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Thursday, July 31, 2008

Estonian Retail Sales and Industrial Output Continue Their Decline In June

Estonian annual retail sales and industrial production declined in June, adding evidence to the hypothesis that the economy is now firmly in the grip of its third - and possibly most important - recession since becoming independent in 1991.

Retail sales fell an annual 7 percent, the biggest drop since at least 2001, and the fourth consecutive month in which sales have contracted on an annual basis, the national statistics office said today.

In June, seasonally adjusted industrial output in Estonia increased 2% compared to May. In comparison with June of the previous year, however, industrial output was down by 5%. The decrease in output was basically the result of a continuous decrease in electricity production — compared to June of the previous year, the production of electricity decreased 28%. As before, the decrease in electricity production was caused by a partial replacement of own production with electricity imports — in June nearly one third of consumed electricity was imported.

Manufacturing output was down 2%. The main reason for this was the decrease in orders. According to the information of Estonian Institute of Economic Research, more than half of enterprises mentioned insufficient demand as the key factor hindering the growth. The growth in production is mainly hampered by the decrease in internal market demand.

In June compared to the same period of the previous year, the industrial domestic sales decreased 5%, however, industrial export sales increased 3%. The decrease in the production of manufacturing was mainly influenced by the production of food, wood and building materials. The decrease in the manufacturing of food is continually affected by price increase and by the decrease in consumption resulting from it. In June, the producer prices of food products rose more than 18% compared to June of the previous year, in the manufacturing of milk products the increase was 28%. Nevertheless, the producer prices of milk products fell compared to May. Due to the decrease in construction volumes, the production of building materials is continually in a declining trend — the production of building materials decreased 24% compared to the previous year. The downward trend continued in the manufacturing of wood, and in the production of furniture.

Wednesday, July 30, 2008

The Baltics - Moving Closer to a Correction?

By Claus Vistesen Copenhagen

Last time I had the Baltics under the spotlight I asked two overall questions. The first dealt with the extent to which the Baltics had entered a recession in the beginning of 2008 and the second question surrounded the risk of the Baltic pegs to the Euro. This time around and with the recent Q2 GDP release from Lithuania it would be nice to revisit the first of these questions. And with the market focus looking to shift from inflation to growth the second question is likely to become in vogue once again.

As the Q1 GDP numbers came in for the Baltics I concluded that it was very likely that the region had entered a recession. In light of the proverbial definition of a recession as a consecutive quarter contraction it seems clear the Lithuania managed to smartly skirt the recession in H01 2008. As far as I can see at this point and from Eurostat's data Estonia was the only one of the three Baltic economies that contracted in Q1 2008 (-0.5% and 0.1% for Latvia).

However and as ever before, the Baltics is increasingly getting stuck in stagflation and one of a particular sinister kind. In the case of the Baltics they may already be seeing the beginnings of a hard landing, whereas others continue to build up steam making it almost inevitable that they too will erupt at some point.

As can be observed, Lithuania just managed to avoid a contraction in Q1 and rebounded nicely in Q2. Yet, in light of the run-up to these numbers and the fact that Lithuania, on a y-o-y basis, grew at its lowest rate since 2004, I have little problem in maintaining my view that this is a hard landing. As for the break up of Lithuania's position it is a bit difficult to tell since the components do not feature seasonally adjusted figures. However, it seems that especially companies paired their investments going in to 2008 while consumers are still going strong. All three forward looking indicators in the form of confidence measures show that the expected trajectory of overall momentum is firmly down.

The other graphs reveal with some clarity I think that the Baltics may now be entering a whole new different growth dynamic with inflation and wages continuing their upward drift at one and the same time as growth is faltering. In this way, it is hardly about the potential recession and slowdown itself but about the economy, and growth rate, which will emerge. This point is similar to one I made recently in the context of the Eurozone and I do think it is important to realize the hole some of the CEE economies are about to dig themselves out of. In fact, depending on the reversion into wage and asset price deflation I would say that this slowdown marks a significant structural break in these economies' growth path.

Consequently, there is simply no way in which these economies can muster the inflows they have been receiving, and many face a decisive need to turn the boat around and become export dependent. The key link will be the extent to which we, absent a currency to devalue, will observe wage deflation to reign in the external position. Consequeuntly, with a fixed exchange rate to the Euro and an extremely wide external position the only way a correction can come is then through severe wage and by consequence price/asset deflation. The alternative would of course be to the abandon the pegs but that would then open up Pandora’s box as the currency most likely would plummet to reflect the external balance leaving Baltic consumers with Euro denominated loans and cash flows in domestic currency (get detailed argument and analysis here, here and here).

