Baltics hope for best, pray worst doesn’t happen

By bne IntelliNews December 19, 2014

Mike Collier in Riga -


As neighbours and the stage on which Russia's conflict with, well, pretty much everyone is played out in a Phoney War way with Russian planes and ships buzzing the borders, the Baltic states will find their 'upside' scenarios in 2015 to be modest and the 'downsides' to be potentially terrifying.

While the mutual sanctions between Russia and the EU have hit certain sectors such as dairy farmers and logistics hard, they have not produced the complete meltdown some were predicting. And there are signs that the crisis could have had the positive side effect of forcing exporters to seek out new markets, particularly in China.

According to Danske Bank's Baltic analyst, Rokas Grajauskas, “Domestic demand will be the key driver of economic growth in all three Baltic states in 2015-2016.”

“Despite China’s impressive economic growth over the previous decade, export shares to China have remained close to zero. Great export potential remains untapped not only in China but in other major growing markets, such as South East Asia, India or the MENA countries [Middle East and North Africa].”

In 2015, Danske expects growth figures for the Baltic trio of 2.3% (Estonia), 2.7% (Lithuania) and 2.9% (Latvia) in 2015, while Swedbank opts for 2.5% (Estonia), 3.3% (Lithuania) and 2.6% (Latvia).


While some were trumpeting the fact that Lithuania overtook Estonia in terms of GDP per capita during 2014, the fact isn't quite as significant as it seems, because it is based partially on the fact that far more Lithuanians than Estonians have left their homeland to find work abroad.

Nevertheless, Estonia is no longer quite the poster child of CEE it once was. “After impressive growth in 2010-2011, exports slowed down dramatically in 2013-2014, mainly due to faltering demand in the main export markets – Finland, Sweden and Russia,” says Danske Bank.

What Estonia does retain is a fundamentally stronger fiscal position than its neighbours that will help it weather the next crisis, just as its reserves helped cope with the last one. The European Commission's Fiscal Compact requires structural deficits to be kept below 1% in countries where the debt/GDP level is significantly below 60%. Only Estonia will meet this requirement in 2014 and 2015.

Parliamentary elections in early March are likely to change little with the current alliance of the Reform Party and the Social Democrats forming the core of the next government under the incumbent Prime Minister Taavi Roivas.


At the conclusion of its latest staff visit on December 5, the International Monetary Fund (IMF) characterised Latvia's medium-term outlook as “favourable provided geopolitical tensions subside and the euro area emerges from its prolonged weakness” and predicted GDP growth of “below 3%.”

As and when the mothballed Liepajas Metalurgs steelworks resumes production under the new ownership of Ukrainian scrap metal dealers (at time of writing the deal still has not been signed), that will help boost GDP.

There's also the question of how much money will leave Russia if the crisis continues and if so, how much of it will head into the Russia-friendly Latvian banking system, where it could potentially cause an imbalance on balance sheets. “The banking system is sound and liquid. But non-resident deposits – which account for about half of all deposits in the banking system – should continue to be subject to vigilant supervision, especially in light of ongoing regional tensions,” the IMF advised.


Lithuania should be the most upbeat of the Baltic trio in 2015. The year begins with a bang on January 1 when it adopts the euro, which quite apart from its symbolic significance makes the idea of a single Baltic market a lot more realistic than hitherto.

And having seen both Estonia and Latvia make a success of the single currency, plus a low-inflation environment throughout the Eurozone, the expected worries about instant price hikes have largely failed to materialise. “The Russian embargo on European food products will weigh heavily on Lithuanian exports to Russia in Q4 14 and into 2015; total Lithuanian exports in 2014 are set to contract for the first time since 2009,” says Danske Bank.

“Due to strong domestic demand and external competitiveness, Lithuania has the highest trend growth among the Baltics over the medium-term horizon... Lithuania is the last among the Baltic states to close the output gap. The Lithuanian economy is set to expand slightly more than its potential in 2015-2016,” Danske believes.

Meanwhile Swedbank points to several factors suggesting the phenomenon of the “Baltic Tigers” may never return. “As to the Baltics, there are structural reasons for growth to slow permanently. Populations are shrinking and aging, and employment will start to fall. Labour costs will only rise. Capital stock and total factor productivity are thus the sources to rely on going forward. Yet, investment has been insufficient. R&D activity is low, but it is key for innovation and productivity growth,” Swedbank says.

“Convergence has been spectacular so far. Latvian average labour productivity is now at 65% of the EU average, compared with just 47% in 2004. Estonian and Lithuanian productivity levels are even higher. But with the gap narrowing, convergence tends to slow. The European Commission now estimates that the potential speed of growth in the Baltics is about 2.5%. We are more optimistic and expect it to be around 3-3.5%. Yet, this is below the last decade’s averages of above 4% for all three countries,” the bank says.

Politically it should be a fairly quiet year. In addition to the Estonian elections there will be a new Latvian president in June, but the position lacks real power and attempts to introduce a directly-elected president instead of one chosen in a secret parliamentary ballot look like they will not make it onto the statute books any time soon.

The one major political event will be the Riga Eastern Partnership Conference at the end of May. The result is likely to be the abandonment of the EU’s now largely discredited Eastern Partnership programme in all but name (like Russia, the EU never admits failure), and its replacement with six individual partnership plans for the states in question: Belarus, Georgia, Moldova, Armenia, Azerbaijan and Ukraine.

Yet again, quite what form those plans take will depend upon events in Russia and Ukraine: there is no way the EU will want to enclose more frozen conflicts (Donbas, Transdniester, Abkhazia, South Ossetia) within its borders any time soon. Most likely the outcome will be more treading of water by all concerned.


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