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Wednesday, September 24, 2008

Estonia Producer Price Inflation Slows Slightly In August

According to Statistics Estonia, Estonia's producer price index rose by 0.3% month on month in August over July and by 7.3% compared to August 2007. The principal month on month influences on the index were the increase in the price of metals and metal products and in the manufacture of rubber and plastic products. Compared to August 2007 the principal factor was the increase in the price of energy.

Export prices were down month on month, and the percentage change in the export price index was -0.1% compared to July and 3.8% compared to August 2007.

Sunday, September 21, 2008

Latvian Inflation Continues To Be A Major Problem

Consumer Price Inflation

The annual rate of increase in Latvian consumer prices was 15.7% in August 2008. Month on month the situation did imporve slightly, since prices decreased by 0.4% when compared with July. The average price of goods decreased by 0.9%, but the price of services continued to increase, and were up by 0.7%. Prices of vegetables and fuel fell, but the price of clothing, catering and rent were all up. Thus while the trend is for annual inflation to moderate, the news is far from unambiguous, with widespread secondary price shocks continuing to make their impact felt.

Food prices were down - by 2.2% - but this was mainly influenced by seasonal decreases in the price of fruit and vegetables and fruit. Bread, dairy products and cheese prices also fell. Fuel prices were down by 4.3%, as were motor vehicle prices.

The widespread presence of discounts meant that the prices of non-durable household goods, individual care goods, bicycles, sports and recreational equipment all decreased. Purchase of new cars became cheaper, as did the prices of data processing equipment, airline tickets, furniture and furnishings, carpets and floor coverings diminished.

Latvian retail sales we should remember were down again in July, both on June 2008 and on July 2007. Compared to July 2007, the seasonally and working day adusted constant price index was down by 8.5%. The largest volume decrease was in non-food products group which were down by 9.4%. There was a slighly smaller decrease in food products, which were down by 6%. The only increases were in mail order business – up by 7.2% and in retail trade in pharmaceutical and medical goods – up by 3.2%. In the face of such a decline in demand the more competition driven sectors have little alternative but to lower their prices.

On the other hand, prices in the non competition driven sectors continued to rise, and rent in municipal flats and houses, the cost of refuse collection and other publicly administered services were up, as were liquefied gas prices.

Alcoholic beverages, cereal products, meat and meat products, fish and fish products, eggs, oils and fats, sugar, sweets and non-alcoholic beverages all went up, as did clothes, textiles, household goods, and school textbooks.

Producer Prices Accelerate In August

Latvian industrial producer prices rose in August at a 13.1% annual rate, up frm the 12.4% annual rate registered in July. Month on month producer prices increased by 0.9%.

On an annual basis it has been the increase in the cost of energy components like electricity and gas, and the price of manufactured food products and beverages which have made the biggest impact on the overall level of producer prices,contributing 4.5 and 4.1 percentage points, respectively.

As can be seen in the chart below, Latvian producer prices are now up over 50% on the start of 2005, and with the Lat effectively tied in value to the euro (which is either used by, or a reference point for, nearly all Latvia's major external customers) this represents a huge loss of competitiveness for Latvian industry and service companies.

Energy Prices

In terms of the outlook for Latvian inflation moving forward we need to think about just when it will be that year on year crude oil turn negative, and when this does happen, what will this mean for Latvian inflation? An interesting question this one since it will really show us the "naked truth" about how resistant Latvian prices are to correcting themselves as the economy continues to languish in recession.

Oil prices have fallen substantially recently, even if with considerable volatility in the process. Last Friday, for example, , the first time oil had closed at over $100 in more than a week. Oil prices in fact shot up by more than $6 a barrel on Friday, with light, sweet crude for October delivery rising $6.67 to settle at $104.55 a barrel on the New York Mercantile Exchange, after earlier rising as high as $105.25. The increase followed the announcement of the sweeping US government financial rescue plan which emboldened investors to re-enter equiity and commodity the markets.