Another crucial link here would be Scandinavian banks who are effectively supplying these Euro denominated loans and thus how they, effectively, are financing the external deficits. We have thus on several occasions been hearing faint but rising voices about how, in particular, Swedish banks are exposed to the Baltic slowdown.

In a recent detailed analysis John Hempton from Bronte Capital serves up some nice points on the whole situation. What is particularly interesting is that he takes the time to scrutinize the books of Swedbank who is operating its subsidiary Hansabank which is, by far, the biggest foreign bank in the Baltics.

One of the important points to latch on to was the one conveyed in my last look at the macroeconomic balance sheet of the Baltic economies. In this analysis I showed that while loans in local currency are now falling on a stock basis (i.e. the amount of loans being paid out or written off outnumber the number of new loans taken out) it is still growing in Euro denomination effectively keeping growth in the overall stock of loans in the positive; even if the trend is inexorably down. Once I have Q2 data for all the Baltic economies I will post briefly on the development.

Yet, if you dig into the Q2 accounts of Swedbank (who are operating under the branded name Hansabank in the Baltics) you will see that they are still churning out positive growth rates in lending in Q1 and Q2. Over the course of H01 2008 Swedbank consequently expanded their lending operations with 7% in the Baltics and over the entire year, this number stands at 21%. If we compare this to the growth in deposits in the Baltics the H01 figure is 1% whereas it is 11% over the year. As such, levering of the balance sheet continued in H01 2008. In short, lending growth is still positive and the leverage multiple measured as the value of lending over deposits is growing.

I don't think it is entirely outlandish to draw a line between my initial results derived from macroeconomic data to these results from one of the biggest players on the Baltic finance market. Personally, I don't see how the growth rate can continue to stay in positive territory and this is especially the case since net interest income is now beginning to decline, if ever so slowly.

In the context of cooking, as it were, the books of Swedbank Hempton makes another interesting observation in his piece.

So what happens next?

Well if the Lati devalues (as would seem inevitable) then Hansa Bank has to pay Euro to Swedbank – and as its assets are in Lati it would be insolvent.

If the Lati doesn't devalue its only because people (i.e. Swedbank) are prepared to continue to fund it. This is not pretty at all. All in Hansa owes Swedbank over 30 billion Swedish Kroner – all denominated in Euro and which can't be paid. The equity capital of Hansa (roughly 7 billion Swedish Kroner) is also going to default.

This is a very big problem for Swedbank. Swedbank's equity is 68 billion SEK – but 20 billion is intangibles. Swedbank is probably solvent at the end of this – but only just. Swedbank will (at best) lose its independence. Swedbank is in turn wholesale funded – and the chance of it becoming Swedish Government property is not low.

Having lent that much to a country with a phoney fixed exchange rate in a currency they can't print – Swedbank management deserve it. Bad things happen to bad banks and this is a bad bank.

Now, Mr. Hempton certainly does not mince his words and even though he may come off as wing nutty the point being made is actually quite simple and valid. What he effectively is doing then is to move the perspective down a notch from the obvious macroeconomic crunch that would ensue as consumers defaulted on their loans to the predicament which would arise in the context of Swedbank's books.

What it means in macroeconomic terms is if the translation risk issue blows up, which it potentially will in the context of wage deflation (i.e. this would force down the pegs), Hansabank would effectively be screwed. Sorry for my harsh tone, but I cannot see how they could shore up their balance sheet unless the ECB moved in with a kind of 1:1 guarantee which let the Baltics de-facto adopt the Euro with one swoop. Now, if Hansabank goes, and this seems to be Hempton's argument, so could Swedbank and by derivative the inflows used to fund to external deficit to the Baltics. And then we are into the big royal mess.

Also, one could easily imagine a rather advanced game of Old Maid. Consequently, if Hansabank et al. suddenly move seriously into the ropes, de-pegging would almost certainly mean a significant write-off of Euro denominated loans. In this case, the Baltics may neatly shift some of the heat on to Swedbank who, almost certainly, will be running to the Riksbank and then perhaps on to the ECB.

