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Thursday, August 21, 2008

Estonia and Latvia Producer Prices July 2008

Prices of goods leaving Estonian factories and mines rose an annual 7.8 percent in July, accelerating for the second time in eight months (from 7.5% in June) as the cost of making electrical appliances and textiles increased.

Even more worryingly perhaps, the percentage change in the export price index was 0.1% compared to June and 4.3% compared to July 2007. Since the Estonian economy can now only realistically grow by increasing exports, and the kroon is pegged to the euro, these costs are passed directly on to many of Estonia's potential customers. The month on month export price index was mainly influenced by the increase in prices in the manufacture of chemicals and chemical products and food products and beverages and by the decrease in prices in the manufacture of wood and wood products and in the manufacture of rubber and plastic products.

Wage growth, the main impetus behind the growth in producer prices over the two years to November, is still close to its 2007 peak, as the labour market remains tight and wages refuse to correct moving into the recession. A weaker-than-expected slowdown in wage growth threatens the competitiveness of Estonian exports according to a statement from the central bank on April 16.

Nevertheless, disappointing as the Estonian figures are, they are still considerably better than the Latvian ones. Compared to June 2008, producer prices in Latvian industry increased in July by 0.3%, according to data from the Central Statistical Bureau of Latvia. Year on year (compared to July 2007) producer prices increased by 12.4%. And as regards export prices, compared to June 2008, producer prices in Latvian export industries increased by 1.3%, and year on year export producer prices were up by 7.1%.

Saturday, August 16, 2008

Latvia Consumer Price Inflation Falls Back Slightly In July

Compared to the July 2007, Latvian consumer prices increased by 16.7% in July, of which prices for goods increased by 16.4%, while prices of services were up by 17.4%, thus inflation is now down slighly from the May peak of 17.9%.

Compared to June 2008 the average consumer price level in July 2008 rose by 0.3%. The average price level for goods did not change, but prices of services increased by 1.1%.

Within the food group the price increase of meat and meat products by 3.1% had the major impact on consumer price level. Cereals, especially rice, non-alcoholic beverages, sweets, fruit, pastry-cook products, fresh fish and potatoes all became more expensive as well.

The price of transport services increased by 6.6%, of which the prices of tickets in intercity buses increased by 28.0%, while prices of tickets in passenger rail transport was up by 17.4%. The average prices of automotive fuel rose by 1.6%.

With the extension of the traditional seasonal sales period the prices of clothing decreased by 6.4%, but the price of footwear was down by 8.2%. Due to the sales the sports, camping and open-air recreation equipment, household textiles, glassware and tableware and bicycles all became less expensive. The prices of computers, TV, audio, video and photographic equipment, telephones, goods and services for the maintenance and repair of dwelling, flowers and toys decreased as well.

Labour Market And Wages Not Adjusting To Downturn

Neil Shearing of Capital Economics makes the following pretty valid points in a research note released soon after the Estonian GDP data were made available. According to Shearing there are three good reasons to think that things will get worse before they get better:

"Firstly, labour markets have yet to react to the slowdown in the first half of 2008. The unemployment rate has actually fallen in Latvia and Lithuania and has remained flat in Estonia. But surveys point to a rise in unemployment over the coming months,"

"Secondly, the growth outlook for the euro-zone has deteriorated in recent months. Since exports to the euro-zone account for roughly 15% of GDP in the Baltics, this could hit manufacturers in the region hard... it is becoming even more difficult for the region to rebalance towards net exports,"

"Finally, external financing conditions are likely to become more difficult over the coming year, as global liquidity dries up. This will make it much harder for the region to fund its huge current account deficits. As a result, these deficits will have to shrink, and this requires a further contraction in domestic demand," he concludes. "The upshot is that we expect the region to enter a deep and protracted recession."

As we can see Latvia's unemployment has risen very slightly in recent months, but it is still well below what it was only as recently as a year ago.There were 55,436 unemployed in Latvia in June, and the unemployment rate was 5.1%, only the same as it was in September 2007.

I would add at least one more issue to Shearing's list, the protracted inflation issue, and the difficulty of the elderly Latvian labour market in adjusting. What we are seeing in Estonia is more people retiring from labour market activity than are joining the market, and hence unemplyment has been falling. I don't imagine things will be that different in Lativa, and thus although unemployment will rise, it will not rise as much as some are expecting (many are saying that the labour market is a "lagged indicator" and this is true, but there is more than that at work here).