Crude thus climbed over $13 in the space of three days, but prices will more than likely resume their downward trend, at least in the short term, since demand for energy is likely to remain weak as the economic slowdown continues to bite in the US, Europe and Japan, while key emerging markets maintain tight monetary policy (although not Latvia unfortunately, since the Lat peg means there is no monetary policy to implement) in the battle to contain inflation (I am talking here of countries like Brazil and India). So, despite the coming and going, the trend in oil is decidedly down, and crude has now fallen around $43 — or over 30 percent — from its all-time trading record of $147.27 reached July 11.

So we are now hitting prices which were reached on the way up in the middle of February, but how long will it be before we are below the same price y-o-y? Then annual inflation rates will start to notice what is called the "high base effect", and it will be interesting to examine the precise differences between those countries where secondary effects have made their presence felt (like Latvia unfortunately), and those where core inflation has basically remained low.

Latvian Wages Continue To Rise

At the same time Latvian wages, and despite the recessionary backdrop, continue their steady upward march, at a rate which is well above consumer price inflation plus productivity. Compared to the second quarter of 2007, gross hourly wages in Latvia were up by 26.1%, according to the most recent data from the Central Statistical Bureau.

The statistics office noted that the seasonally adjusted rate of increase has been reducing since 4th quarter of 2007, but this is very small consolation for a process that is effectively blowing a massive hole in the side of the Latvian economy's ability to compete internationally. And indeed they also point out that compared to the second quarter of 2007 the most rapid increases in hourly labour costs have been in economic activities like education – up 30.5%, hotels and restaurants – up 29.3%, mining and quarrying – up 27.7%, construction – up 27.4%, and trade – up 27.3%.

Unemployment Rises While Employment Stagnates

On the other hand unemplyment has started to rise, slightly, and according to the labour board there were 56333 people unemployed in August - nudging up the unemployment rate to 5.2%. To put things in perspective, the number of unemployed is still below that registered in August 2007 (57940), when the economy was, to all appearances, still booming.

Employment, on the other hand, has been more or less stagnant over the last 3 quarters, although year on year rates of employment increase have been healthy (an average of 4% during the last three quarters) and total emplyment has not started to decline in any notable form.

Household Indebtedness

Internal demand, as we have noted, has collapsed, and the Latvian economy is in recession.

So what is the answer to this mystery? How can employment be stable, real wages rising considerably, and yet the economy slumping. Well, the answer isn't too difficult to find, it revolves around household borrowing, and the rate of increase in household debt. If we look at the chart below, we can see that the Latvian "boom" was being fuelled by truly massive y-o-y rates of increase in household borrowing. So the high rates of growth were not due to large productivity gains pushing a supply side expansion, but due to rapid increases in domestic consumption fuelled by growing debt, a process which pushed the Latvian labour market (given Latvia's unusual demography) way beyond capacity limits, and stocked-up a huge inflation bonfire.

As we can see in the above chart, this all really became "one big party" after mid 2005. Now I say Latvia has no available monetary policy, but this isn't entirely the case. Had the Latvian central bank imposed very strict credit restrictions starting in 2005 (and not in the spring of 2007), and had the Latvian government operated a large (liquidity and demand draining) fiscal surplus of 5% of GDP or so starting in 2005, then maybe much of the worst of the distress which is now about to come could have been avoided.

But it is always easy to be right after the event, and I am not claiming to have had any better idea than anyone else at that point. Certainly even the IMF staff economists (who seem to me to be normally much more on the ball than their Brussels and Frankfurt equivalents) only started pushing the idea of fiscal surpluses strongly rather late in the day, and I am sure if we could rerun all this they would have acted differently. But then, you know, the owl minerva only flies after dusk, and all that.

But, as we can see, once the credit restrictions were put in place to some extent, the rate of increase in new credit did slow, and what is so remarkable is how quickly the whole economy itself slowed as this increase in credit lost steam. We are still seeing a year on year rate of increase in household credit of around 25%, and yet the economy is contracting, so what happens if credit stops growing is anyone's guess.

So what is the future? Well basically, given what we have just seen about the debt side of the equation, I think we can safely say you can forget about Latvian domestic demand as a driver of growth. And since government spending is not going to be the answer given the impending liabilities which will be hitting the Latvian state from the ageing population phenomenon (health, pension costs etc), exports would seem to be the only way out. But this is where, after all that inflation, we hit a snag.

