Facebook Blogging

Edward Hugh has a lively and enjoyable Facebook community where he publishes frequent breaking news economics links and short updates. If you would like to receive these updates on a regular basis and join the debate please invite Edward as a friend by clicking the Facebook link at the top of the right sidebar.

Wednesday, April 30, 2008

Estonian Retail Sales Decline in March 2008

Estonian retail sales contracted in March when compared with March 2007, the first contraction since at least 2001, suggesting the Baltic economy may face a much more abrupt slowdown than may had been anticipating. Retail sales excluding cars and fuel declined an annual 4 percent, compared with a revised 6 percent rise in February. Sales including cars and fuel last showed a decline in November 1998, according to the statistics office database.

Clothing sales declined an annual 19 percent and sales of household goods fell 12 percent. Food sales remained unchanged, the office said.Estonian economic growth, which had been largely driven by a surge in wages and borrowing which lead to large increases in consumer spending and property investment, slowed in the fourth quarter of 2007 to a near six-year low of 4.8 percent. The central bank on April 16 forecast growth of 2 percent for 2008, expecting a contraction in the fourth quarter, while AS Hansapank, the biggest Baltic lender, forecast yesterday 2008 growth at 3.5 percent.

``Even before today's data, any hopes of a quick recovery in the second quarter looked unrealistic. Now they must have faded altogether,''
Neil Shearing, analyst at Capital Economics

Basically domestic Estonian demand is now in full retreat, government spending is having to be cut because of the "no deficit" rule, and the only positive note is exports, which means that Estonia is now ultra-dependent on the magnitude of the developing slowdown in the other EU economies.

Tuesday, April 29, 2008

Estonia Foreign Trade February 2008

According to the latest data fromStatistics Estonia, the exports of goods increased and imports remained on roughly the same level in February 2008 compared to February 2007. As a result the trade deficit was the smallest in two years.

In February 2008 exports in current prices were 10.4 billion kroons and imports 13.2 billion kroons. Compared to February 2007, the value of exports rose 7% and imports remained on the same level. The trade deficit was 2.8 billion kroons. The trade deficit was smaller last in February 2006 — 2.6 billions kroons. Compared to February 2007, the trade deficit decreased by about 0.7 billion kroons.

Obviously this is fairly positive news, but we need to wait and see a little what the future dynamic is going to be, since a slowdown in growth across EU countries is now clearly visible.

And Estonia is obviously now very dependent on what happens in the rest of the EU (with internal demand in Estonia now contracting) since in February 2008 the share of the EU countries was 73% (and the share of CIS countries 12%) of total exports. The most important partners in exports were Finland (17%), Sweden (15%) and Latvia (11%). Exports of goods increased to all main destination countries.

In terms of imports the share of the EU countries was 80% and that of CIS countries 12%. The most important origin countries were Finland, Germany and Sweden. Imports from the EU countries increased nearly 0.6 billion kroons as compared to February 2007. The biggest decrease was announced in the imports from Russia (0.9 billion kroons)

The foreign trade deficit with the EU countries decreased 0.5 billion kroons compared to February of the previous year. The foreign trade deficit with CIS countries decreased 0.9 billion kroons.

In both exports and imports the most important commodity section was machinery and equipment (the share was 23% for exports and 21% for imports). Compared to February 2007, the nominal increase in exports was biggest in exports of raw materials and chemical industry products(31%), agricultural products and food preparations (25%) and machinery and equipment. The exports of mineral products decreased significantly — 0.7 billion kroons or 44%. Imports increased for raw materials, chemical industry products and machinery and equipment. The biggest decline in imports was for mineral products and of wood and products thereof.

Thursday, April 24, 2008

Latvian Producer Prices March 2008

Compared to February 2008, Latvian producer prices were up in March by 0.6%, according to data from the Central Statistical Bureau of Latvia. Over the year (ie compared to March 2007) producer prices have increased by 10.5%. As we can see from the chart below producer prices had been falling, but the rate of increase has now remained stubbornly flat since the end of last year. This is not good news, and especially not in the export sector, where - if you they to maintain the euro-lat peg - they need negative price increases over a period of time to restore lost competitiveness.

According to the statistics office:

Compared to February, the overall level of producer prices in March 2008 was mostly effected (by 0.4 percentage points in each activity) by the increase of the tariffs of electricity, gas, steam and hot water supply (mostly in the steam and hot water supply and in the distribution of gaseous fuels) and by the price rise in the manufacture of basic metals. However, the price decrease in the manufacture of food products and beverages (mainly in the manufacture of dairy products and cheese), in the manufacture of fabricated metal products, except machinery and equipment, in the manufacture of furniture; manufacturing n.e.c. lowered the overall level of producer prices by 0.1 percentage point in each activity.

Over the year the price increase in the manufacture of food products and beverages left the biggest impact on the overall level of producer prices, increasing it by 4.3 percentage points. The increase of the tariffs of electricity, gas, steam and hot water supply raised the overall price level by 2.0 percentage points. The price rose in the manufacture of furniture; manufacture n.e.c. increased the overall price level by 0.7 percentage points, in publishing, printing and reproduction of recorded media, in the manufacture of other non-metallic mineral products, as well as in the manufacture of basic metals – by 0.5 percentage points in each activity.

