around 65% of their earlier high point, and the key 25 to 49 age group peaking nearly everywhere as a proportion of the total population, before the total working age population finally enters terminal decline. This is very different from the sort of demographic dividend driven growth we are seeing across most of the other strong growth emerging economies, and the economic consequences of this difference are now becoming all too evident.

Of course, we are still waiting for an adequate Mea Culpa for the Argentine case, but at least people have generally lined up and accepted their "haircut" with dignity. Now it will be the turn of all those who piled in and fuelled all this madness. It is easy to get things wrong, we all do, the important thing is to know how to accept when you have been wrong, to recognise mistakes, and to be "big" enough to take the necessary remedial steps.


indrek said...

One can be pretty certain, that Estonia will choose market-based restructuring of businesses over devaluation even if this means decreasing GDP. The same happened after the Russian crisis.

First of all the currency board has been the cornerstone of economic policy from the reimplementation of Estonian currency at 1992. As such it will be politically disastrous for any political party to vote for changing this (unless the public view would change dramatically, but this will not happen before some very serious and long lasting decline in the GDP - the currency board is part of the belief system for the public in Estonia and the incumbent government and parliament consists pretty much from the same parties who introduced it). And it is a political matter, as the currency board can only be changed by the parliament.

So the really important topic will be how will the economy cope with recession and what will the recovery path be. The aftermaths of the Russian crisis has given some confidence to the Central Bank and local analysts. As well as the high economic freedom (incl comparatively free labour market), openness of the economy and inflow of EU-s money. Which is yet another reason for not considering devaluation - the following rise in inflation expectations and currency risk price raise affecting long term growth potential is considered to be much higher than the price of short-run fluctuations in output and unemployment.

Edward Hugh said...

Hi Indrek,

And thank you for your comment.

"One can be pretty certain, that Estonia will choose market-based restructuring of businesses over devaluation even if this means decreasing GDP."

Possibly you are right here in the short term, this is the road people will go down. This indeed was what happened intitially in Argentina, which - I don't know if you have noticed - had the misfortune to be attached to a rapidly upwardly rising dollar in the same way that many EU10 countries are lock-in, whether via direct pegs or otherwise - to the euro when it is going through the roof.

So we are headed for negative GDP growth territory as things stand now, in that I would agree with you.

"it will be politically disastrous for any political party to vote for changing this"

Oh, of course, they will probably want to lock all the politicians up at some point. This is what happened again in Argentina, where they wanted to imprison De La Rua and Carvallo, even though at the end of the day they were only following best advice from the IMF, just like your local politicians have been doing.

Did you see the poll Latvian abroad published? Less than 50% of those questioned would vote for any of the parties on offer.

So I agree. The economic crisis is going to pass through a political one before we get to any real resolution.

The thing is though, this is not a simple re-run of the past, and the issue is a much more general regional one, and neeeds to be analysed and understood in this way. So I think events elsewhere will cut across all this, maybe in Bulgaria, or maybe in Hungary. As I keep indicating on the Latvia blog (and yes I have been putting a lot of posts up today, and I think all the charts are worth looking at) the problem is of the book values of the outsanding swiss franc loans if Hungary makes its currency adjustment (there is no peg, but they can't reduce interest rates, since the forint would fall, and half of Hungary's homeowners would become bankrupt, and without reducing interest rates they can't stimulate domestic demand. These are very old and classic problems, but they have, it seems, all been forgotten about).

I am suggesting that this issue needs a serious initiative in Europe just like the sub-prime problem in the US is getting in the form of a bail out from the Bush administration. Maybe it shouldn't be like this, but I'm afraid it is, and it needs to be, since the problems are deep and important.

So I think someone somewhere will break ranks, and send the Austrian (or whatever) banks to hell, or at least off for a big haircut. Once one country moves the rest will more or less have no alternative. Herd dynamics work like this. The market pressure on anyone who "hung out" would become just unbearable, even if the problem wasn't foreign currency reserves directly, but the penal rates of interest people would have to pay to borrow money.

And the wage deflation needed to become competitive again is not to be sneezed at. Again, look at Hungary, and they are just begining (check the PPI comparative chart on one of the Latvian posts too). And then there is the danger of out migration during the recession. If the problem is in-part a demographic one, then several years of very stagnant growth is only going to make this problem much worse.

