The End of the Road In Lithuania?

by Claus Vistesen

Cross posted from Alpha Sources


I am sorry for the rather dramatic headline deployed above but I really don't think that any of this should be taken lightly. I will begin with this short yet very telling note from Bloomberg which informs us that unemployment in Lithuania dropped to a staggering 2.7% in June. This of course signifies an extremely tight labour market and quite simply this cannot go on for much longer. The clear evidence of this is first and foremost to be found in the quarterly y-o-y GDP figures which demonstrate Lithunia's sizzling growth rates much alike the other Baltic countries. As such, Q1 2007 saw an annual growth rate of 8.3% and on average the last five quarters saw a growth rate of GDP of 7.8%. This is of course putting strains of capacity in Lithunia and like in the rest of the Baltic countries the short term cyclical indicators point to very brisk growth in labour costs. Data on Lithuania shows an average increase of a whopping 21.8% in the last four quarters. However, it is the labour force we need to look at I think where Lithuania just can't keep on running up a near vertical hill; and indeed, when the hill turns into a wall the fall might be very far I fear. As such, it might serve us to go back a bit to a post here on AS about the general tendency in net migration in the Baltics. As you can see, outward net migration is particularly pronounced in Lithuania which of course only serves to exacerbate the general sittuation. Below, I field three seperate graphs (two on the labour market and one on net migration) and it should not require much mathematical skill to see how fast this is going in Lithuania and thus how unsustainable it is with the current growth rate. To put the numbers in perspective note that the total population in Lithuania is 3.384.700, that fertility (TFR) has been below 1.5 in more than a decade and that the population (and to some extent also the labour force) is diminishing by means of natural decline. Note especially the figure for unemployed persons which I have expanded with the data from the small Bloomberg piece linked above which notes that the number of unemployed stood at 63.343 in May down to 58.396 in June. In short; this is progressing very quickly indeed, especially if we take into account that the net migration most likely primarily takes its toll from the labour force.

lithuania.labour.market.lforce.jpg

lithuania.labour.market.unemployed.jpg

lithuania.labour.market.net.migration.jpg

As can readily be seen this is not sustainable much longer with the current growth rates and wage inflation. For a general economic perspective on the Baltic the FT has a nice piece this morning as well as of course Edward's recent note on the Latvian economy (linked above) is a must read. Note in particular how the tug-of-war with the rating agencies as well as Swedish banks supporting the credit boom has begun. People are increasingly beginning to smell a hard landing ahead which is of course prompting market participants to position themselves accordingly. In terms of the general dynamics we might be looking at, this I think is a good quote ...

Nevertheless, the danger facing all three states comes not so much from a collapse of foreign confidence – there is not much speculation in Baltic currencies and the banking sectors and public finances remain solid – as from the impact of any sudden change in consumer behaviour as expectations of continued future growth are dashed. This could lead to a collapse in house prices and a steep economic slowdown.

Such a “hard landing” could stop the three EU newcomers in their tracks as they struggle to catch up with western Europe. Even Estonia, the richest, is still only two-thirds of the EU average gross domestic product (GDP) per capita.

Of course, speculation in Baltic currencies could easily become the flavor of the day if rumours mounted that these countries might have to de-peg from the Euro in order to restore competitiveness. In the end, my advice will be to watch the labour market since the continuous tigtening, not only in Lithuania, at some point will put a ceiling on the current spurt after which the correction will come. Solutions are of course available in terms of bying these economies some time but time, as it were, is indeed running out. Yet, it still seems prudent to advice that inward migration is strongly stimulated and in Lithuania's case where labour force participation rates have been steadily declining for a decade it seems to be a trend which quite simply needs to be reversed although this will be difficult in the immediate short term context.

