AB Snaige, the only refrigerator maker in the Baltic states, will cut about 300 jobs in its Lithuanian factory, citing lower demand in Russia and Ukraine as both the ruble and hryvnia lose value against Lithuanian litas. Sales in Russia and Ukraine have “stopped” and “there is no evidence these markets will revive” during the first quarter, the Alytus, Lithuania-based company said in a statement to the Vilnius Stock Exchange today. The company employs “more than” 2,300 workers in its two factories in Lithuania and Kaliningrad, Russia, according to its Web page.
Basically as I say, it also matters which currency you are pegged to. One commenter has made this point.
Regarding Latvia, I'm working for industrial company in Latvia, with most customers from Sweden or Russia and latest SEK and ruble rate changes have really eaten up business both for export and import. From SEK/LVL we lose in funny sequence, more you sell - more you lose. Today, here are a lot and a lot of industries closed, closing or planning to close.
Evidently there is a lot of "restructuring" going on, but is it the kind of restructuring Latvia and Lthuania need, I ask you?
Euro To Swedish Krona
Here's the chart of the Euro with the Swedish Krona.
Euro To Russian Ruble
Here's the Euro/Ruble chart:
Euro To Polish Zloty
Finally, here's Latvian industrial output for November, anyone spot the trend?
And incidentally, Latvian exports were down 19.7% between October and November 2008. And incidentally, Latvian exports were down 19.7% between October and November 2008. Oh, I know, I know, not only doesn't Latvia need exports, it doesn't need industry either. Meanwhile, onwards and downwards we go.
17 comments:
I understand that you have supported the devaluation as a viable alternative to the existing plan for such countries as Latvia.
This article seems to show me as a non-economist why devaluation could help exporters.
However, I wonder, if you would care to also write an article about the scenario for typical middle-class family in Latvia in case of devaluation and how it would differ from what we are experiencing now, considering that a major part of the population does have housing credits and vast majority of those credits are in euros for periods of 20+ years.
I tried to find statistical data about typical family income/expenses here. At the moment I don't have it yet, but I remember a publication about that sometime last year.
ah come on, this article was very speculative
Let’s introduce two concepts internal devaluation (that is going on) and external devaluation (proposed by author of the blog).
So first case - one in which our economy becomes more competitive via increased unemployment which can be controlled to some level (in the end lower cost of labor) caused by the cuts in the government spending and drastically decreasing internal consumption that supports many industries. In this scenario the collateral damage can be addressed to low-class residents of our country, middle and upper class is somewhat unaffected. Following this scenario our currency uncompetitiveness is compensated by the factor of cheap labor (due to economical pressure low-class employees will be willing to work for very low wage levels - just to survive long economical winter). So in case even our currency looses competitiveness to our export partners, the gain in the labor factor can makes us more competitive in overall Euro market, even we will be less competitive in authors described markets. Let’s even further introduce concept of the WTO, which has very interesting tariff system, which makes our export goods even more uncompetitive for example for Russia. Thus, in the end of the day internal devaluation connects our economies future with the exports towards EU. Even Turkey and China will dominate in some part of EU imports (textile there will be plenty of niches that will be available due to geographical or other constrains (quality, tariffs etc.) In addition this scenario ensures that banks (read foreign lenders) do not loose faith in Latvian economy and somewhat can control their risk exposure and adjust it to minimize losses.
Second case – one in which our economy drops down exchange rate peg. What happens? Firstly unemployment skyrockets due to defaults of enterprises which cannot service their debts and banks do not come forward as they have suffered large losses already and they would try to fix their loss, FDI drops, mutual confidence problems between various market players etc. In this scenario the collateral damage can be addressed to low-class and middle-class residents. Thus our economy makes huge short term adjustment and ensures that there won’t be any significant foreign investments in our country for next five years. Most of the banks either go bankrupt or are given back to government (I doubt that foreign owners would invest more to cover losses by external adjustment). Eventually we become uber competitive only for what sacrifice?
Summing up we have two choices either live in stone age for 2-4 years or do it 5-10 years. We chose 2-4 years.
Hello There Mr Logical and welcome.
"What happens? Firstly unemployment skyrockets due to defaults of enterprises which cannot service their debts and banks do not come forward as they have suffered large losses already and they would try to fix their loss, FDI drops, mutual confidence problems between various market players etc."
