Latvian Inflation Stays Stubbornly High In September

Latvia's inflation fell for the fourth month straight in September, and was down to 14.9 percent. Monthly inflation over August was at 1.1 percent, due largely to a jump in textile and education prices.



Latvia has had the European Union's highest annual inflation rate for more than a year now, a starnge trophy to obtain, this one. Inflation peaked at 17.7 percent in May, and has since been slowing steadily.

Latvia's economy posted 10.5 percent growth in gross domestic product in 2007, following 11.9 percent growth in 2006. Since that time Lativia's economy has turned sharply downward, with GDP expanding only 0.2 percent during the first six months of 2008 - down from 10.2 percent over the same period in 2007.

And the future seems to be even more bleak with the IMF forecasting that Latvia's gross domestic product will decrease 0.9% in 2008. Only Ireland and Estonia are forecast to see their GDP contract by more than Latvia – by 1.8% and 1.5%, respectively. The IMF also expects that Latvia's GDP will shrink another 2.2% next year.

The IMF also expect inflation to remain high in Latvia. According to IMF estimates, annual inflation in Latvia could reach 15.3% this year, 10.6% in 2009 and 6.7% in 2007. On the other hand, they expect the current account deficit to decrease to 15.1% of GDP this year and 8.3% in 2009.

Latvia needs to cut spending in next year's budget to avoid rising loan costs as turmoil in financial markets drives up borrowing rates, central bank Governor Ilmars Rimsevics said in Dienas Bizness.

``The global financial crisis has strongly dried up the flow of money: borrowing
abroad for a reasonable price has become practically impossible,'' Rimsevics
wrote in an Ed-op piece for the Riga-based newspaper.

The central bank forecasts growth between zero and 0.5 percent next year, which would widen the budget gap to as much as 4 percent. Rimsevics also said that Latvia may end next year with a fiscal deficit of 5.5 percent of GDP, in an interview with Leta newswire today. A shortfall that size would be ``unacceptable" he said accusing the Latvian government of having given up trying'' to cut spending. As can be easily imagined, Rimsevics song, when coupled with an IMF forecast of an 8.3% CA deficit for 2009, will be like sweet music to the ears of the global investment community at this point.

It is thus hardly surprising that Fitch Ratings recently cut Latvia's credit rating to BBB from BBB+, the second lowest investment grade, citing a deterioration of the European economy.

Estonia's Inflation Comes Down (slightly) As Unemployment Rises (a bit)

Estonia's inflation rate fell in September to the lowest level this year as fuel and food prices declined. The rate declined to 10.5 percent, the lowest since December 2007, from 11 percent in August, according to the latest data from the statistics office in the capital Tallinn. Month on month prices were up 0.6 percent, mainly because of rising alcohol and tobacco prices after an excise tax increase in July.



Lower fuel costs cut transport prices by 1.3 percent in the month for an annual increase of 12.1 percent. Food prices eased 0.3 percent from August to cut the annual gain to 13.9 percent. Alcohol and tobacco prices rose 7 percent in the month, gaining 26.7 percent on the year.


Unemployment Edges Up


Estonia's registered unemployment rate rose to the highest level in more than three years in September as Estonia's recession continued to deepen. The jobless rate, based on the number of unemployed registered with labor offices, rose to 3.1 percent, the highest since July 2005, from 2.9 percent in August, According to the Estonian Labor Market Board. The number of people signed on as seeking a job rose 6.6 percent from the previous month to 20,015, it added.

Lower consumer spending and weaker industrial output pushed Estonia into a recession in the second quarter as gross domestic product shrank for two quarters following the onset of a sharp credit crunch. Unemployment, which usually follows changes in economic output with a time lag, is expected to rise considerably from current levels.


The unemployment rate as measured by the Estonian statistics office in quarterly labor surveys, may rise as much as 10 percent by the end of 2009 from a 16-year low of 4 percent in the second quarter, according to estimates from Erkki Raasuke, head of Baltic operations for Swedbank AB.

Latvian Credit Downgraded As Retail Sales Continue Their Decline

As reported in this post, on Friday Fitch Rating Service announced they were cutting long-term sovereign ratings for Estonia, Latvia and Lithuania, citing worsening financial conditions in Europe. Latvia's long-term foreign-currency Issuer Default Rating was cut to BBB from BBB+. The outlooks were kept negative.

The move by Fitch follows an earlier decision by Moody's Investors Service to lower its Latvia outlook to negative. The outlook change affects Latvia's A2 foreign currency and local currency debt rating. The outlook on the Aa1 country ceiling for foreign currency bonds was kept at stable. Moody's A2 rating is five levels above investment grade. Kenneth Orchard, senior analyst at Moody's wrote in the statement: "Although it is not Moody's central scenario, Latvia's economy is vulnerable to a sharp reduction in foreign capital inflows.''

Latvia has low levels of government debt and no foreign bonds maturing for over five years, so there is little serious danger to Latvia's public sector funding. On the other hand Latvian interest rates to households and companies are expected to rise and the number of non-performing loans to grow as a by-product of the ratings changes and the global financial market turmoil which lead to them.

``Credit is becoming more difficult to access, and if you can access it, it will be in smaller sums and at a higher interest rate,'' Janis Brazovskis, vice-chairman of the Latvian Financial and Capital Market Commission, speaking in an interview on Latvijas Neatkariga Televizija's program 900 Seconds.