As can be seen in the chart below, Latvian exports, far from having risen to the role which falls upon them, have rather weakened over the last six months or so.

True, in year on year terms, they have been rising, but the rate of increase has been slowing steadily, even if - due largely I think to an especially weak month in June and a low base effect in July 2007 - they did rebound a bit in July. The weakness in Latvian exports as a growth driver has been rather masked by the much more dramatic decline in imports, which have moved strongly into negative y-o-y territory despite the high level of oil costs, and this has obviouly been a headline GDP growth positive (that is GDP would have been worse had imports not shrunk so considerably). The decline in imports has also prevented the trade deficit from deteriorating further.

But of course, if exports are now to drive growth (and if Latvians are to start paying back all that foreign debt they have been accumulating) then what is needed is a surplus not a deficit. Well, Latvia needs to start selling more abroad, whatever, however, and I think that in order to do this, Latvian relative prices now need a very substantial adjustment, which either means very substantial internal price deflation, or that horrible and unmentionable "D" word. If people sit back with their arms folded and simply wait to see what happens (out of idle curiousity, perhaps?), then the former will inevitably happen, but the thing is the process could become so violent that it provokes the second inevitably in its wake, which raises the question as to whether it might not be better in the longer run to grasp the bull by the horns, and go down the second road now and dircetly. Whatever happens, none of the possible solutions for the current predicament are going to be easy.

Monday, September 8, 2008

Estonia GDP Q2 2008 Details

According to revised details released this week by the Estonian Statistics Office, gross domestic product (GDP) decreased by 1% in the 2nd quarter of 2008 when compared with the same period in the previous year. Statistics Estonia changed over to a chain-linking method for calculating real (constant price) economic growth in this quarter, so there have been some changes to the earlier time series data.

Compared to the 1st quarter, the GDP, chain-linked by the reference year 2000 and seasonally and working-day corrected, decreased by 0.8 %.

The decrease in the GDP was mostly influenced by the weak domestic demand and at the same time by the decrease in exports of goods and services. Compared to the same quarter of the previous year, total domestic demand was down by 2.8% primarily due to the decrease in private consumption and capital investments (-2.0% and -2.5%, respectively).

Private consumption decreased mainly due to the decrease in expenditures on transport and clothing and footwear. The growth of expenditures on food and non-alcoholic beverages decelerated. Capital investments decreased in both the financial and the household sector. Investments by manufacturing were almost stationary year on year. At the same time public sector construction investments accelerated.

The decrease in exports and imports since the second half of the previous year deepened in the 2nd quarter this year even more. Compared to the 2nd quarter of the previous year, exports of goods and services decreased by 4.9% and imports by 8.2% by chain-linking method.

Goods exports were down by 3.2% primarily due to the decrease in exports of refined petroleum products. At the same time, exports of basic metals and electrical machinery (electrical motors and appliances), which significantly influence export movements, increased. Exports of services decreased by 8.9% primarily due to the decrease in exports of services for railway cargo, airway passengers and cargo transport and trade related exports services. The decrease in imports of goods was influenced mainly by the decrease in imports of refined petroleum products and motor vehicles. While imports decreased faster than exports, the deficit of net exports in GDP has increased since the second half of 2007 and amounted to -4.6% of GDP in the 2nd quarter. In the 1st quarter the impact of net exports was -7.1% (so the negative impact slowed vis a vis Q1).

On the supply side the deceleration of the GDP was influenced mainly by the decrease in the value added in wholesale and retail trade, transport and storage, manufacturing and electricity, gas and water supply activities. The value added in financial intermediation activities also decreased.

The decrease in the value added in manufacturing was mainly caused by weak domestic demand and the resulting decrease in orders. A significant impact was the decrease in the value added in the manufacture of wood, furniture, building materials and food.

Estonian Inflation Holds On The 11% Mark In August

Inflation slowed a little in Estonia in August, but only very slightly. During the whole of 2008 the rate of change of the consumer price index when compared with the respective month of the previous year has hovered around the 11% mark, with the lowest reading being in March (10.9%) and the highest in April and June (11.4%). August was in fact no exception.