Ultimately, I think the Baltics will fight long and hard against devaluation and much will depend on the severity of the correction. It may end up a perfect storm for them, but I want to stress that this would require the ECB to step in with some kind of de-facto, behind the curtains, guarantee to the currency board. That is to say, the ECB or the Riksbank would need to foresee the chain of events above (or a derivative thereof) and nip it, preemptively, in the b*t so to speak.

Quit With the Dooming and Glooming Already?

Uff that was some outlook was it not? I should immediately point out that much of this represent musings and it is still quite difficult to see where it ends. However, I have pointed out the shaky links between Scandinavian banks and the Baltics more than once before, so it should not come as a big surprise that I am massaging this topic.

If we move up the perspective to macroeconomics, the points above relate to a more general point concerning the Baltics and the manner in which the current imbalances potentially will be corrected. This consequently lays out a path well trodden here at Alpha.Sources. As the rest of the CEE countries, the Baltic economies have quite simply been converging too fast given their underlying capacity (read: demographic) constraints. In fact, given the loop sided nature of almost all CEE economies after two decades worth of lowest low fertility the whole convergence hypothesis was always going to hit shallow waters. As such, and coupled, in the past 5-6 years, with significant outward migration, these economies have quite simply been administering a growth strategy wholly incompatible with their underlying fundamentals.

This obviously does not mean that Eastern Europe will sink into the ground, but it does mean that a correction is due; both in terms of expectations and the trajectory of economic fundamentals. Note in passing here especially how this will affect Germany's ability to leverage its export muscle towards its Eastern borders. In a more broad policy oriented context I have also been amazed, even if I can understand it, with the push to de-peg from the Euro and subsequently raise interest rates. Sure enough, when you have imported inflation you want a strong currency but in administering this kind of policy you are also assuming that the implied process of nominal convergence can be speeded up; almost as if the CEE economies could attain nominal convergence with EU15 in one clean and bold sweep.

Conclusively, my guess is that while Q2 data will tell give us important forward looking indicators Q3 and Q4 may be where the real action is. As per reference to my points above I am watching FX markets in particular and, in the case of the Baltics, the link with Scandinavian banks and the potential ways in which these economies can correct.

Friday, July 25, 2008

Estonian Exports Drop Sharply Again In May

Estonia,s exports dropped sharply again in May, falling by 816 million kroon (or 6.7%) over April, and by 2% over May 2007. Imports were also down sharply (by 11% year on year) and as a result Estonia's trade deficit was the narrowest in more than two years in May, helped by falling imports of wood and cars.

Basically this is all really not very good news, since when you are an export driven economy falling exports are the last thing you need!

Tuesday, July 22, 2008

Estonia Producer Prices Tick-up Again in June

Estonia's Producer Price Indices increased again in June. According to Statistics Estonia, in June 2008 the producer price index was up 0.4% month on month (compared to May) and 7.5% Year on year (compared to June 2007). This is up from 0.2 and 7.2 respectively in May.

The month on month cahnge in the producer price index was mainly influenced by the increase in prices in the manufacture of electrical and optical equipment and in the manufacture of textiles and textile products. Compared to June of the previous year, prices increased most in the manufacture of food products and beverages.

In June 2008 the percentage change in the export price index was 1.1% compared to May 2008 and 5.2% compared to June of the previous year, while the percentage change in the import price index was 2.8% compared to May 2008 and 8.7% compared to June of the previous year. This move in export prices does not bode well for the export outlook, especially being pegged to such a hard currency as the euro at this point.

Monday, July 7, 2008

Estonian Inflation Rises Back Again in June 2008

According to the Estonian statistics office annual consumer price inflation in June 2008 was 11.4%. This is now the six consecutive month for which the consumer price index has remained around the 11% region.

Food prices were up by 15.8% and the price of manufactured goods by 7.0%. The services iprices ncreased 12.5%. Regulated prices of goods and services were up by 22.0% and non-regulated prices by 8.5%.

As in the previous months, the index was largely influenced by the increased price of food and housing, as well as by the increase in petrol prices. Dairy-, cereal- and meat products made up four fifths of the price increase of food. The increase in housing costs was mainly the result of an increase in the price of heating. Three quarters of the 14.7% price increase in the transport index was the direct result of the increased fuel cost.

The price of goods and services in June were 0.6% higher than in May. The monthly rise was mainly produced by the increase in fuel prices which was responsible for two thirds of the monthly change in the consumer price index.