Sorry. I think there is some misunderstanding here. This happens on both scenarios. The result is the same, with the only difference - as Krugman points out - that on the non devaluation path the people who have loans in Lat also default. This is why the Group of Ten West European banks are currently asking for a bail out from the EU for a part of ALL EU12 lending.
"Summing up we have two choices either live in stone age for 2-4 years or do it 5-10 years. We chose 2-4 years."
Sorry, you've got this wrong way round. It is the devaluation path which gives the more rapid rebound. It is the non devaluation one which leads to longer horizon recession and then very slow - Portugal style - growth.
It is now apparent - if you read the IMF staff report on the standby arrangement, on their website, that they favoured an expansion of the band to 15% (which basically means 15% devaluation) and it was the EU who objected and pushed to retain the peg. I quote directly:
The authorities and staff examined the merits of alternative exchange rate regimes. A widening of the exchange rate band to ±15 percent (as permitted under ERM2; currently Latvia has unilaterally adopted a ±1 percent band) would result in a larger initial output decline, since adverse balance sheet effects would reduce domestic demand. However, competitiveness would improve more quickly, reducing the current account deficit and fostering a more rapid economic recovery. The case for changing the parity would be stronger if it could be accompanied by immediate euro adoption. Technically, this would address many of the risks described above, and give Latvia deeper access to capital markets. With its negligible public sector debt, the government would also find it easier to borrow in euros on international capital markets. However, the EU authorities have firmly ruled out this option, given its inconsistency with the Maastricht Treaty and the precedents it would set for other potential euro area entrants.
Here's the IMF again (see Box 1 in the report). They have no doubt about which way round it is and nor do I.
I think basically the EU has made a huge policy error here, especially since I think the peg will eventually have to be abandoned, since the situation will just become inustainable for the local population. I will be writing more fully on all this soon.
The main advantage of widening the bands is that it should eventually deliver a faster economic recovery. Although growth would be depressed in the short run by balance-sheet effects (see below), the economy might then bounce back more sharply, and a Vshaped recovery would likely start in 2010. This reflects a faster improvement in competitiveness since high pass-through (reflecting Latvia’s openness to trade and liberalized movement of labor within the European Union) would be dampened by the negative output gap. Enhanced competitiveness would also reduce the current account deficit more quickly. This would come mainly from import compression, with a relatively slow response of Latvia’s underdeveloped export sector, especially as the external environment is not as supportive as in previous devaluation-induced recoveries as Argentina, Russia or East Asia.
However, balance-sheet effects would cause a sharp drop in domestic demand. The net foreign currency exposure of Latvia’s private sector is around 70 percent of GDP, with the corporate sector’s foreign currency open position roughly double that of the household sector’s. A 15 percent devaluation against the euro would increase private sector net foreign currency exposure by 11 percent of GDP, two thirds in the corporate sector and one third in the household sector. Mismatches between owners of foreign currency assets and liabilities suggest that devaluation may cause substantial redistribution effects. Private consumption would fall by around 6 percentage points due to negative wealth effect as net foreign debt increases, house prices decline, debt service costs increase, and consumer confidence deteriorates. Experience of other countries suggests that a devaluation of this magnitude would lead to a 5 percentage point decline in private sector investment.
Euroization with EU and ECB concurrence would also help address liquidity strains in
the banking system. If Latvian banks could access ECB facilities, then those that are both
solvent and hold adequate collateral could access sufficient liquidity. The increase in
confidence should dampen concerns of resident depositors and also help stem non-resident
deposit outflows.
However, this policy option would not address solvency concerns and has been ruled out by the European authorities. If combined with a large upfront devaluation, there would be an immediate deterioration in private-sector solvency, which could slow recovery. Privatesector debt restructuring would likely be necessary. Finally, the European Union strongly objects to accelerated euro adoption, as this would be inconsistent with treaty obligations of member governments, so this option is infeasible.
Incidentally,
"Following this scenario our currency uncompetitiveness is compensated by the factor of cheap labor (due to economical pressure low-class employees will be willing to work for very low wage levels - just to survive long economical winter)."
