OUTLOOK 2014: Politics to spice up the Baltics

By bne IntelliNews December 20, 2013

Mike Collier in Riga -

What was looking to be a rather quiet year in the Baltics is showing signs of turning into something a bit more interesting - politically more than economically perhaps. However, with business and politics never far from one another in this particular corner of Europe, investors would be well advised to keep a weather eye on the wheeling and dealing in the parliaments and presidencies of Estonia, Latvia and Lithuania even more than on the modestly-sized stock markets.

"In the Baltic states, crisis economics is long gone, and standard business cycle issues are back," says Swedbank. "Exports and investments will gain from the global recovery, and growth is seen at about 4% in 2014-2015. Perhaps somewhat slower growth for Estonia in 2014 as it struggles with very weak growth this year. The key challenge for the three Baltic states is to balance wage and productivity growth."

Latvian progress at risk of collapse

Until the end of November, Latvia was sailing towards a triumphant entry to the Eurozone, which would usher in further economic growth. The country boasted fastest-growing economy in the EU for a third successive year in 2013. Prime Minister Valdis Dombrovskis would waltz his way through parliamentary elections in October 2014 to extend his tenure as the country's longest serving non-dictator.

That all changed on November 21 when the roof of a Maxima supermarket collapsed in Riga, killing 54 and leading to the resignation of the PM a week later. The shocks plunged the country into political chaos.

Heading towards the end of the year, weeks of negotiations have failed to come up with a replacement. Whoever does eventually get the job will be able to do no more than oversee administrative duties until the scheduled election at best. At worst, next year will be characterised by nine months of jockeying for position, which would likely stymie efforts on structural reforms and corruption.

However, Nordea's chief economist for Latvia, Andris Strazds, remains optimistic about the country's path in 2014. "Export growth should increase by a few percentage points," he says. "Several amendments in taxation policy will enter into force next year and increase the income of households, consequently raising consumption. As private individuals mostly do not tend to accumulate savings in Latvia, it can be expected that almost all additional income will be directed into additional consumption... a "fat year" can be expected."

Thanks to that, "inflation is due to return to Latvia next year," Strazds forecasts. "However, taking into account the very low average price increase in the Euro area, it is hard to imagine that inflation in Latvia could exceed 2%, even if the expected liberalisation of the electricity market for households is included,"

One thing to keep an eye out for is a possible major deal on rare earth metals (REMs). Estonia is already a major REM player and a very highly-placed source suggests to bne that Latvian deposits may be revealed in the not too distant future, with backing from North American investors.

Lithuania prepares to board the euro

The common opinion is that Lithuania did a pretty good job in its role holding the presidency of the European Union in the second half of 2014. However, with typically Baltic irony, the centrepiece Vilnius summit in November will be remembered only for the failure to obtain Ukraine's signature on an association agreement, thus kicking off the ensuing strife in Kyiv.

Still smarting from that disappointment, Lithuania will have to rouse its euro-enthusiasm once more in 2014 as it prepares to become the final piece of the single currency jigsaw in the Baltics. The country has targeted euro accession on January 1, 2015, meaning a sharp eye will remain on fiscal indicators throughout the coming year.

In essence, Lithuania will need to copy what Latvia did in 2013 (and Estonia in 2010), keep a lid on inflation and retain tight control of spending and deficit levels. Perhaps most challenging of all however will be generating at least majority support for the currency switch among an apathetic population.

The central bank says increasing domestic demand growth, fuelled by growing incomes, is set to continue in 2014, albeit at a slightly reduced rate. "Next year private consumption should not grow as much as it is increasing this year, because changes in minimum wage are not expected," the Bank of Lithuania says in its 2014 preview. That forecasts GDP growth of 3.5% and unemployment finally dropping below double figures.

Incumbent, Dalia Grybauskaite looks a shoo-in at the presidential election in May, but the weeks leading up to the vote are likely to see the revival of mud-slinging at the formidable head of state in the Russian-language press. Quite what the Russians claim to have in their files about the peroxide topped president has never been fully revealed, and while it seemed disclosure might come in the run-up to the Vilnius summit, the Russians chose to keep their powder dry for another day.

All quiet on the Estonian front

The coming year is likely to be a fairly quiet one for Estonia. However, that will be of immense satisfaction to the stability-loving Estonians who regard themselves, with some justification, as the Scandinavians of the Baltics.

There are no major elections scheduled (unless you include the European elections on May 25) which will come as a great relief to Prime Minister Andrus Ansip and his allies, who took a bit of a pasting in October 2013 local elections. However, the 2014 budget predicts a slight deficit in this surplus-loving country, as Ansip seeks to spend some cash to win back support ahead of the next parliamentary elections in March 2015.

"In our baseline scenario, we expect economic growth to gradually pick up to around 4% in the medium term with the recovery of foreign demand and investments," says Swedbank. "The main risk to the economy stems from the labour market, as wages are growing much faster than productivity, driving up unit labour costs and prices."

That sounds familiar, with much of the "Baltic tiger" hysteria of the mid-2000s fuelled by wages spiralling out of control. But Estonia wouldn't be dumb enough to fall into that trap again - would it?

Estonia will continue to push hard for progress on the Rail Baltica project, which would ultimately see a modern rail connection all the way from Warsaw to Helsinki. Of all the Baltic states, Estonia has the most to gain from the project, but progress is likely to be slow as Lithuania (which is likely to benefit least) drags its feet. Repeated assurances that a joint stock company to handle the scheme would be formed by the end of 2013 have turned out to be as solid as the mist rolling in from the Baltic sea, and are spookily reminiscent of that other great joint infrastructure project that never seems to get anywhere, the now near-mythical Visaginas nuclear power plant.

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