Friday, July 4, 2008

Sharp Slowdown In Latvian Industrial Output in May 2008

Well the May industrial output reading is really quite a shocker, since when compared to April 2008, industrial output in May 2008 at constant prices (i.e. allowing for the influence of the price change) was down by 3.1%, according to the (seasonally adjusted data) accoring to the Latvian Central Statistical Bureau. Of this there was a volume decrease of 3.3% in manufacturing, 3,4 % in electricity, gas and water supply, and in mining and quarrying the production volume was up by 7.1%.

Compared to May 2007, industrial output in May (according to working day adjusted data) was down by 8.5%. Of which there was a volume decrease of 8% in manufacturing, a 9,6 % decrease in electricity, gas and water supply, and a 3.1% increase in mining and quarrying.

According to the statistics bureau the decrease in industrial production is related to a drop in demand and a decrease in orders in the following economic activities: food, textiles and wearing apparel, manufacture of wood, paper products, printing, chemicals and chemical products, rubber and plastic products, construction materials and furniture.

I don't know where all the people are right now who were predicting a "soft landing" (in hiding to conceal their shame I hope, or at least doing public "mea culpas" and correcting the flaws in their methodologies), but it really does look as if the Q2 2008 GDP result could be something of a shocker, if the Industrial Output readings and the retail sales data are anything to go by.

The only saving grace at this point would appear to be external trade, and this could be more of a positive element due to the statistical impact of the slowdown in import growth (caused by the drop in domestic demand) rather and real robustness in exports. Still the May 2008 extrenal trade data is due out next week, and at that point we should get a much better idea.

Exports werte up a healthy 24.7% year on year in April.

Although it is important to remember that Latvia still runs a substantial trade deficit dèspite some recent improvement.

Wednesday, July 2, 2008

Estonia Industrial Output May 2008

Estonia's industrial production fell the most in nine years in May, providing us with the latest evidence (following yesterday's retail sales data) that the Baltic economy has slipped into what now seems likely to become a pretty deep recession. Output, adjusted for working days, decreased an annual 6.7 percent, the biggest decline since May 1999, compared with a revised 0.1 percent fall in April, according to data from the Estonian statistics office released today. Production fell a monthly 4.8 percent on a seasonally adjusted basis.

Industrial output, led by food production and wood procession, has now fallen for three straight months.

Tuesday, July 1, 2008

Estonia Retail Sales May 2008

Estonian retail sales declined in May for the second time in three months, suggesting the Baltic nation's economy is on the verge of contraction. Retail sales, excluding car and fuel sales, fell an annual 3 percent, after remaining unchanged in April and declining 4 percent in March, according to the latest data from the Tallinn-based statistics office. Sales were up however when compared with April, by 4%, but we need to remember there are a great many seasonal factors at work here, and we also need to remember that in May 2007 we were at the height of the consumer boom.

Year on year retail sales reached a record 23 percent in March 2007 and then started to decline as the economy began to slow as banks tightened lending to avoid overheating as inflation accelerated. As a result the economy only grew at an annual 0.1 percent in the first quarter.

Following a gross domestic product expansion of 10.1 percent in the first quarter of 2007 we may now well see a full-year contraction this year, the first since a 0.1 percent decline in 1999, when exports dropped dramatically following the 1998 Russian default. Certainly an annual contraction in Q2 would seem to be very much on the cards at this point.

Adjusted seasonally and for working days, the economy actually shrank 0.5 percent from the fourth quarter of 2007.

Household spending which accounts for 55 percent of gross domestic product fell by an annual 0.4 percent in the first quarter, and this decline now seems set to continue, although exports, are on the upside at the present time.

In fact in April 2008 Estonian goods exports were up sharply, to 12.2 billion kroons during the month. Compared with April 2007 the increase in exports was 1.8 billion kroons or 18% in nominal (non inflation adjusted) prices. The main increases were in metals and products thereof and of machinery and equipment. This performance is promising, but it will probably be insufficient to offset the sharp decline which is now taking place in domestic demand (in particular since the Estonian government cannot run a deficit to give a stimulus), and exports may well become increasingly difficult if the economies of those who receive the exports themselves in turn start to slow.

Estonian Consumer Confidence, which was boosted by entry into the European Union in 2004, has all but collapsed after reaching record highs in January 2007. According to the Tallinn-based Konjunktuuriinstituut confidence bounced back slightly in june to -16 from the four-year low of -19 registered in May.

The EU Economic Sentiment Index for June has also now been published, and here is the principal chart for the Baltic countries. As can be see the composite index for Estonia remains steady at a very low level, while Latvia just shot below them.