Swedbank Profit Falls On Baltic Losses

Swedbank AB, the largest bank in the Baltic region, announced today that their profit in the first quarter of 2008 dropped by a little under 1 percent when compared with the first quarter of 2007 - basically on higher costs and increasing bad loans. Their shares fell following the announcement.

Swedbank net income dropped to 2.9 billion kronor ($494 million) from 2.91 billion kronor a year earlier, the Stockholm-based bank said in a statement today. Costs rose 13 percent to 4.44 billion kronor while loan losses almost gained sixfold to 288 million kronor, the bank said.

Swedbank gets about a third of its earnings from the Baltic states of Latvia, Lithuania and Estonia. These economies had previously been among the fastest growing in the European Union, driven in part by a credit boom that sparked concern that bad debt might increase significantly during the subsequent downturn. All three economies are all now slowing quite quickly, the Latvian economy may have entered recession in the last quarter of 2007 and the Estonian central bank recently loweed its 2008 GDP forecast to 2 percent.

Swedbank shares fell 4.1 percent to 162 kronor at 9:52 a.m. in Stockholm. They have lost 11 percent so far this year.

Net interest income, the difference between what the bank makes from lending and what it pays on deposits, rose 16 percent to 5.24 billion kronor. Fee income fell 4.7 percent to 2.18 billion kronor, because of a slowdown in mergers and acquisitions in Sweden and Norway, the bank said.

Net gains on financial items fell 86 percent to 75 million kronor, because of the ``continued credit crunch in financial markets,'' said Swedbank. The fair value of Swedbank Market's credit bond portfolio declined by 187 million kronor, it said.

Swedbank is currently expanding in Ukraine and Russia in an attempt to offset slowing growth in the Baltic states and it will be interesting to watch whether or not these ventures encounter similar problems. The bank plans to open as many as 75 offices in Ukraine this year to boost volumes and increase profitability at its OJSC Swedbank unit, which the Swedish lender acquired last year. It has 200 branches, 170,000 retail clients and 18,000 corporate clients in Ukraine.

Swedbank may make acquisitions in Ukraine and Russia if opportunities arise there, Chief Executive Officer Jan Liden said in a telephone interview today. The bank believes in ``its stable base in Sweden, significant growth in the Baltic states and exciting growth in Russia and Ukraine''.

``Current economic conditions in the Baltics have affected general sentiment towards the region, however there has been no major impact on the bank's profit for the period,'' the bank said. ``Turbulence from the U.S. subprime crisis negatively affected earnings in the quarter, even though Swedbank directly or indirectly had no significant exposure to this market.''

Monday, April 21, 2008

Estonia Producer Price Index March 2008

Prices of goods leaving Estonian factories and mines rose an annual 8 percent in March, the least in twelve months according to data from the Estonian statistics office this morning. Producer-price inflation, which may be regarded as an indicator of competitiveness and an early indicator of the future path of consumer inflation, slowed from 8.3 percent in February. Prices rose a monthly 0.1 percent, compared with 0.7 percent in February. So - as we can see from the chart - since peaking at 9.1% last October producer price inflation has been slowing, but the pace has been painfully slow.

Perhaps more to the point the percentage change in the export price index in March was 0.2% compared to February and 6.4% compared to March 2007, while the percentage change in the import price index was 1.1% compared to February 2008 and 5.2% compared to March 2007. Again as we see from the chart the rate of increase in export prices is virtually stationary at the moment, which means effectively (with the kroon pegged to the euro) that Estonian exports are becoming less competitive by the day.

Wednesday, April 16, 2008

Downward Revisions in Estonia Growth and IMF Warnings

Estonia's central bank recently published a "revised overview" of the Estonian economy - with the intriguing title of "Estonia's economy on the way towards a more sustainable development path". At the same time the bank took the opportunity to cut its 2008 growth outlook in half, bringing its annual forecast down to 2% from an earlier 4.3% prediction. If this forecast proves accurate it will, as can be seen from the chart below, certainly involve a rather noticeable stench of burning rubber as the tyres screech to a halt.

"The long-awaited economic adjustment is under way in Estonia, but it is no longer as smooth as expected due to the less favourable external environment," the Estonian central bank said as it presented its lower forecasts.

This current 2 percent forecast compares with the 7.1 percent growth rate achieved in 2007 and the 11.2 percent one in 2006.

The bank also suggest that growth will pick up again to 3 percent in 2009, however, since we still don't really know how low the GDP growth number will - at the end of the day - fall in 2008 it is perhaps early days to start reaching any hard and fast conclusions on this front. In particular we still don't know whether or not we are going to see a hard landing in Estonia (or in the rest of the Baltics for that matter, or in Bulgaria, or in Romania) - and especially in the financial sectors in these economies - so until things are a bit clearer any hard-and-fast speculation about future growth and recovery paths is rather premature in my view, however happy it may make some full-time analysts to keep churning out the numbers regardless.