The big damger is that young people will simply back up their bags and leave, looking for work elsewhere and making the future of your country completely unsustainable. Especially given the "full resourse" mortgage credit laws which basically mean that young people with mortgages who lose their home and stay in the country have to keep paying the debt that is left after the house or flat is sold.
The IMF was most insistent that the law was changed here, otherwise it is impossible to see how these people can ever get out from under the debt, and they will have no alterantive but to emigrate.
There is quite a debate going on in Sweden at the moment, about the level of resposibility of the Swedish banking authorities for the Latvian mess.
Baltic Business News had this very interesting piece from the Swedish publication Dagens Industri.
International ratings agency Standard & Poor's noted this in the summer.
"As a result, it is the Scandinavian commercial banks rather than the regional central banks are best placed to regulate the level of monetary stimulus in the Baltic countries", said the S & P report.
So how have SEB chief Annika Falk Grenville and Swedbank Jan Lidén handled their duties as governors to Estonia, Latvia and Lithuania?
As the Baltic economies are today must be rated a resounding fail. What SEB and Swedbank are doing is direct monetary policy mismanagement. They have destabilized our neighboring countries economically and, by extension, perhaps even politically.
The sharp increase in bank lending has not gone to building a competitive business. An increasing share of lending has instead gone to fund the vast private consumption. With reckless lending, Swedish banks have contributed for Riga residents having more SUV’s per capita and higher prices per square meter of housing than in Stockholm.
Stimulus has been reviewed in austerity.
"Latvia will be the next Argentina", warns last year's economics prize winner Paul Krugman.
Like so many others failed governors have had to go, Falk Grenville and Lidén will go to the International Monetary Fund, IMF, to save out of devaluation.
Shortly before Christmas, the IMF came out with an aid package for Latvia. Together with the EU, the Nordic countries and some help with the IMF lent a total of EUR 7.5 bln. If you want to draw parallels with Argentina, one is unfortunately far from certainty that the rescue package is sufficient.
To get money, Latvia needs to implement tough austerity. It is about tax increases and expenditure cuts in the corresponding 7 percent of its GDP. Lenders require cutting wages of public employees and by extension also of private employees.
The IMF notes that wages in Latvia have increased much faster than productivity in recent years, which undermined the country's competitiveness and made the Latvian currency over-valued. Like Argentina before the currency collapse in 2002, Latvia has thus to choose between devaluation (reduced currency) and deflation (wage) in order to restore competitiveness.
The government in Riga has chosen the latter path, trying to drive down wages. The problem is that neither the devaluation nor deflation reduces the value of the debt. Another similarity with Argentina is that Latvia's own currency, song, used in parallel with a foreign currency.
SEB, Swedbank and the other banks in the Latvian market has left almost 90 percent of their household and corporate debt denominated in foreign currencies, primarily the euro.
If Latvia devaluates - that is, write up the value of the euro in relation to latency - would thus have the effect that led to the liabilities of the euro is growing by as much in relation to lead the revenue, which mostly is in local currency.
But wage cuts with the result that debt is growing in relation to earnings. As Paul Krugman describes it: "A nominal devaluation and a real depreciation achieved by means of deflation, would have exactly the same impact on debt payments (unless the debt is in the lats rather than in the euro, in which case devaluation would make minor harm)."
An important difference between Latvia and Argentina, of course, is the size. For the EU, it is much easier to keep up the value of the small Latvian currency than there was for the U.S. neighbours to save the Argentine peson.
The risk is that Frankfurt wants to stand as an example. If the ECB solves out the Baltic States, it is difficult to say no to other vulnerable members such as Greece, Spain and Italy.
For Germans, this has always been a nightmare with a single currency, it will force them to let bank-note makers roll to bail out bankrupt Member States, which is incapable of managing their own finances.
The IMF was also divided. When the decision was taken was the number who favoured devaluation as a condition for lending.
If Latvia finally goes the way of Argentina, there may also be devaluation, combined with some sort of forced conversion - from the euro to latitude - of the private sector's debts and receivables. In that case it becomes a currency loss that strikes straight into the income statements of the SEB and Swedbank.
But it is really inevitable that Sweden suffer in one way or another. If our neighbours are facing economic collapse, we have a heavy responsibility to clear up the situation. Not just for the sake of the Swedish commercial banks but of pure, blatant safety political self-interest.