So given the labour market can't adequately correct, then wages and prices won't moderate as much as they should, which, given that domestic demand is now more or less done as a structural driver of Baltic growth, is going to make the issue of getting exports competitive very hard work indeed.

Bottom line: Latvian GDP will soon be going under water and into negative territory, my feeling is it will now be quite some time before we see it "resurfacing" again.

Thursday, August 14, 2008

Latvia GDP Contracts In Q2 2008

Latvia's GDP only expanded by 0.2% year on year in Q2 2008:

and quarter on quarter the economy contracted by 0.5% over the first quarter of 2008(Eurostat data):

This will be very brief coverage of these results at this point, since this is, at the present time, all the detail we have. A more precise and extended breakdown of second quarter GDP data will be published by the statistics office on September 8.

Exports Waning

Latvia's June exports dropped 3.6% over May, and were up 3.1% on June 2007. The rate of y-o-y increase in exports is thus dropping rapidly. In June compared to May the most rapid decrease was in exports of vodka (by 55.8%), of rough-cut wood (by 23.6%), of iron and non-alloy steel (by 22.0%), of chocolate and other food preparations containing cocoa (by 17.4%) and of clothing, not knitted or crocheted (by 11.3%), but exports of paper and paperboard, articles of paper increased by 44.1%, pharmaceutical products were up by 31.2%, and machinery and mechanical appliances by 14.6%.

Compared to June 2007 the largest exports increase was in wheat and meslin (exports to Lithuania, Oman, Denmark and Poland) which were up by a multiple of almost 13 times (increase from 187 thsd lats to 2414 thsd lats), in fish, fresh, chilled or frozen (by 85.7%), iron and non-alloy steel (by 43.5%), articles of iron or steel (by33.8%), pharmaceutical products – (12.1%). Exports of sawn wood decreased by 52.3%, furniture, including mattress and articles of bedding and similar furnishing was down by 33.0%, chocolate and other food preparations containing cocoa were down by 24.3%, and veneer sheets and plywood by 17.8%.

In June compared to May the most rapid increase was in imports of electricity – by 54.7%, of iron and non-alloy steel (by 48.4%), meat of swine, fresh, chilled or frozen (by 36.6%), of cigarettes (by 30.7%), but imports of agglomerated cork decreased by 35.9%, as did particle boards (by 28.0%), pharmaceutical products (by 17.2%), plastics (by 13.5%), electrical appliances and equipment (by 5.6%), and coniferous sawn-wood (by 4.4%).

Compared to June 2007 the most notable decrease was in imports of sawn wood (by 76.0%), passenger cars (by 49.7%), furniture, including mattress and articles of bedding and similar furnishing (by 37.9%), machinery and mechanical appliances (by 29.8%), clothing, not knitted or crocheted (by 19.8%). Imports of pork and pork products increased by 73.1%, iron and non-alloy steel (by 42.8%), residual fuel oils (by 36.8%), diesel oil (by 27.2%) and electricity (by 13.9%).

As a result Latvia's trade deficit increased again in June when compared with May.

Wednesday, August 6, 2008

Where Now for CEE and Baltic Currencies?

By Claus Vistesen: Copenhagen

Ever since the illusive credit turmoil began sentiment in the market place has been fickle and essentially, like the assets of which it consists, volatile. We started off with an adamant focus on downside risks to growth which then turned into a focus and fear of inflation. Now, as the cyclical data has turned for the worse in Europe and many places in Asia the focus seems to be reverting to growth. Now, I won't go into the whole decoupling v recoupling discussion at this point since I think that this dichotomy is a false one. It never was about de-coupling à la traditionelle but moreso about two interrelated points. The first would be the extent to which the world already has decoupled from the US in the sense that a key group of emerging economies are now set to ascend in economic prowess. The second would be the extent to which the de-coupling thesis always built on a fallacy. The main point would be that the main fault line of slowdown was observed across economies with external deficits; something which, I am sure most will agree, is sure to impact surplus economies too.

Now, that does not completely let the ECB off the hook since by maintaining a focus on inflation it also assumed the role, if only temporary, of the new anchor in a re-wamped version of Bretton Woods II as the Euro ascended to new highs. This bet on global re-balancing was always going to end in tears and in this light the Eurozone could not decouple from the US; that much, I think, is true.