Returning for a moment to the growth numbers for Q4 2007, perhaps the most important detail to note is that annual growth for the quarter was still running at 4.8% while the seasonally adjusted estimate for quarter-on-quarter growth was only 0.8% - or an annual rate of 3.2%. These numbers - when they were first made public - were of course very low in the Estonian context, but now, given the sort of downward revisions we are seeing (the IMF also recently lowered their 2008 forecast to 3%, and of course there may well be more revisions still in the pipline), they seem quite the opposite. What I think we should thus be taking away with us here is the way in which trend has been showing a very steep and continuing fall over a number of quarters, and the decline has not come to a halt yet. When it does, then we will be in a much better position to start thinking in more detail about what a recovery might look like. For the moment perhaps our time would be better spent looking at just what downside risk we still have in the Estonian context.

The Outlook For Q1 2008

What is quite evident from the above chart is that growth momentum in Estonia has now been declining since the first quarter of 2006. What is also evident is that the loss of momentum is moving in fits and starts. Q3 2007, for example, shows a certain recovery from Q2, but then the decline continues in Q4. We will see moving forward if this "fits and starts" process continues. It wouldn't surprise me to see a Q1 2008 number which was slightly up on Q4 2007. But if it was - at say 1% quarter on quarter - that would mean we had effectively seen more than half the growth anticipated by the Estonian bank in just one quarter, which makes me want to ask myself some awkward questions concerning just what sort of growth we will then see over the rest of the year (ie, are we headed directly into recession in Q2?).

Alternately the downward drift might still continue in Q1 (hard to say looking at things like the industrial output numbers at this point) in which case the whole edifice would be well on its way down towards trawling the bottom.

Industrial output - according to the latest data release from the statistics office - was up in February, on both January (1.8%) and February 2007 (2.6%). This follows on the back of a revised 4.2% increase in January. Manufacturing output was also up, by 5.2% on February 2007, and by 2.4% (seasonally adjusted) on January. As can be seen in the chart below, December was very definitely a bad month, and even seems to have been an exception, so we now need to wait a little to see just where things move from here. Patience, I do believe, is most definitely a virtue in this type of situation.

EU Economic Sentiment Index

The EU Composite economic sentiment index for Estonia is also interesting, since while it shows a steady and constant decline from August 2006, since December 2007 it seems - for the moment - to have stabilised, a reading which is consistent with the idea that growth in Q1 2008 may not be dramatically down when compared with Q4 2007.


Inflation - which has really been hitting the highs of late - was seen by the central bank as speeding up over whole year 2008 to 9.8 percent from 6.8 percent in 2007, and then falling back again to 3.0 percent by 2010. Estonia's inflation rate in fact fell back slightly in March from what had been virtually a 10-year high in February as the growth rate in food and housing costs eased back slightly. The annual rate dropped to 10.9 percent from 11.3 percent in February, according to data from the statistics office. Prices rose a monthly 0.8 percent.

Unemployment and Wage Inflation

Although the situation is far from dramatic at the present time, Estonian unemployment is ticking up steadily, and in March 2008 there were 17181 registered unemployed in Estonia - this was the ninth consecutive monthly increase - and unemployment was up 441 or by 2.6% from February. Nonetheless the unemployment rate remains extremely low at 2.7% according to recent data from the Estonian Labour Market Board.

So the labour market remains extremely tight, and as a result the adjustment process is very slow. Wages and salary increases peaked in Q2 2007 (see chart below) but they were still rising at an annual rate of 20.1% in the fourth quarter, and at an annual rate of 18.1% in December (which is the latest month for which we have data) or in real terms (subtracting the monthly 9.6% CPI inflation)by 8.5%, which is hardly the normal conditions for an economic slowdown and correction. We can reasonably draw the conclusion that this tight labour market and difficulty in getting wage inflation under control is going to make the correction a longer and more drawn out affair than it otherwise would be.


Estonia's trade deficit narrowed in January, reaching its lowest level in almost two years. A large part of the reduction was a result of a rapid drop in imports - which fell year on year by 4% in January, and this undoubtedly reflects the rapid contraction in internal consumer demand, but exports did also bounce back nicely, although the level of growth - at 4% - was still well below the 12% year on year growth rates achieved in October and November.

So while - looking at what has been happening in Germany and other CEE economies - we might reasonably expect that the uptick in exports may be sustained in February, the rather volatile nature of Estonian exports makes it hard to draw any worthwhile lasting conclusions at this point. We should however note that the improvement in the trade balance will impact positively on GDP, so this would argue in favour of a slight temporary improvement in growth in the first quarter.

The bank see Estonia's current account gap - which is one of the points most cited by ratings agencies as a key worry in terms of the overheating problem - falling to 7.5 percent of GDP by 2009 from 17.4 percent in 2007. The IMF currently forecast a CA deficit of 11.2% of GDP in 2008.

Meantime the slowdown is making itself felt on the Estonian government, which faces a revenue shortfall and needs to cut spending. Estonia must cut spending this year by 3 billion kroons ($303.4 million) to avoid a budget deficit this year, the central bank said. This fiscal tightening on the government's part will obviously be a negative as far as 2008 growth is concerned.

IMF Hard Landing Warning

However, if we look beyond the current quarter it is evident that things look rather bleak, and the risk of the slowdown becoming rather more disorderly is evident. Indeed, according to the the latest IMF Global Financial Stability report (published this week), a number of Eastern European countires now face a continuing and growing risk of having a "hard landing" as the global financial crisis continues to spread. The fund also drew attention to the possibility of serious of spillover problems arising for the Scandinavian, Italian and Austria banks that have lent heavily in the region, and this warning will not be taken lightly by these banks (whose benevolence and cooperation was, it will be remembered, thought to be the principal lifeline for the Baltic economies in times of distress).