In the event of a worsening economic crisis, an increasingly authoritarian and revenge desirous Russia takes the opportunity to whip up sentiments among the Russian-speaking population in Latvia. Russia's actions in Georgia in the summer should serve as a cautionary example.
Swedish taxpayers' money can be used to stabilize our neighbours, both economically and politically.
But only as an alternative. In the first instance let there be the consequences of an economic crash in the Baltics affect shareholders of SEB and Swedbank.
Then in the same publication former governor of Swedish central bank Bengt Dennis replies. Responsibility for the economic imbalances in the three Baltic countries lies with governments.
The three Baltic countries are in a deep economic crisis. According to DI columnist Gunnar Örn is the responsibility of SEB's CEO Annika Falk Gren and Swedbank CEO Jan Lidén. They should have dealt with "direct monetary policy mismanagement." In my opinion Gunnar Örn should have the spotlight on governmental responsibility for stabilization policy.
The economic imbalances in the Baltic states did not come suddenly, they originated for several years and strengthened with every passing year.
And it was topped for a long time by excessive domestic demand, which led to inflation and cost increase was violent and current account deficit unsustainable.
Competitiveness is weaker when not linked to productivity. Mistrust of the prevailing exchange rates increased. Now is an inevitable shift of policy in all countries, most clearly demonstrated by the IMF-led rescue operation for Latvia.
Warning signs were missing, but not met with silence or - as in Latvia, when the crisis became clearer - with threats and attacks by the critics.
What would have been? Central banks can’t do much because of the prevailing exchange rate regimes. The ability to switch to a more flexible currency system wasn’t in their entry to ERM. Then there was a golden opportunity to move to the broad band that is within the ERM, namely fluctuations up or down to 15 percent. Instead, countries chose to stick to the old system that did not allow any movement at all for the exchange rate - and in Latvia's case, the extremely limited movement up or down at 1 percent.
When central banks can not act - given the exchange rate system in force - is the responsibility of fiscal policy, that is, governments and parliaments. But nothing or very little was done. As recently as last year was expansionary fiscal policy in Latvia. Domestic demand continued to be strong to the end. What happened in the Baltic region is closest to the textbook in nature.
The demand came in the way that was increasing the demand for credit including stimulation by expectation of ever-rising asset prices. Demand for credit was strong and the banks were willing to keep it up. Then the total credit flow was so large it can not be blamed for individual banks.
Banks, regardless of national origin, can not sit in place and operate state stabilization policy. In many countries, attempts have been made to rein in credit expansion through so-called voluntary agreements, admonitions and various kinds of pressure on banks. The outcome is always a magnificent flop.
The market is innovative and strong competition among banks. A collective responsibility is impossible. The general experience, also from Sweden in the early 1990s, by the way affect the credit expansion, that is, from the supply side, is failures. Credit flow must be affected by the demand side - and it was not in the Baltics.
Have banks made any mistakes? They could have realized earlier that the loans would be significant losses. They could probably have done much to curb lending in foreign currency, in any case in Latvia which had not the currency board.
Gunnar Örn is also criticizing "that bank lending has not gone to building a competitive business." The political objective of the business direct control bank lending to certain specified purposes by the State had called another economic-political system, far removed from what these countries have created and consistently worked for since liberation from the planned economy in the Soviet era.
However, a balanced taxation certainly dampened lending to property sector. My conclusion is that banks in general were too generous in their credit rating, which now is punishing. This year and next year, banks will account for huge losses in its Baltic lending, much greater than has so far emerged and suggested. The ultimate responsibility for the economic imbalances - and the total credit flow - is, however, of the governments that did not keep back domestic demand.
Finally, this is a much more general problem than Latvia, and the FT had a piece about the Group Of Ten Banks who want a collective bail out initiative from the EU Commission, or national governments to help them in the East. This is really the only way for them to go, and there needs to be a large scale "debt restructuring".
Banks ask for crisis funds for E Europe
By Stefan Wagstyl in Vienna
Published: January 21 2009 23:36 | Last updated: January 22 2009 09:52
Leading international banks operating in central and eastern Europe have clubbed together to lobby the European Union and the European Central Bank to extend their anti-crisis policies to ease the credit crunch in the region.