According to Brazovkis, interest rates will rise by between 0.5 and 2 percentage points for Latvian borrowers. Overdue loan payments may rise to 2 percent of total credits from the current 0.7 percent. Brazovkis stressed that Latvia's exposure to the U.S. financial system was "extremely minimal,'' and that Latvian lenders did not invest in "toxic financial instruments,''. This is undoubtedly true, but on the other hand I have never actually seen anyone suggest that Latvia's problems were a by-product of poor quality investments made in the US - in other words this would simply seem to be yet another one of those famous "red herrings". Latvian lenders also did not buy toxic instruments, since they were effectively selling them - to eg Swedish investors. Latvia, like the US, the UK and Spain, has a current account deficit, and it is the current account deficit countries who were effectively issuing the toxic instruments to finance their external borrowing at rates which were below the real level of the risk being assumed. If lending practices in Latvia were not lax (which is the normal argument directed towards the United States), then I simply do not understand the chart below - which shows bank lending going off a cliff once documentation and lending rules we tightened up in the spring of 2007.




So the problem is, it seems to me, that the people who bought instruments issued by the Latvian banking system (or who created instruments elsewhere to then inject funds into Latvian banks) are the ones who have the problems, and they are unlikely to be so forthcoming in the future, which is why credit will remain tight in Latvia (about this Brazovkis is undoubtedly right) and interest rates may well rise. Which is just one more reason why we should not expect any imminent revival in Latvia's flagging retail sales (see below) - and by imminent I do mean over the next few years. This recession is in for the long haul.

Retail Sales Continue To Decline



Month on month seasonally adjusted retail sales (at constant prices) were down by 1.2% In August. Compared to August 2007, and according to working-day adjusted data, at constant prices, total retail sales decreased by 8.9%.





The largest volume decreases were in food products – down by 10.3%.

Fitch Cuts Baltic Long Term Rating As Estonia's Industrial Output and Retail Sales Continues To Slide

Fitch Rating Service has today cut long-term sovereign ratings for the Baltic countries of Estonia, Latvia and Lithuania, citing worsening financial conditions in Europe. Estonian and Lithuanian long-term foreign-currency Issuer Default Ratings were reduced to A- from A, while Latva's rating was cut to BBB from BBB+. Outlooks were kept negative.

``The downgrade of the Baltic states reflects the risk that the deterioration in the European economic and financial environment will impose a more costly macroeconomic adjustment in the Baltic countries, given their large bank-financed current account deficits,'' Edward Parker, head of emerging Europe sovereigns at Fitch says in the accompanying statement.

All three Baltic economies are in the global top 10 of those with the largest gap between outstanding bank credit and bank deposits relative to both gross domestic product and total bank credit, Fitch said. Gross external financing requirements plus short-term external debt will be at around 400 percent of end- 2008 foreign exchange reserves in Latvia, 350 percent in Estonia and 250 percent in Lithuania, the highest ratios in emerging Europe.

Industrial Output Onwards and Downwards


Meanwhile in Estonia the whole real economy continues to meander along its steady downward course. According to Statistics Estonia, industrial output was down 2.6% in August when compared to August 2007. Month on month outpot was up 1.6% on a seasonally adjusted basis.

Manufacturing output was down 2% year on year. According to the statistics office statemet The main reason for the decline was the decrease in orders, both on the external and internal markets.




The decrease in manufacturing was mainly influenced by food production, and wood and building materials. The decrease in the manufacturing of food is obviously affected by the large price increases and by the decrease in consumption which follows. Compared to August 2007, 20% less beer, 15% less soft drinks and 10% less meat products were produced. Although the rate of price increases has eased back in recent months, food product prices increased 17% in August year on year.

As in previous months, production increased in August primarily in the export-oriented branches of industry — in the manufacture of metal products, chemical products, electrical machinery etc. Output was also up in the manufacture of machinery, precision instruments and motor vehicles, sectors where there is a sjgnificant export share. The share of exports was 89% in the manufacture of motor vehicles and 93% in the manufacture of precision instruments.

And if we look at the longer term evolution in the working day and seasonally adjusted output index, It is clear that output levels hit a maximum in the first two or three months of this year, since which time they have been moving gradually downwards. In the present climate we are unlikely to see any change in this trend anytime soon.





Retail Sales Also Continue Their Decline


According to Statistics Estonia, retail sales of goods of retail trade enterprises were down 6% in August over August 2007 at constant prices. Compared to July 2008, retail sales decreased by 4% in August at constant prices.



In August, retail sales ran to a total of 4.8 billion kroons. In grocery stores rsales were down by 3% compared with August of the previous year. The decrease in sales was significantly influenced by a rapid growth in the prices of food products (and of course this decline in sales then fed back into industrial output). Retail sales in stores selling manufactured goods decreased by 9% compared with the same month of the previous year. Compared to August of the previous year, retail sales decreased in most economic activities except mail order sale, which increased 24% during the year. The main reason for the increase in the mail order sale was the low reference base of the previous year. Mail order sales do not significantly influence the retail sales in retail trade enterprises, because the share of this activity is very small: it was only 2% in August 2008. The retail sales of stores selling household goods and appliances, hardware and building materials suffered the greatest decrease (15%) as compared to the previous year.