At the heart of the IMF's concerns are the large current account deficits being run in certain CEE countries, deficits which have now reached extreme levels in some cases, running to the tune of 22.9pc in Latvia, 21.4pc in Bulgaria, 16.5pc in Serbia, 16pc in Estonia, 14.5pc in Romania and 13.3pc in Lithuania.

"Eastern Europe has a cluster of countries with current account deficits financed by private debt or portfolio flows, where domestic credit has grown rapidly. A global slowdown, or a sharp drop in capital flows to emerging markets, could force a painful adjustment,"

The IMF said lenders in Eastern Europe had built up "large negative net foreign positions" during the boom, especially in the Baltic states. "Liquidity for these banks has all but dried up and [interest] spreads have widened 500 basis points."

Many of these countries concerned rely on credit from branches of West European and Nordic banks, but these foreign lenders are now themselves having difficulty raising money in the wholesale capital markets.

"A soft landing for the Baltics and south-eastern Europe could be jeopardised if external financing conditions force parent banks to contract credit to the region. Swedish banks, the main suppliers of external funding to the Baltics, could come under pressure,"

One interesting indicator of potential risk for the financial sector comes from the inventory overhang in the property sector (see the chart below). Basically if important building and construction companies steadily accumulate unsold properties and then are forced into bankruptcy then the outstanding loans can all fall back into the banking system, causing all kinds of problems in the process.

As the IMF note in their report, awareness of higher risks in the CEE countries has been rising in recent months, and this rising awareness has been been reflected in the performance of bank stocks exposed to the region, in Credit Default Swap spreads, and in the performance of the Romanian leu (see chart below) given that the leu is the only floating currency with a liquid forward market among the group of eastern European countries with large external imbalances. As we have seen it has depreciated substantially since July 2007, as investors have been expressing their negative views on the region as whole The stocks of Swedish banks exposed to the Baltics have underperformed other Nordic bank shares (and here) partly owing to significant short-selling and CDS spreads on sovereign debt have surged since August 2007, as investor demand for credit protection has pushed up prices. The interesting point to observe is how this is now all moving in tandem.

Convergence and Growth

Finally, looking beyond immediate risks, it may also be useful at this point to consider some of the basic structural characteristics of the Estonian economy in the future. Now one of the underlying assumptions in the Estonia central bank forecast is that at some point Estonian domestic demand will recover in a fairly predictable manner. But there is no apriori reason why this need be the case. Part of the justification for the central bank view is what is known as "convergence theory". But in fact the evidence on convergence is quite contradictory, and really there are so many things we don't know and don't understand about the factors which condition economic growth that there are good reasons to be cautious here.

To give just one example I will take the cases of Ireland and Portugal. I do not do this randomly, since Ireland and Portugal form two quite contrasting cases, but then if we understood better why Ireland has been on one growth path while Portugal has followed quite a different one, then we would certainly be a lot wiser than we currently are. These two cases are interesting since both countries were founding members of the eurozone and both have experienced since the turn of the century one and the same monetary policy. Yet the results, as we can see in the charts below, have been very different. If we first look at the comparable growth rates the situation is clear enough.

While Ireland's growth rate dropped by from the very high levels of the late 1990s - which were never accompanied by the kind of inflation we are currently seeing in the Baltics - they comfortably settled into the 4% to 6% range, while Portugal's growth rate dropped steadily following the 2000 "correction" and has subsequently remained in the 1 to 2% range.

The result of this has been that Ireland's per capita income has first overtaken that of Portugal, and then soared way above it. If we look at the chart below, which is based on data prepared by Eurostat, we can look at the volume index of GDP per capita as expressed in Purchasing Power Standards (PPS) (with the European Union - EU-27 - average set at 100). If the index of a country is higher than 100, then this country's level of GDP per head is higher than the EU average and vice versa. Basic data is expressed in PPS which then effectively becomes a common currency eliminating differences in price levels between countries and thus making possible meaningful volume comparisons of GDP between countries. Please note that the index, since it is calculated from PPS figures and expressed with respect to EU27 = 100, is valid for cross-country comparison purposes rather than for individual country inter-temporal comparisons. Nonetheless this chart is extraordinarily revealing, since it is quite clear that Irish and Portuguese GDPs per capita are far from converging.

Now if we start to think about the EU10, we could look at the case of Hungary. Hungary's domestic consumption as can be seen actually peaked in 2002., and since 2004 it has not be especially strong. It is now in full retreat. Would anyone like to tell me when it will recover, and by how much? I certainly can't tell you, but I certainly strongly doubt we will ever see the 2002 level again, and I am even rather unconvinced we will get back to the 2005 level. My intuition is that Hungary will now become an export driven economy.

And so we come to Estonia. As we can see domestic demand has been in massive retreat since the start of 2007. Will this recover, and by how much will it recover. The Bank of Estonia is reasonably happy to give an optimistic response. Personally I think there are good theoretical and empirical reasons for being rather more cautious at this point.