Addressing Labour Shortages in Estonia?

by Claus Vistesen

Cross posted from Alpha Sources

This is just a small pointer in relation to my note on net migration in the Baltics a few days back as well as my note on Demography.Matters on catch-up growth in Eastern Europe. At the heart of this issue is of course a severe labour shortage in many Eastern Europe fuelled in part by structural labour mismatches as well as a more profound shortage of labour as a result of very low fertility levels throughout the 1990s. In Estonia, as was demonstrated in the post linked above net migration has been virtually positive since 2000 with an ever so small net inward migration flow. Yet, policy makers and employers in Estonia are well aware of the labour shortage which will persist even if net migration is not negative. What is interesting here (see excerpt below) of course is the distinction between whether Estonia should attract low skilled labour or more high skilled labour. At this point you could of course claim that both of these labour groups should be incited to come to Estonia from abroad but it will be interesting to see where the proposed institutional initiatives will predominantly be focused. Here is a relevant excerpt from the article from the Baltic Times linked above ...

The process of bringing foreign workers to Estonia is to be streamlined under a plan to ease the country’s worker shortage. The quota of foreign workers will be doubled to about 1,300 and the bureaucratic paperwork slashed by November under an Economy Ministry proposal. Economy Minister Juhan Parts said the bureaucratic simplifications were an obvious solution to give companies faster access to skilled labor. Employers have welcomed the proposals, but said they did not go far enough in addressing Estonia’s shortage of low skilled workers. Parts told The Baltic Times that the proposal would be before Parliament by November. “Diminishing bureaucracy will make it much easier for entrepreneurs to use labor from third countries,” Parts said.

“The changes have broad consensus from both business and most political parties.” He said it was “unacceptable” that “good qualified brains” were having difficulty entering the Estonian labor market. However, he stopped short of opening the borders to low-skilled workers, saying that employers should look to hire from the 380 million available workers within the European Union to address their staff shortages. “This is not a liberalization of our immigration policy. We don’t want to see millions and millions of third country workers here,” he said. Employers seeking long-term permits for workers will have to commit to paying a salary of at least 1.24 times the average Estonian salary, which currently sits at 9,600 kroons. Those applying for six month permits will have to pay their workers the average salary for their sector, Economy Ministry executive officer Sille Rossi said.

As a final note it is also interesting to note the quibble over whether it is fair (or perhaps prudent?) for Estonian employers to systematically pay a premium for labour just because it is foreign. Of course, this might be necessary in order to actually attract the needed labour. However, with the wage pressure and inflation already at very high levels and even if net migration to Estonia were to pick up, the current inflation/wage expectations are clearly not warranted given the underlying capacity issues which inevitably will materialize in Estonia as well as other Eastern European countries at some point. In short, the longer this goes one the further these economies will fall, I fear, given the relative inability for capacity to respond on the backside of these very high inflation expectations and developments. Having said and as a very final note it does seem (for various reasons which I might go into later) that Estonia is much better suited to handle the inevitable backdrop better than for example its neighbours Lithuania and Latvia.

Estonia Revises Down Economic Growth to 9.8 Percent

From Bloomberg recently:

Estonia Revises Down Economic Growth to 9.8 Percent

Estonia, the European Union's second fastest growing economy, revised down its economic growth rate in the first quarter to an annual 9.8 percent as the property market cooled and export growth slowed.

The pace of growth was revised from the preliminary estimate of 9.9 percent released May 15, the Tallinn-based statistics office, Statistikaamet, said on its Web site today. The annual rate was the slowest in two years. The Baltic country's economy grew a revised 10.9 percent for the previous three months.

``Domestic demand weakened mainly due to slowing investment growth, even as the warm winter benefited construction,'' Maris Lauri, the chief economist with Hansabank Markets, said in e- mailed comment. ``The worst hit came from modest export growth and continued strong import rise.''

The $15.1 billion economy is poised for a ``soft landing,'' according to the central bank, after rising house prices and higher interest rates slowed growth in the property market in the first quarter and banks including the Baltic region's biggest lender AS Hansapank set stricter mortgage lending criteria.

Unemployment at a 15-year low and a 20 percent increase in wages during the first quarter are still boosting spending power and pushing up inflation, which stood at 5.7 percent in May and forced the government last month to postpone its target for meeting euro-adoption criteria to 2011.