In fact, in August 2008 when compared to August of the previous year, Estonian consumer prices were up by exactly 11.0%. Food prices increased by 17.1% and the prices of manufactured goods by 6.2%. The prices of services increased by 11.2%. Regulated prices of goods and services were up by 23.5% and non-regulated prices by 7.6%. The index was mainly influenced by the price increase of food, higher prices of motor fuel accompanied by the increase in the prices of transport services, increase in the expenditures on housing, as well as by the increase in the prices of alcoholic beverages and tobacco. The annual price increase of food and transport accounted for half the increase, housing — for a sixth.

Month on month, prices in August were 0.1% higher than in July. The monthly change was mainly influenced by the decrease in the price of motor fuel, by the seasonal price decrease of vegetables, by the increase in the prices of tobacco products proceeding from the change in the rates of excise duties, and the end of special sales of clothing and footwear.

Latvia's Economy Has Now Been Shrinking For At Least Two Quarters

Well I think it's now official, or at least as official as its going to get: the Latvian economy is now in recession, as defined by two successive quarters of contraction (quarter on quarter, on a seasonally adjusted basis). The Latvian economy contracted by 0.2% in the second quarter from the first, and by 0.3% in the first quarter from the last quarter of 2007. Not that you would be able to read this information on the data release from Latvijas Statistika, nor would you find any great enthusiasm anywhere for having a technical "linejudge" (like the US NBER recession dating commission) to present this datapoint in a semi official way it seems to me. Indeed Bloomberg seems to have needed to take the bull by the horns and phone the statistics office direct in order to have a conversation with Alla Vanaga, the central statistics office's deputy head of national accounts, and thus extract this otherwise well-guarded piece of information.

The root of the problem is that the statistics office do not publish seasonally adjusted quarterly data, and there may well be very good explanations for this, since, apart from any other reason, with the very violent recent movements in output, they may have difficulty in establishing weights to use in the seasonal adjustment in which they have any great degree of confidence (another example of this type of problem could be found in the seasonally "adjustments" applied to the data we got for retail sales and industrial output - which was often scarcely credible - from statistics offices all across the globe in April, simply because Easter this year was in March). So they have my sympathy, and I'm sure the data Alla Vanga has provided needs to be treated as only a first approximation, which is why I still am reluctant to give up completely my initial feeling that the recession may even go back to Q4 2007. Certainly GDP contracted in Q4 last year, and the only real issue is the seasonal correction to be applied. My gut feeling is we may see some later revisions which will change things slightly, in the meantime, Latvia officially entered recession on 1 January 2008.

Anyway, on to the data, which really is pretty horrible. First off the quarterly evolution of GDP as we now have it.

Now looking at this chart, is there still anyone around out there who is willing to own up to having imagined Latvia was going to have a "soft" landing - and unfortunately, we need to bear in mind that the worst isn't over yet, this is only just starting.

If we look at the annual growth rate - given as 0.1%, but even this number is the effect of a decimal rounding operation, and the accurate number is a miniscule 0.05% - or put another way, the Latvian economy only grew by a bare, inflation corrected, 1.1 million Lats between July 1 2007 and June 30 2008.

And the situation is almost guaranteed to get worse, since we are more than likely about to see some more quarter on quarter contraction, and hence the annual number is also going to head into negative territory. Final private consumption was down 5.02% year on year. As we can see in the chart below, there is no mistaking the boom-bust. The question is really what is likely to happen now to private consumption. I will try and go more into this in the coming months, but there is just no way we are going to see a sudden leap back in consumption. Obviously it won't simply continue shrinking (or at least I hope it won't), but the kind of positive growth we see may be more like what we are seeing in Hungary now, something in the 1% to 2% y-o-y growth range (and this is when the situation "normalises", which is still some distance ahead, and with some hard bridges to cross in between).

And Gross Fixed Capital Formation was down 6.77% on the year. As can be seen in the chart (again below), the slope is rather smoother than in the case of consumption, which is not surprising, since investment obviously comes to a halt some time before consumption does. Equally, we could expect this part to pick up more quickly, and pull consumption along behind it, but for that Latvia has to become an attractive destination for export activity, and this involves putting all the distortions in relative prices straight. Its like you just crashed a bike at the moment, the frame is intact, but all the wheels are bent and buckled, and the chain has snapped.