Finally, and at the risk of pushing my point just one bridge too far, I would like to take a quick look at German private consumption data. One of the core arguments I am presenting on this blog is the idea that part of the issue facing the Baltic economies is the population ageing one. This argument is being by and large ignored by mainstream analysts, but simply ignoring a problem doesn't make it go away. As we have seen from the Irish case, rapid economic growth is both possible and sustainable over long periods of time. But do the Baltic countries have the demographic profile to be able to follow the Irish path (and remember Ireland's growth has in part been possible as a result of migration there on the part of some - at least - Baltic citizens).

The Bank of Estonia, as I have been arguing, simply look at what is happening in Estonia on a "convergence" cyclical basis. But there are reasons for thinking that this view may be inadequate. Germany also had a very significant consumer boom and correction back in 1995, and if you look at the chart below German domestic consumption has never recovered.

And indeed if we look at the next chart we will see that in 2007 (following the significant VAT rise induced local spike in the 4th quarter of 2006) German private consumption has been steadily declining across 2007, and this despite a very rapid rate of new job creation and a substantial drop in unemployment. I think people should at least think about this carefully, and ask themselves whether or not Estonia may now follow this course, becoming an export driven economy. At least, I would argue, there are prima facie reasons for considering this outcome to be a real and present possibility.

Eesti Pank now estimate private consumption growth for 2009 at 3.8% and for 2010 at 4.5%. I think this view is unduly optimistic, and really puts the whole forecast in doubt. In the meantime we might perhaps like to ask ourselves whether Estonia's economy really is "on the way towards a more sustainable development path" or not. As I say, exports not domestic consumption are now likely to be the key, and with the inflation fire still burning away, and the rate of increase in global trade now slowing notably on the back of the credit crunch we may well ask whether the forecasted real (ie inflation adjusted) export growth of 4.8% for 2009 and 6.5% for 2010 are really all that realistic. It is one thing to pull numbers - like rabbits - out of a hat. It is quite another to make realistic forecasts.

Update 22 April

Estonia will aim for a budget surplus of 1 percent of gross domestic product next year, the Estonian newspaper Eesti Paeevaleht reported this morning, citing Prime Minister Andrus Ansip. Spending will rise by 7 billion krooni ($710 million) from this year. The news follows a coalition meeting held yesterday. Finance Minister Ivari Padar said on April 3 the government will aim for balanced budgets through 2011, instead of its earlier policy of surpluses.

Wednesday, April 9, 2008

Next Stop Kamchatka?

As the economic train of the Baltics and Eastern Europe (and soon I would imagine Russia) steadily slows down while at the same time producing a tremendous amount of steam in the form of rampant inflation industrial organizations and businesses seem to be waking up to the fact that something is afoot in Eastern Europe. And what are we talking about then? Well, regular readers of this space will know the story just about as well as the chorus of their favorite rock ballad but allow me to repeat it anyway. As such and in a historical context the success of Eastern Europe after the fall of the Berlin Wall can hardly be disputed. Throughout the 1990s structural reforms were slowly but surely put in place and immediately up to as well as after the grand meeting in Copenhagen in 2004 where eight Eastern European countries were adopted into the EU (followed by Romania and Bulgaria in 2007) growth rates were very impressive. These notable growth rates were accompanied by strong capital and investment inflows as well as expectations of future growth both from the perspective of regional policy makers and foreign investors. However, you cannot escape history and even though I wholeheartedly agree with Stefan Karlsson's assertion that Eastern Europe is not a homogenous region the current region wide slowdown and lingering risk of stagflation/deflation do seem to mark a structural break. Contrary to what you might expect it is not these countries' Communist and Soviet history that haunts them but rather a demographic ghost which emerged in the midst of the region at the beginning of the 1990s. Thus almost two decades worth of lowest low fertility (i.e. at TFR below 1.5) as well as a steady outward trickle of labour of the prime vintage to Western Europe are now showing its effect in the form of adding to an increasingly tighter labour market and ensuing inflation and rising wage costs. Slowly but surely, the mainstream media and business managers are thus beginning to wake up the inescapable fact that the biggest risk they now face in the context of Eastern Europe and beyond is not dodgy institutions but missing labour.

A while ago in my continuous coverage of Lithuania I noted that Bloomberg, in one of their small news snippets, were relating the dropping unemployment rate and subsequent inflation and wage cost issues to net outward migration. From this point it is not a big leap to the inclusion of core demographic variables such as most notably fertility. This worrying fact of missing labour to feed the cranes, factories and offices of western companies marching East is beginning to show up all across the board not least in the former cheap sweatshop of the world China where we recently learned how those hitherto labour abundant rural areas are running dangerously dry.

A couple of recent pieces by Reuters and Bloomberg respectively further intensifies this change in discourse. Reuters' Simun Shuster takes us to Russia which is fast becoming anything but the promised land foreign investors marked it out to be. The main problem as you might have expected is a latent shortage of labour which is fuelling wage costs and inflation with the important and much cited point that the former by far out paces the growth in productivity. As could have been expected this tendency is rolling in much to the chagrin of foreign executives and HR managers. As Nestlé's head of corporate affairs Andrei Bader notes;

"There needs to be a balance between the quality of the labour and its cost ... Once that balance is broken, the future of this economy loses its promise," Bader said.