The group of ten, which wants action to ease liquidity shortages and help revive lending, is urging Brussels and the ECB to extend support beyond the EU's new member states, such as Poland, to prospective members, such as Serbia, and to Ukraine, which has few prospects of joining the bloc soon.
Herbert Stepic, chief executive of Raiffeisen International, the Austrian bank, who brought the group together, said it was important that any action to support banks was not limited to western Europe.
"We fought for 50 years, many of us, to get these countries away from communism and now we have a free market economy in the region, we can't leave them alone when there is an extremely harsh wind blowing," he said.
The group has kept a low profile until now, but Mr Stepic told the Financial Times he was speaking out "because of the deteriorating economic circumstances".
He said the costs of possible support would be "relatively" modest in comparison with the huge sums pledged to assist western European banks. The total gross domestic product of formerly communist central Europe was €740bn and for south-east Europe €270bn. This compared with €290bn for Austria alone.
His remarks come amid a week of fresh turmoil in the financial markets and a darkening economic outlook. The European Commission released a forecast of a 1.8 per cent decline in EU economic output for 2009, its gloomiest prediction in years, while Moody's, the credit ratings agency, on Wednesday said the outlook for the Ukrainian banking system was negative.
EU institutions have already played a role in the emergency financial packages assembled by the International Monetary Fund in the region. The ECB has extended liquidity support to Hungary and the EU is contributing to Latvia's bail-out. The ECB has also extended liquidity support to Poland, where the IMF has not been involved.
But the international banks want Brussels and the ECB to make clear that they stand ready to assist vulnerable non-EU members. Mr Stepic declined to specify which countries might need such support but bankers said they could include those with high external financing needs, including Serbia and Bosnia, as well as Ukraine.
As well as Raiffeisen, the banks involved are Italy's Unicredit and Intesa Sanpaolo, Austria's Erste Bank, Société Générale from France, Belgium's KBC, German Bayern Landesbank, Sweden's Swedbank and SEB and EFG Eurobank from Greece.
Common problem with most economic theories are that they are derived for economies with long history. Latvia has less than 20 year history. Our economy being the underdeveloped and weak maybe need to follow a bit different type of rules.
Lets assume that we would not be having crediting boom and Scandinavian banks would not enter this market. Where we would be? Would have same comfort level as now? .....
My main point was - if we devalue currency we can speculate of outcomes regarding competitiveness and export to other markets etc. But one thing is for sure in case of devaluation, we would need to finance ourselves for quite long period of time, when confidence of foreign investors return. But would we able to do it? Of course not, as we are on verge of bankruptcy.
And I highly doubt that in case of devaluation it would be V type of recovery. As lack of funds would not allow us to build new plants, improve infrastructure etc.
Maybe I am not economics expert, however I see logic behind exchange rates as follows. If two economies are pegged with exchange rates, then beneficiary from that is the weakest economy. Because strongest economy's exchange rate in case of free float would appreciate - thus foreign goods would become expensive for us. However peg keeps them rather cheap for us and we are able to develop much faster due to that and availability of foreign funds.
If we devalue, then we become more close business model to turkey or other cheap labor countries, but in my option, bearing in mind intellectual capacity of our country I do not think that this is model to follow.
To sum up, I am proponent of Latvia as technologically developed country with export products of high value added. (IT, specialized manufacturing etc.) We need to forget about textile and similar industries, it is just not for us.
Hi again Mr Logical,
"But one thing is for sure in case of devaluation, we would need to finance ourselves for quite long period of time, when confidence of foreign investors return."
No. Its not like that. If you devalued and restructured private debt as part of an IMF programme with support from the EU and the ECB then confidence could return quite quickly, since all the bad news would be over in one clout.
This way the crisis of confidence can drag out for years, since why the hell would anyone in their right mind invest in Latvia now, better to go to Poland (or eventually, when things steady up) in Ukraine.
You are simply way too expensive for anyone to take seriously, there are no possibilities for exports, and there is only going to be internal contraction. Where is the interest here?
Basically it is devaluation which can facilitate FDI, but not the stupid construction and financial services/real estate FDI you had before (or the lets buy the telephone company kind) but real greenfield FDI to build new factories for exporting. With the right kind of mix of structural reforms and devaluation there is really no reason why you can't become quite attractive quite quickly.