The key issue here however, as I have argued time and time again is represented in two crucial interlocked questions which together form a key structural trend in the global economy. One is what happens when the surplus economies slow down and there is not sufficient demand to pull the economy back up? Demographics and a high median age are key variables to watch in this regard. The second question is the extent to which hitherto deficit nations can turn the boat around and increase savings (i.e. rely more on exports) and what it will mean for global capital flows when they begin this process?

In the context of the CEE economies the themes above are also present. In a recent note I detailed the change in sentiment from growth to inflation and what it might mean for Eastern Europe's economies and their respective currencies. The key situation as I sketched it was one of a dilemma.

On the one hand, the rampant inflation levels suggest that the exchange rate be loosened to allow appreciation and thus pour water on the roaring inflation bonfire. On the other hand however the Baltics, as well as many other CEE countries, are saddled with extensive external deficits financed by consumer and business credit denominated in Euros. It is not difficult to see that this represents a regular vice from which it will be very difficult to escape since as long as the peg remains deflation seems the only painful alternative as a mean of correcting.


Another point which is specifically tied to Eastern Europe is that if domestic nominal interest rate increase to keep up with inflation rates it will have a strong substitution effects towards Euro denominated loans. This can become a dangerous cocktail should the tide turn against the currencies.

Now that the focus seems to be changing back again it appears to be a good time to revisit the situation

Within this global nexus of what exactly to do with inflation relative to growth, many Eastern European economies has so far opted to go for inflation by raising interest rates. At an initial glance this seems quite reasonable and in many ways the CEE central banks merely latched on to market sentiment and expectations that many emerging economies would seek to use nominal appreciation as a tool to flush out inflation.

Consequently we have seen how both Ukraine and Hungary have chosen to loosen the peg to the Euro as well as other floating currencies in Eastern Europe have seen their yield advantage increase in an attempt to flush out inflation. This has not been without problems though or more specifically it is not clear that an appreciation of the currency is all for the good. Two points here would seem particularly important. One is the simple question of whether in fact an appreciation is deflationary in a world where capital flows, and in particular the hot kind, act strongly on yield. However, another point would be specifically tied to the situation in Eastern Europe. As such, nominal appreciation of the currency also increases the purchasing power which is not what many CEE economies need at the present time as they stand before the task of correcting a rather large external balance. Moreover, rising domestic interest rates will increase and exacerbate the credit channel by which loans denominated in Euros and Swiss francs become more attractive. I have shown this to be true, for example, in the context of Lithuania. The important thing to do note here would what would happen to the servicing of these liabilities should the domestic currencies depreciate.

What happens next then? Or more concretely, even though CEE currencies, in general, have enjoyed a rally on the back of market expectations of nominal appreciation fed by hawkish central banks what happens if and when central banks reverese course?

An initial warning shot across the bow was handed to us as the governor of the Czech central bank mused that he might lower rates come next meeting due to the strenght of the Koruna and the subsequent effect on exports. Also Poland recently opted to abandon the hawkish stance as rates were kept steady. In light of this event Macro Man managed, as ever, to hit the proverbial nail on the head.

There is little more bearish for a currency these days than abandoning the inflation fight in a pursuit of growth; this is particularly the case when the market is heavily positioned the other way.

This is exactly the issue which now confronts many Eastern European economies. What to do as growth visibly tanks at one at the same time as inflation stays high. One thing here would be for the central banks to hold their raising cycle which in itself should ease the pace of appreciation but what if they need to lower rates.

Now the numbers above do not, in themselves tell anything remotely interesting. For one, the difference between the economies are quite big. For example the Czech Republic has been able to gain, with a comparatively low interest rate, currency appreciation which has actually helped the external balance in so far as it has made imports cheaper. Obviously, at this point the benign effect on the trade balance is just as much down to decreasing domestic demand as the value shield of a dear currency. On the other hand, if we consider especially Ukraine, Romania, and Hungary the price has been dearer and the subsequent effect on inflation less pronounced. One could always argue that the situation would have been much worse, but one thing is certain; the ensuing loss of competitiveness has not been compensated for with a decrease in inflation. And one has to wonder whether pushing nominal interest rates ever higher would be a sound solution.