This is a discussion about quality then rather than quantity and this also leads to a positive spin of the current situation by Russian authorities and interest groups.

"Will this scare away foreign investors? Yes, absolutely. This is what we need, to scare away the speculators and slave traders. The responsible employers will stay," Shmakov [head of Russian trade union] said. "Russian workers are not Chinese workers. We will fight."

However, if we consult the underlying state of Russian demographics it is very easy to plug holes in this positive narrative. As such, both in terms of quantity and quality Russia's labour market is in a very poor condition. As in all other countries in the Eastern European edifice fertility has been at rock-bottom for nearly two decades. Even though Russia remains a magnet for intra-regional migration flows her overall population is still declining. And when it comes to quality the news is not much better. A lingering and rising problem with AIDS and a persistently too comfortable relationship with alcohol are showing up in aggregate statistics in the form of an appalling track record in terms of male life expectancy. With this as a backdrop and keeping in mind that the current inflation and wage issues are set to continue the human capital foundation is by far the biggest challenge for Russia's economy even though some would also argue that the ongoing poor state of societal and political institutions are equally important.

I am of course painting too much of an ominous picture here. But the message from Shuster's piece is not to be taken lightly. Business comes to Russia to invest, in expectations of conditions which are not present. At all points in time economic growth on a microeconomic as well as a macroeconomic level is primarily driven by people, especially in the context of Russia and Eastern Europe where re-locations have been made in expectations of relatively cheap and abundant labour not to mention the access to a growing middle class with purchasing power to buy more than the bare necessities. It thus my argument that at the heart of the predicament is a mismatch between the process of economic and institutional development which is fairly well known and documented and then a less known but crucial process known as the demographic transition. This is also why I have always felt that Goldman's old 'BRIC economy' narrative should not include the R for Russia since Russia is completely different from the rest. Moreover, one of the big challenges globally will be to make sure China does not go down the same road in terms of a mismatch between expectations of and actual growth potential. Sadly, it seems as if this may precisely what is about to occur in China now in the sense that inflation now seems to have taken an effective hold.

Turning to the piece by Bloomberg authored by James M. Gomez and Andrea Dudikova it echoes the themes from Simon Shuster's piece. However, in stead of focusing on one country Bloomberg presents a veritable tableau d'horreur of stories by companies and business managers and how they cope with the reality of labour scarcity. The main theme, as I have been chanting endlessly here, is that the Eastern European growth story itself is now threatened by the erosion of the human capital foundation. As for concrete examples? Well, why don't we have a look at the travails of one my fellow country men.

Such costs [i.e. labour costs and inflation] helped drive Niels Larsen, a Dane who founded Amber Furniture in Riga, Latvia, out of business. His company was the Baltic nation's largest furniture maker until it went bust late last year. (...) ``Latvia went from being one of the cheapest places in east Europe to do business to one of the most expensive,'' he said. ``We just couldn't cope. What we had in the last three years was what we call the perfect storm.''

Indeed as you can see, the honeymoon stage enjoyed by foreign business in Eastern Europe is now clearly over. But what are the solutions then? Well, one obvious solution is to substitute man for machine as we learn Volkswagen is contemplating on a number of their factories. Of course this begs the question of who is actually going to buy all those Passats and Golfs but that will be for another day. Another reply by foreign investors which I find more interesting is the common call to peer further to the East. Thus and contrary to what the Pet Shop Boys sang in 1992 business managers across Europe are readying themselves for an expedition to the East in order to satisfy their hunger for human capital. Gomez' and Dudikova's article even commences with a quote by Jiri Cerny employed by the PSA group in the Czech Republic noting that the company was now eyeing Mongolia as a potential labour repository. And before you dismiss this completely I would recommend that you had a look at Edward's recent potboiler on the Czech Republic over at Global Economy Matters which indeed shows that Mongolians are steadily but surely making their presence felt in the Czech Republic; and so, by the way, are the Vietnamese.

In the end and as companies across Eastern and Western Europe saddle up for a trip across the Ural and then on to the barren lands of Siberia the main question remains as to what exactly is going on. I mean, where are all the people? Above I have tried to present my answer. And as all those business and HR managers work their way across the Asian mainland they will perhaps even venture a trip to the Kamchatka Peninsula. There, I will be sitting in my hut offering a nice pot of cod, scallop and squid and over my premises will be a sign, bent in neon, reading; "Yes Virginia, fertility does matter."

Tuesday, April 8, 2008

Latvia Inflation March 2008

Latvia's consumer prices rose again in March, hitting an annual rate of 16.8 percent due in part to the increasing cost of services, according to data today from the statistics office. This was the 10th month in a row that the rate of annual price increase hasrisen in Latvia, keeping it at the top of the European Union inflation Leahue. Month-on-month, prices in March in rose 1.5 percent.

Food prices continued to increase, soaring by 20.8 percent from March 2007. Housing costs were up by 25 percent, while alcohol and tobacco are 45 percent more expensive than a year ago.

A comparative view of Baltic inflation is also quite revealing. As can be seen in the chart below, Latvian inflation is head and shoulders out in front, though this is one competition noone is very happy to be winning.

Lithuania Inflation March 2008

Lithuania's inflation rate continues to rise. The annual rate rose to 11.3 percent, the highest since January 1997, from 10.8 percent in February, according to data released by the Vilnius-based statistics office earlier today.