Of course you would need to attract migrant workers to come in and work in the factories, but that would help your population problem in the short term, and give your government revenue to support those young women who want to have children to help address the long term fertility crisis. This is all so obviously incredibly win win that I can't for the life of me see why everyone keeps saying No, No, No.
"If two economies are pegged with exchange rates, then beneficiary from that is the weakest economy."
No. I don't agree. Wrong even. Look at Southern Europe and Germany. The beneficiary has been Germany, and the South of Europe has simply gotten into debt debt and more debt as the factories close and close due to the overheating and the excess inflation.
Unfortunately not everything in this world is what it appears to be, which is why we sometimes need science. Or does the sun really go round the earth?
"We need to forget about textile and similar industries, it is just not for us."
Well I'm sorry to have to remind you that there is an old English saying, "beggars can't be choosers", and Latvia is actually out with the begging bowl right now.
Get those textile factories built, and get recruiting migrants to work on the shop floor! Plenty of work for Latvians in the offices and sales departments (eg).
If not it is Latvian migrants who will go and work in the new textile factories they will now build in Ireland. Is that really what you want?
Oh, incidentally, apart from dropping wages substantially (they cannot devalue), Ireland will certainly have to"restructure" and default on something, but you just watch the FDI flood in after they are done.
I agree with you that there is no point for FDI in finance sector and construction/real estate one.
However saying that after devaluation private debt would be restructured with help of IMF and EU is very populist opinion. Devaluation = bank ownership to government. Because 1) already it is expected that there will be 30-50% bad credits 2) after devaluation they will be up to 80%. What is the point of keeping those banks? If you can promise that those 80% of bad assets will be forgotten and noone will ask them back (or IMF & EU will repay them instead of Latvia), then I go for your choice of devaluation.
Now lets think, if we would want to purchase some factory equipment, then it costs much cheaper in peg system for us (if our beggar economy is well financed from abroad), because we are weak economy. In case we would not be pegged, we would still use all those soviet time manufacturing units, best PC hardware available for mainstream now would be Pentium 3 etc. Fixed regime (and foreign financing) in Latvia case keeps us using more advance things than we would have in case of floating system. In medium run hopefully this advancement will be sustainable.
Textile is just wrong here - Turkey, Greece, China for that (even Poland). Niche manufacturing is way to go (producing specific parts for larger assemblies for example in Germany). Medicine (pharamacy). etc. There are many examples.
Why the hell someone would invest here now? Answer is easy, noone will invest in cheap labor industries here (textile, low value woodworking etc.), but there are pleanty of investors for IT, food, pharma, and niche value added manufacturing. As well as I want to mention that in terms of EU (geographical & intra EU support system) we are very competitive even in specific low cost industries.
If labor from low skill industries, do not want to refocus towards more qualified industry or is not willing to work for appropriate salary, then they are free to leave (free workforce movement). Other will come here and substitute them. By the end of the day there have not been cases in Europe and wont be that everyone leaves country and never comes back, even our population might shrink a bit it might be for better?
ah and one more thing :)
I dont remember who said that but:
"In the end of the day resources are in those hands which use them the most effective way" or smth like that
Hello again Mr Logical,
Thanks for all the comments. I will come back later. But in the meantime, well look:
Risk aversion remains heightened around the world and so the US dollar is getting stronger, which usually keeps European EM currencies under depreciation pressure. This is clearly reflected by today's exchange rate movements. The region's currencies suffered serious blows already in morning trade and Hungary's forint slumped to a new all-time low, hitting 290 to the euro. The CZK kicked off Friday's session at a 1.5-year low and Poland's zloty started at a 4.5-yr low versus the euro.
You're going to get squeezed dry as a lemon here if you are not very very careful. As Esonia's PM said yesterday, Polish food is already arriving in Lithuania, soon it will be in Latvia and Estonia.
I know that ECB does not like lemons :) so I expect rate cuts from them
As well I can expect rate increases for other economies (PL, HU etc.), because falling exchange rates might increase inflation.... aswell there is tradeoff between falling imports (intra country consumption down) and rising exports... (HU, PL case)
Latvian exports were down 19.7%, but this is only one fact. The crisis in all, and the Latvian bureaucracy kill the economy.
There is so much discussion about devaluation in your blog. Any suggestion on how Lithuania can revive its banking sector?
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