Finally, if we come to look at foreign trade, we find that imports were down 8.16% on the year, while exports were up 2.49%. This position is more complicated than it seems, since the rate of increase in exports is falling, not rising, and this does not bode well for a sector that now needs to pull the economy, while imports are down strongly on the back of falling domestic demand. But this decline in imports produces a statistical effect whereby the NET trade balance in Latvia improved in Q2, which actually helped GDP growth, that is if imports had held up better, the contraction in the domestic economy would have been worse (i know this must seem a strange result, but GDP accounting is like that). But the rate of import decline cannot be expected to continue indefinitely at the current strong rate, and with the Lat pegged to the euro, and continuing inflation well above the eurozone average, then Latvian products will only become less competitive (oh, I know, people will increase productivity, but everyone else will be trying to do that too), so my feeling is that what we will now see is a slowdown in the rate of contraction in consumer demand, but an increase in the negative component in the trade balance (due to the bottoming out of the import decline, in part supported by the internal demand for imports as internal demand itself bottoms, and remember, with the high Lat, Chinese - eg - imports are quite cheap) and hence we should envisage GDP lingering in contraction territory for some time to come.

Well, that is a brief resumé of where we are at this point. Clearly there are huge downside risks out there, in particular associated with the slowdown in the eurozone, and the future of the Lat peg. There is also a demographic risk associated with the possibility that more people may leave looking for work abroad. But I think we can safely cross all these issues as and when we get to them. For the time being there is enough to digest in what we already have, I think.

Wednesday, September 3, 2008

The Decline In Latvian Industry Accelerates Again in July

Latvian industrial output contracted again in July 2008, indicating that GDP contraction will almost certainly continue into at least Q3 2008.

Industrial production at constant prices decreased in July 2008 by 0.7%, according to seasonal and working day adjusted data released today by the Latvia statistics office. Manufacturing was down by 1%, electricity, gas and water supply by 0.5%, while in mining and quarrying there was a monthly increase of 7.7%. The drop in industrial output was largely due to adecrease in the manufacturing of other transport equipment (repairing and construction of ships and boats) which was down by 34.7%, the manufacturing of chemicals, chemical products and man-made fibres, which was down by 8.7%, and in the manufacture of wood, wood products and cork, down by 3.7%.

Compared to July 2007 industrial output dropped by 6.9%, according to working day adjusted data. Manufacturing was down by 9.1%, electricity, gas and water supply by 1.6%, and mining and quarrying increased by 20.9%. The decrease was mainly influenced by the volume reduction in the manufacturing of furniture – down by 44.7% - the manufacture of wood, wood products and cork – down by 15.5% - and the manufacture of food products and beverages – down by 9.5%.

As we can see in the chart above, output peaked in August 2007 and has been declining steadily since.

Monday, September 1, 2008

Estonian Industrial Output Declines Again In July

According to the latest data from Statistics Estonia, Estonian industrial output was down by 5% in July compared to July 2007. The decrease in the industrial output was mainly the result of an ongoing decrease in electricity production — compared to July 2007 electricity output decreased by 29%. This decrease is the result of a partial replacement of own production by imported electricity — in July nearly one third of the electricity consumed was imported.

Manufacturing output was down a much smaller 0.3% on the year. The main reason for this was the decrease in orders, and most importantly on the internal market. According to the information of the Estonian Institute of Economic Research, more than half of enterprises mentioned insufficient demand as the key factor weakening production.

The decrease in the production of manufacturing was influenced by the production of food, wood and building materials. The decrease in the manufacturing of food is obviously affected by recent price increases and by the decrease in consumption resulting from them.

Since construction activity is weakening, the production of building materials is on a declining trend — the production of building materials decreased 27% compared to July 2007. The downward trend also continued in the manufacture of wood, and the production of plastic products.

In July compared to June, the seasonally adjusted industrial production of Estonia nudged up by 0.3%, largely due to a reasonably strong monthly increase in manufacturing.

Production was up in July in the export-oriented branches of industry — in the manufacture of metal products, chemical products, electrical machinery. Production grew in all branches of machinery and apparatus manufacturing, where the share of exports is 64% in the manufacture of machinery and 97% in the manufacture of radio apparatus.