Prices rose 1 percent in a month, compared with a 1.1 percent gain in February. Food prices, the biggest item in the consumer basket with a 26 percent weight, rose an annual 18.1 percent. Housing expenses such as water, heating and gas, the second biggest item in the consumer basket, rose an annual 17.6 percent, the statistics office said.

Lithuania is struggling to get the inflation rate, which is the third-fastest in the 27-nation European Union behind Latvia and Bulgaria, under control. Growing prices recently lead to teachers' strikes over pay increases and helped provoke a no-confidence vote in the parliament which Prime Minister Gediminas Kirkilas survived. Parliamentary deputies voted 68-65 to reject the motion. Kirkilas, whose five-party coalition controls 72 of the parliament's 141-seats, became prime minister in July 2006. His government's term expires in October.

The Finance Ministry have recently raised the 2008 inflation forecast to 9.2 percent.

A comparative view of Baltic inflation is also quite revealing. As can be seen in the chart below, Latvian inflation is head and shoulders out in front, though this is one competition noone is very happy to be winning.

Monday, April 7, 2008

Estonia Inflation March 2008

Estonia's inflation rate fell back slightly in March from what was virtually a 10-year high in February as the growth rate in food and housing costs eased back slightly. The annual rate dropped to 10.9 percent from 11.3 percent in February, according to data from the statistics office in Tallinn this morning. Prices rose a monthly 0.8 percent.

Prices of food and non-alcoholic drinks rose an annual 16.7 percent, compared with 17.1 percent in February, the statistics office said. Housing costs rose 14.9 percent, down from 15.2 percent in February. But prices of services are still increasing strongly, transport is rising at a 13.7% annual rate (2.1% m-o-m) and hotels and restaurants at a 15.5% one (1.1% m-o-m). So core inflation is still very high, and in the background wages continue to rise at a very steep pace.

Update May 2 2008

This report in the press today about possible gas price rises in estonia caught my eye. At this point it is hard to say whether or not Eesti gas will get the full price rise they are seeking, but nonetheless the increase is still likelyy to be substantial, which really must raise a lot of concern about the level consumer price inflation will be running at during the first half of 2009.

AS Eesti Gaas, an Estonian gas company, applied to raise prices for consumers 41 percent between September and October, Eesti Paeevaleht reported, citing management board member Raul Kotov.

Gas prices would rise 35 percent for an average household if the application is approved by the Estonian Competition Board, the newspaper quoted Kotov as saying. Eesti Gaas, owned by Russia's OAO Gazprom, E.ON Ruhrgas AG of Germany, and Finland's Fortum OY, has 120,000 household customers, the newspaper said.

Friday, April 4, 2008

Estonia Growth Forecast and Budget Changes 2008

Estonia's Finance Ministry cut its 2008 economic growth forecast for the third time in under a year earlier this week, while indicating that lower tax revenue will require spending cuts to balance the budget through 2011.

Gross domestic product is now expected to expand by 3.7 percent this year and 6.4 percent in 2009. Last November, it had forecast 2008 growth of 5.2 percent and 2008 growth of 6.1 percent. I think we can safely leave the 2009 forecasts on one side at the moment, since frankly I am sure that no one at this point can see as far ahead as 2009. That is to say these forecasts are not really worth the paper they are written on.

3.7 percent is certainly a much more realistic figure for 2008 than the ones we have been seeing up to now, although even this may well turn out to be rather on the high side.As far as the present quarter goes it is not impossible that we will see some sort of bounce back from last quarters 0.8% quarterly growth rate. Certainly industrial output has been a lot better in the first two months of this year than it was in the last two of 2007. Retail sales are however down over the same months, and exports were better in January than in December, but the rate of increase was still below that achieved in October and November of 2007.

But if we look at the the Estonian Institute for Economic Research surveys of Construction and Services and Construction activity, we see that the level of activity is not noticeably better, if at all, from that registered in the last three months of last year. So the position is far from being clearcut.

So I'm not sticking my neck out and actually saying that growth will be up this quarter, but it may not decline as quickly as it has been doing in the past. However as we move beyond Q1 2008 the numbers get ever more difficult to foresee, but given that the EU, eurozone and global economies are all slowing noticeably at this point, downside risk must abound here, so while we may see something in the region of 1% quarter on quarter growth in Q1, this may well be the strongest growth Estonia gets all year, so that 3.7% current forecast looks subject to revision, and lots of it, as far as I can see.

Meanwhile Finance Minister Ivari Padar told a news conference this week that the government will have to cut spending all the way through to 2011 to balance the budget. The government previously had a policy of targeting budget surpluses. He said the government had already decided to cut 2008 spending by 3.1 billion krooni, or 1.1 percent of gross domestic product. Parliament adopted the 2008 budget in December with a surplus of 2.7 billion krooni ($270 million), or 1.3 percent of planned GDP.

Prime Minister Andrus Ansip said last week public spending cuts are ``unavoidable'' given a slowing economy and waning tax revenue. Estonia uses budget policy as its main tool for controlling inflation because the Baltic nation has a fixed exchange rate under a currency board system, and in addition the Estonian government is legally constrained from willingly running a deficit, a feature which may well make it difficult to move in and offer support should the situation deteriorate more substantially later this year than any of us are currently forseeing.