Which is why I think it would be much better to come clean now, and make a firm and decisive change of course, which means starting by scrapping the currency board. Unlike the Argentine case, the default will not be on public debt, which hardly exists, but on private debt, both household and corporate. This, I think, is inevitable.

"The aftermaths of the Russian crisis has given some confidence to the Central Bank and local analysts."

Well look, take a look on the Eastern Europe blog, I did an in depth analysis of Russia last week precisely for these reasons. Russia (and Ukraine for that matter) are now headed off down the same road, and we need to understand why.

"Which is yet another reason for not considering devaluation - the following rise in inflation expectations and currency risk price raise affecting long term growth potential is considered to be much higher than the price of short-run fluctuations in output and unemployment."

Well again look, this is more or less standard textbook Robert Lucas and Neo Classical growth theory, and this is in the end why I am interested in this problem, as I think the textbook model is severely flawed. Basically on the old model all this shouldn't be happening, and it is, so we need to talk, in a calm and reasoned fashion, about why it is happening, and ammend our theories as necessary.

I also think that demography is a very important and neglected dimension here. Basically I would say that most of the EU 10 societies have a window between now and 2015 to get a bit richer before the full weight of population ageing hits them. If they spend half of this period in semi-recession then the problem really may become irreversible. That is why some sort of initiative on all this is important now.

Basically all of this is not simply a text book argument, but as it happens the world neo-classical economics moves in is the timeless one of the eternerally revolving planets, not the one we have, where populations age and enter numerical decline. You won't find any talk of this issue in any of the "convergence" literature, you know, no matter how hard you scour it.

And on top of it all, we have the makeshift Bretton Woods II system breaking apart under our feet, with uncertain consequences for the short term relative values of the euro and the dollar. The main threat to your development (in competition terms) comes not from within the eurozone, but from without: think perhaps Turkey, or China. The developing economy members of the EU 10 are likely to face the full force of extra community trade pressure, especially from effective dollar peggars if things continue like this. And your economies are too fragile, they simply cannot stand the force wave which might come.

Going back to Argentina, I had a friend who visited in the December just before they folded. He went into a shoe shop and said "those are lovely shoes, where is the leather from". "Brazil" came the reply. "But don't you have lots of cattle in Argentina?" he asked innocently. "Oh yes sir, but that is all for export, since it is too expensive for us". Of course they weren't having too much luck with exports either, but the moral of this lesson is that Brazil's Real was floating, and in Brazil they were able to leverage and gain advantage from Argentina's difficulty. Someone in the EU10 will think of doing this, and gaining first mover advantage at some point, and then the whole deadlock will break.

Anyway, despite the fact that we don't agree, thanks once again for a thoughtful and considered comment.

indrek said...

Thank you for the answer, Edward. I have been following Baltic Economy Watch for some time now, and it is really nice job you are doing! There is actually no site in Estonia matching your level of analysis.

Just trying to offer some comments from a grad student inside the country. As my own interests lie more in long term than cycles, I am basically referencing some of the discussion going on here, not necessarily my own strongly held beliefs. Distance in time and/or place is definitely a good thing for adequate economic analysis, but information from inside can hopefully contribute. On one hand there is this strong support for currency board which I mentioned in previous comment. Especially public, but also from economic analysts community. Which means - in combination of currency board system which is able to technically sustain speculative pressure - that we will not see any preemptive devaluation. Btw, nobody here expects to get away without any speculative pressure on exchange rate - the only question remaining is wether it will hit harder than the one after the Asian crisis.

There is also a context of applying for joining the euro-area - something which is utterly impossible if the economy is not able to deal with shocks under fixed exchange rate regime. Thus the common stance within the economists' circles is to "wait and see" and not to care about short run troubles. There is also a wide consensus that the economy has been overheating through recent years and that readjusting comes with a bankruptcy wave and everything implied, especially within sectors not able to cope with wage pressure. On the other hand this is mostly considered to be inevitable and even positive sign for the health of the economy and for laying foundations for future growth (both alleviating the shortage of labor and increasing the quality of businesses - the rate of bankruptcies has been near zero during last years). You can probably get the general view on economic policy in here, lets just add that a week ago the trade unions (sic!) made a joint request with employer's organisation for government to increase the budget surplus for next year from current 1.5% to 3% of GDP.