May Overheat

Estonia's inflation and widening current account deficit, at 14.8 percent of GDP in 2006, increased worries among foreign investors and credit agencies earlier this year that the Baltic economy may overheat, similarly to that of neighboring Latvia, and trigger a sharp decline in the growth rate.

``Strong consumer demand coupled with a slowdown in export growth means the external balance is likely to have worsened this quarter,'' Neil Shearing, an economist at Capital Economics in London, said in e-mailed comment. ``We want to see signs that consumption is starting to ease before signaling the all clear on overheating.''

The Finance Ministry said it expected the economy to slow further in the second quarter because order books in construction are declining, retail and service industries are forecasting lower revenue growth and consumer optimism has ``slightly'' declined. A ``consumption boom'' will still persist ``in the near term,'' the ministry said in an e-mailed comment.

Increases

Private consumption jumped 18 percent, the biggest increase in 14 years, according to the ministry. Gross fixed capital formation, which includes investment and stock-building, also increased 18 percent, slowing from previous two quarters. Exports of goods and services grew 5 percent from a year earlier, while imports rose 11 percent.

Exports slowed most in fuel shipments and electronics, the Finance Ministry said. Analysts, including Lauri from Hansabank Markets, have said the decline in electronics trade is due to rising wages which are forcing companies such as Elcoteq SE, a Finnish contract manufacturer with a factory in Tallinn and Estonia's biggest exporter, to move its high-volume production to lower-cost countries.

Latvia's economy grew a revised 11.2 percent in the first quarter, the fastest pace in the European Union. Lithuania's economy grew 8.3 percent.

Estonian Current-Account Gap Is Widest in 14 Years

From Bloomberg recently:


Estonian Current-Account Gap Is Widest in 14 Years

Estonia's current-account deficit swelled last quarter to the widest in at least 14 years as soaring wages and consumer borrowing spurred spending on imported cars and clothes.

The deficit, the broadest measure of trade in goods and services, widened to 17.9 percent of gross domestic product from 16.1 percent a year earlier and a revised 17.2 percent in the previous quarter, the Tallinn-based central bank said on its Web site today. The deficit is the highest since at least the first quarter of 1993, when the bank started giving quarterly figures.

Economic growth of 9.8 percent in the first quarter, the second-fastest pace in the European Union, helped trigger a 20 percent surge in wages in the period while credit growth of about 30 percent underpinned household spending. The widening deficit and faster inflation has raised concern the economy may overheat.

``The Estonian economy is living beyond its means,'' said Neil Shearing, an economist at Capital Economics in London, in an e-mailed comment. ``More needs to be done to slow domestic demand. The fiscal position could be further tightened and measures to curb rapid credit growth are needed.''

Estonia's biggest retailer, AS Tallinna Kaubamaja, more than doubled profit in the first quarter at its department stores and supermarkets. New car sales rose 49 percent, according to the association of car sales and service employers, AMTEL. Private consumption jumped 18 percent, the biggest increase in 14 years.

Deficit Outlook

Andres Saarniit, an adviser to the central bank, said the deficit is expected to ``decline in coming years, but still remain sizeable.'' The central bank revised up the 2006 current account deficit to 15.7 percent of GDP from an earlier estimate of 14.8 percent.

The Finance Ministry said it expects the current-account gap to widen further this year, citing fast growth in domestic demand and worsening competitiveness of industries where growing wages make up a bi part of overall costs. It also expects lower demand from abroad due to lower growth in Estonia's export destinations, the ministry added in an e-mailed statement.

Moody's rating service warned today the economy may slow more than expected if confidence slumps among borrowers and banks, which started tightening credit requirements in the first quarter.

Analysts said the risks to the economy were reduced by strong levels of foreign direct investment, which help cover the current account deficit.

``Some comfort is provided by the fact that the financing of the deficit seems to be okay, as 45 percent of the deficit was covered by FDI,'' said Mika Erkkila, a senior analyst with Nordea Bank in Helsinki, in an e-mailed comment.