The government have also revised their inflation forecast and prices, as now measured on the EU HICP, are now expected to rise an average 9.1 percent this year and 5.3 percent next, the ministry said. The previous inflation forecast had been for a 2008 inflation rate of 8.5 percent, and a 5.5 percent one for 2009.

Of course, I would be grateful if someone could explain to me how Estonia is going to be able to generate the level of export increase necessary to sustain the economy in the face of what will soon be long term very constrained domestic demand and maintain the currency peg with this kind of inflation over this length of time. Something here simply doesn't add up.

Update Tuesday 8 April 2008

Prime Minister Andrus Ansip said today that Estonia should delay any 2008 spending cuts until September, by which time the Cabinet will have a better understanding of how much needs to be trimmed. Ansip said in an interview with public broadcaster Eesti Televisioon that it may be necessary to cut more than the 3 billion krooni ($302 million) suggested last week by Finance Minister Ivari Padar. Even if cuts are delayed, ministers will have to find savings of 7 percent to 9 percent of their budgets by next week, the prime minister said. Ansip's coalition partners in the Reform Party, the Pro Patria and Res Publica Union and Padar's Social Democrats, support the passage of budget cuts in parliament as soon as possible, according to the Baltic News Service yesterday.

Latvia Has Budget Surplus in Q1 2008

Latvia posted a provisional budget surplus of about 70 million lati ($158 million) in the first three months of 2008, the state treasury said today. The government had a provisional surplus of about 2 million lati in the month of March. Official budget figures will be released in mid-April, the treasury said.

Latvia's economy is slowing rapidly and while a budget surplus of about 1 percent of gross domestic product had been envisaged for this year this now seems unlikely to be achieved. Indeed there has been some discussion as to whether it might not in fact be advisable - given the rate of the slowdown in Latvia - to move sooner rather than later into suplus to try to avoid the now much feared "hard landing". Be that as it may we are still at this point in surplus, although the situation is more than likely going to change as the economy slows and revenues decline.

``The pace of growth is no longer as strong as last year, when revenue in the first quarter grew 26 percent,'' Finance Minister Atis Slatkeris said in the statement. ``Second quarter results will show if this pace of growth will remain for a longer period of time,''

A deficit now seems quite probable, since it has been estimated that Latvia would have a deficit equal to 1.5 percent of GDP this year on economic growth of 5 percent (which is the latest Latvian government growth forecast for 2008 made by Prime Minister Ivars Godmanis earlier this week), and my feeling is we are already way below that rate.

EU Economic Sentiment Indicator For the Baltics March 2008

According to the Estonian Institute for Economic Research Survey, consumer confidence bounced back slightly in March, from the ultra low reading of minus 16 in February to the pretty low one of minus 11 in March. To put things in a little perspective here, when the reading hit minus 11 for the first time in January, this was an all time historic low for the index, now, of course it isn't, since things got even worse in February, at least according to the sentiment index. On the other hand this does fit in with a variety of other data we have been getting which lead us in the direction of thinking that things weren't getting worse quite so rapidly in Estonia in March.

The European Commission has also now reported its eurozone “economic sentiment” indicator for March, with the composite number bouncing back a little from the February reading which its lowest level since December 2005. The indicator, which gauges optimism across all economic sectors and is regarded as a good guide to likely future trends, was back up to 102 after falling to 100.1 in February from 101.7 in January.

This indicator provides a little more evidence for the above hypothesis about Estonia, since as can be seen in the chart below, the Estonian index has stabilised since December, while those for Latvia and Lithuania continue to head down. Of course all of this is relative, since they are both at levels above the current Estonian one.

Latvia Industrial Output February 2008

Latvian industrial output again showed substantial signs of contraction in year on year terms in February, even if on a month on month basis, and as compared to January 2007, industrial production rose by 1.3%, according to the seasonally adjusted data from the Central Statistical Bureau. In mining and quarrying there was an increase of 4.3%, and in manufacturing of 1.5%, while in electricity, gas and water supply decreased by 6.8%.

Compared to February 2007 however, industrial output in February - adjusted for changes in the number of working days - decreased by 4.7%. In manufacturing there was a decrease of 1%, in electricity, gas and water of 10%, while in mining and quarrying the volume of output increased by 31.4%. So while manufacturing is still contracting on annual basis, it is perhaps doing so at a slightly slower rate. As is becoming typical at the moment, we need to see just a bit more data before reaching any strong conclusions.

Tuesday, April 1, 2008

Estonia Industrial Output February 2008

Well we have another sign today, following last weeks retail sales data, that things in Estonia have stabilised somewhat, although, as I keep arguing, it would be very premature to draw longer term conclusions from the data we have at this point. Industrial output - according to the latest data release from the statistics office - was up in February, on both January (1.8%) and February 2007 (2.6%). This follows on the back of a revised 4.2% increase in January.

Manufacturing output is also up, by 5.2% on February 2007, and by 2.4% (seasonally adjusted) on January. As can be seen in the chart below, December was very definitely a bad month, and even seems to have been an exception, so we now need to wait a little to see just where things move from here. Patience, I do believe, is normally a virtue in such situations.