Thus negative growth rate will not hit anyone as something surprising or something that would change the positions, at least as long as the trend will turn within ~4-6 quarters (if this will be the case is the point where your thoughts seem to differ from the general view here). It would be considered as the price for doubling the GDP during last 7 years. Everyone also remembers the last speculation against EEK (during the Asian crisis), the motivation behind the speculation (including the preceding increase in price levels, CA deficit problem, devaluation of Russian Rouble - note that at the time the share of Russia in Estonian export was 29%, decreasing to 9% during the crisis) and the quick recovery afterwards, leading to doubling of GDP as I already mentioned.

Estonian trade with EU is ~65-70% of the total trade (contrast this with Argentina), if we remove transit, then probably ~80%. Russia's share is in single digits (and even this tends to consist mostly from transit flows, contributing little to value added). Thus the movement of euro can mostly only have secondary effect through competition with suppliers outside of euroarea, but this should be happening already (fall of SEK might be a bigger problem, it shows some downward trend, and any moves of LVL will have consequences, albeit I would be much more worried of the psychological than real ones). And Estonian Bank has continuously estimated that due to the composition of Estonian trade the fall of dollar seems to have positive effects. Government has continuously sustained budget surpluses acquiring reserves held overseas, which gives them some fiscal freedom for negative scenarios.

This is the intellectual and informational environment in which both incumbent politicians and local economic experts think. And they are responsible for holding or changing the currency board. Let's just say I will most happily put my money at least against the preemptive devaluation speculations and probably well into the GDP decline, for which I have actually asked local investor's forum to analyze the behavior of Hong Kong stock exchange during speculations :)

NB! the numbers I use are not heavily checked, as I found myself in a bit of hurry now, they should be "almost" accurate though.

But I am posting this comment now as it is, the situation unfolding during next quarters really is most interesting for anyone interested in economics and will give me enough reasons to continue later :)

Thank you again for sharing your analysis on this blog!

Edward Hugh said...

Hi again Indrek,

And thanks one more time for your lengthy and considered comment.

On the trade front, I appreciate that the Baltic states are to some extent shielded from the rising euro problem in terms of their exports being mainly to countries whose currencies are also rising. But their imports are not, in the sense that gradually there will be Asian penetration (and even US penetration) of the import market across the whole eurozone if things continue like this. The EU10 haven't really felt the full blast of this yet, due to their low cost environment, but if things continue as they are they will. So we will have growing ex-eurozone import substitution for domestic production, which may mean that however fast you raise exports imports may rise faster. This would be one thing I would be concerned about.

At the same time being so closely linked to the euro sucks you all in to the whole Bretton Woods correction process. Obviously the long term answer to this problem is for the central banks to hold a balanced currency composition in their reserves - including a growing proportion of the new currencies (the yuan, the rupee, the real, and of course for this to happen capital controls would have to come off in China, and the currency be allowed to float freely, but watch out for the current inflation backdraft there) - and thus we will get to a sort of Bretton Woods III situation with a much more balanced basket of currencies. But right now this hasn't really gotten started, so all the weight which goes with the declining role of the dollar falls onto the Euro. And this isn't happening, as some commentators are suggesting, because the outlook for the US economy is particulary weak. I think they look fairly solid, although they may have a recession due to all the sub-prime bloodletting. But this is a temporary blip. The real currency adjustment if following behind the changing importance of the different economies in the global one.

See this post, for example, and this one (and this MacroMan post. MacroMan is very ineteresting for the areas he has insight into).

Incidentally, on the SEK, don't miss what is happening in the Czech Republic with the koruna and rising inflation. The smooth win-win curve they have been riding may be about to invert, if rising inflation produces rising interest rates (as the fed goes down) and the koruna may move from being a carry currency to a "carried" one. This can suck in a lot of capital seeking yield, and the whole thing can head towards Baltic terrain. So no easy answers here, and what we need is more up to date analysis of what is happening, rather than a recitation of old models from the textbook (I'm obviously not talking about you here).

OK, well keep in touch! Lets now go and see what actually happens.