The key here is that these high interest rates carry with them a high lock-in premium which makes it difficult to reduce them without causing substantial pain to the currency. Add to this that as long as interest rates stay in this territory the incentive to borrow in foreign currency remains very appealing. In fact, the incentive structure here is quite disruptive as many of these economies have higher rates on domestic currency deposits and lower rates on foreign credit. This incites consumers and companies to place their deposits in local currency while funding themselves in foreign currency. Finally, there is of course the more standard economics 1-0-1 point that whatever nominal rate is ascribed to a currency and an economy the latter needs to be able to provide the structural demand for which to satisfy the yield. Otherwise you just pour more gasoline on an already raging bonfire.

Obviously, as long as the local currency remains strong and on an upwards march or the trading band is kept in place the show goes on. But the longer this structure lingers the more difficult it will be to break free; and break free they must since I am quite sure that Eurozone membership is off, for the immediate future at least.

Another more hard hitting point would simply be that whatever growth momentum these economies had going into 2008 it is now steadily levelling off. Now, these economies need to rebalance their external accounts at the same time as they labour under the yoke of slowing growth, high interest rates which are difficult to reduce and/or a quasi fixed exchange rate to the Euro. Can you feel the chilling cold of deflation blowing across the Urals? I can.

Basically, the past years' rapid process of nominal convergence will now need to be kicked into reverse, since it is quite obvious that many CEE economies have been riding a blade too tough.

Be Careful Indeed

Last time I massaged this specific topic I summarised by ominously stating that the CEE economies and their central banks should be careful what they wished for in terms of using higher interest rates and subsequent nominal appreciation of their currencies to flush out inflation. The key point was that the effect would likely be limited and only further worsen the imbalances in the economies. And thus, here we are.

Another more subtle point in the context of market reactions would be the boomerang effect which comes from the currency appreciation as interest rates are increased (and the peg/band abandoned) to the subsequent plunge when the economic tide turns. In line with the change in global sentiment towards growth and deflation (see e.g. here) and the fact that other hitherto strong yielders (e.g. the Kiwi and Aussie) are beginning to falter we may be at an inflection point in the whole discourse of upwards movement in CEE currencies. Stephen Jen's recent tour of global FX markets is a fine addition to this argument.

As ever, this is obviously still a dilemma for most of these economies since inflation continues to rage ahead. In Romania for example the PPI rose at its highest pace since 2004. However, as long as the credit tap stays open and as long as the purchasing power is increasing so will the the demands for higher wages stay strong. This is particularly true in the context of the CEE economies as these are in possession of structurally broken population pyramids after two decades worth of lowest low fertility and, in the cast of the latter decade, net outward migration.

The main point I would like to emphasise here is that correction is coming and that it will only become harder the higher the currencies move upwards. In a more general light this correction will not be a small one and it most certainly will not be felt exclusively in Eastern Europe. Basically, the big hidden data point in all of this is the dependence of Germany on CEE imports. So far, this has moved along just nicely but Germany is in for a rude awakening once the link breaks ... and break, I am afraid, it will.

Monday, August 4, 2008

Latvia Industrial Output June 2008

Industrial output rebounded slightly in June over May, but was still considerably down year on year.

Compared to May 2008 industrial output at constant prices rose by in June by 1.2%, according to seasonally adjusted data (seasonal and working day influence was taken into account) from the Central Statistical Bureau. Of which in manufacturing there was an increase of 0.2%, in electricity, gas and water supply - of 4.9%, but in mining and quarrying the volume decreased by 6.7%. The increase of industrial output was mainly influenced by output growth in the manufacturing of basic metals - by 8.6%, in manufacture of non-metallic mineral products – by 4.9% and in manufacture of wood and of products of wood and cork – by 4%.

Compared to June of previous year in June 2008 industrial output was down by 6.4%, according to working day adjusted data. Of which in manufacturing – by 7.5%, in electricity, gas and water supply - by 1.8%, but in mining and quarrying there was an increase of 0.8%. The reduction of industrial output was influenced by volume decreases in: manufacturing of food products and beverages – by 10.9%, in manufacture of wood and of products of wood and cork – by 7.9%, and in manufacturing of furniture; manufacturing not classified otherwise – by 37.4%.