Baltic economies slide into era of hard times

Associated Press
June 3, 2008

It’s the middle of the work day, but Iveta Vitkovska’s notary office in the heart of Riga’s Art Nouveau shopping district is dead calm.

Just a year ago, there was a waiting list at notaries throughout the city as Latvians hustled to seal promising real estate deals. But an economic malaise in the Baltics has put an end to that.

“Things have definitely slowed down in the last few months,” said Vitkovska, reduced to organizing files in her office, located on a cobblestoned street where streetcars rumble past designer-name boutiques — dozens of which are now closing due to rampant rent increases and sluggish sales.

Over at Paus Konsults, a debt collection firm in the same neighborhood, business is booming. Director Marcis Katajs said Latvia’s banks submitted more than 6,500 new overdue debt cases in April, up 45 percent from February. There are about 200,000 such cases in the firm’s database, extraordinary for a country of 2.3 million people.

Little Latvia, along with its neighbors Estonia and Lithuania, is in an economic free-fall. After four years of thunderous expansion, the so-called “Baltic tigers” are lying down for what may be a prolonged hibernation.

Analysts say the downturn is a hangover from the dizzying expansion. “Growth was too strong for a number of years — growing above potential — leading to an overheating of capacity,” said Marcus Svedberg, chief economist at East Capital, a Stockholm-based fund manager with about $6.8 billion in assets and the largest portfolio investor in the Baltics.

“So this fall did not come as a surprise.”

The Baltic economies started slowing late last year, but more recent figures showed the drop became more severe. In Estonia, first-quarter growth plummeted to a bare 0.4 percent year-on-year — the lowest in eight years. A year ago, first-quarter growth hit an annual rate of 9.9 percent. Latvia saw quarterly growth drop to 3.6 percent year-on-year, down from 9.6 percent in the previous quarter, and analysts say it will continue dropping.

Some fear the boom is ending in a hard landing — pronounced and painful. Others people welcome the slowdown, saying it will correct excesses such as swollen trade deficits, excessive wage increases and galloping inflation.

“These economies are really slowing down, but this is a positive,” said Franklin Gill, a London-based analyst at credit rating agency Standard & Poor’s. “It is driving an improvement in the imbalances.”

While the boom lasted, it was astonishing. From 2004 to 2007, Estonia’s economy ballooned 42 percent, and Latvia’s grew by an incredible 50 percent — by far the best results in the European Union.

But inflation spiraled out of control, reaching close to 18 percent in Latvia, and over 11 percent in Estonia and Lithuania — devouring households’ disposable income and postponing for years the countries’ ambitions to adopt the euro.

The three countries had broken free of the Soviet Union and its state-planned economy when it fell apart in 1991, and immediately set a course for free markets. After the nations won EU membership in 2004, Baltic consumers embarked on a borrow-and-spend binge by taking advantage of cheap, accessible loans. They bought new Toyotas, refurnished their apartments and vacationed on the Mediterranean.

By the end of 2007, bank lending in Latvia skyrocketed to 93 percent of gross domestic product, up from 39 percent four years earlier. By comparison, in wealthier Finland the same measure was at 84 percent.

But it was real estate that really fed the tigers as Latvians bought land, homes and apartments. The construction sector boomed — and property values were propelled skyward.

The price of a new apartment in suburban Riga tripled in four years, according to Ober-Haus Real Estate. And since capital gains on property deals in Latvia were not taxed, Latvians and foreigners alike jumped in on the action.

“We have cab drivers who are real estate specialists,” Katajs said.

Investment tended to focus on the Baltic capitals, where each country’s population is concentrated — Riga boasts one-third of Latvia’s population — and the combination of medieval, Art Nouveau and Baroque styles attract flocks of tourists each year.

Just as in the United States, rising housing prices created a feel-good environment of perpetual wealth, and Latvians returned to the banks to borrow more.

Amazingly, many borrowed from several banks at once. Very few even thought of saving.

“It is our common problem. The savings cushion for hard times is very small, if there is any at all,” said Ainars Ozols, chairman of SEB Banka, Latvia’s second-largest bank. He said that only 10 percent of SEB Banka’s customers have savings.

The result was a massive accumulation of household debt in all three Baltic countries. “The households in these economies are extremely indebted, even relative to West European countries,” said Gill.

Lithuania was slightly different — though overall trends are similar, the Baltics’ largest country never posted the huge imbalances that Estonia and Latvia did. Economic growth was moderately fast — 36 percent over 2004-07 — and Lithuanians were far less inclined to borrow and spend.

Now businesses throughout the Baltics are cutting back because of rising costs for energy, labor and materials.

Trials, a Swedish-owned meatpacker in Latvia, announced it was letting go nearly a third of its work force. Lauma Lingerie, which began sewing women’s underwear in the 1960s during the Soviet period, said it was laying off 100 employees and moving production to Belarus and China. Consumer confidence has plunged.

The most pessimist economic forecast has come from the International Monetary Fund, which has predicted that Latvia’s growth would slow to 0.5 percent this year, down from 10.5 percent in 2007. Economist qualify such a precipitous drop as a “hard landing,” a predicament that Latvian policy makers have denied strenuously.

“Our only concern is that these economies could slow down so rapidly that this could lead to a rise in unemployment — something we’re not seeing right now,” said Gill.

For his part, debt collector Katajs believes the worse is yet to come. “We expect the number of debt cases will peak in October,” he said.