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Saturday, September 29, 2007

Second Homes Face Price Fall

The Financial Times has a very important article today.

According to Michael Ball, a professor of real estate at Reading university and a housing adviser to the UK government. Second home owners in the Mediterranean and eastern Europe face a property correction because of the credit crisis. I thoroughly agree with this diagnosis. In Spain, where I live, I am absolutely convinced of this, my only query is whether the crrection will happen dramatically over one or two years, or more slowly over 5 years or so, as happened in Germany after the 1995/96 boom.

I imagine Eastern Europe may have regions which are similarly exposed (the Black Sea coast etc). Ball says holiday homes in many parts of the European continent are vulnerable. Not only have prices risen fast amid speculative interest and easy availability of credit but the supply of new flats has also been increasing at a prolific rate. Ball pinpointed the Mediterranean and central and eastern Europe in a speech to the Investment Property Forum given on Thursday night.

There are a variety of reasons in that in both of those areas, credit has been used and people have been very optimistic about long-term values....There has been a boom, the market has been driven by foreign investors, and now that is beginning to turn."

He specifically cited the Estonian case, where house prices had dropped by an estimated 10 per cent in the past 12 months. "That will probably trickle through to other countries." he said.

As the FT point out these warnings come amid widespread price falls in the second home markets of Florida, where some resorts have seen double-digit drops in the past year. The number of home sales in Florida dropped 43 per cent between the first and second quarters.

Friday, September 28, 2007

Czech Central Bank Maintains Interest rate

The Czech central bank kept its benchmark interest rate unchanged at the lowest level in the European Union's lowest level yesterday, after perviously raising it three times this year, citing in justification for the decision the stronger koruna and increased global borrowing costs.

At the close of the meeting, the Board decided to leave the CNB two-week repo rate unchanged at 3.25 %. All six board members present voted in favour of this decision.

Key Czech Economic Indicators

Price indicators:

- annual industrial producer price inflation in August (3.7 %)
- annual agricultural producer price inflation in August (15.6 %)

Leading indicators of growth:

- annual growth in retail sales in July (8.9 %)
- annual growth in industrial production in July (11.5 %)
- annual growth in construction production in July (-1.7 %)

External balance:

- trade balance in July (CZK -0.7 billion)

According the the bank press conference presentation:

The risks of headline inflation forecast are on the upside, risks of monetary-policy relevant inflation forecast are on the contrary on the downside.

Major risks and uncertainties:

- tax changes and faster expected growth of regulated prices
- faster then expected growth of food prices
- drop in market expectations of 1Y Euribor rate
- stronger koruna exchange rate against the euro
- lower August inflation and in particular adjusted inflation excl. fuels
- extent of fiscal restriction in 2008

Bank Governor Zdenek Tuma indicated at the press conference that the bank may reduce its forecast for future interest rates next month. Policy makers have previously said more increases are needed through 2008 to combat the effect of rising domestic demand and excise taxes. The koruna, which rose 2.1 percent against the euro in the past seven weeks, and the rising cost of credit, may have eased that concern.

``The koruna has been stronger than we anticipated in the latest forecast'' in July, Tuma said. ``There is a great question-mark'' over the impact of the global market turbulence on economic growth, inflation and monetary policy, which ``will be a subject to study'' in the next few months.

He also suggested that inflation adjusted for one-time effects is more likely to undershoot July's forecasts than exceed them, even as the headline inflation rate may rise higher than estimated.

The inflation rate rose to 2.4 percent in August from 2.3 percent in July, 0.2 percentage point below the central bank's forecast for that month.

"The monetary-policy inflation is what we react to directly...it is below our forecast ....Were we to evaluate that the secondary effects of tax and regulated-price changes..... we feel that will not be too significant, and that could theoretically lead to a somewhat lower interest rate trajectory"

Still, the central bank sees ``upside risks'' to its quarterly inflation forecast from rising taxes and regulated costs as well as from a larger-than-assumed jump in food prices.

The banker also expects an upward ``correction'' of inflation by the end of the year in the order of fractions of a percentage point after the impact of a new methodology on measuring inflation introduced this year led to unexpectedly slow price growth.

A reduced outlook for interest rates in the euro region, being one of the most marked effects of the turmoil on global markets, is also a risk to the bank's inflation prediction, according to the central bank chief.

The government's fiscal policy next year, which will be reflected in the October inflation prediction, may be more restrictive than expected, Tuma said.

The koruna has been the best performing emerging-market currency against the euro in the third quarter, reversing a trend from the first half when it lost 4.1 percent. It was trading at 27.595 to the euro as of 5:06 p.m. in Prague, compared with 27.620 yesterday.

The currency's gains cap inflation by making imports cheaper and undermining export revenue. The koruna is used for so-called carry trades when investors buy higher-yielding assets using loans taken out in currencies with low interest rates. With the recent aversion to risk on global credit markets, investors unwound those trades, buying back the koruna.

Thursday, September 27, 2007

World Bank Report on Labour Shortages in the EU10

The European Union's 10 eastern members must take concerted action to increase employment participation levels to avoid a serious short-term slowdown in economic growth and important supply-side structural problems in the longer term according to a report published today by the World Bank.

"Addressing the emerging skills shortages is particularly important, because failure to do so will constrain job creation and future economic growth"

You can find the report summarized here, or you can download direct here.

Claus and I will prepare a full summary and review over the weekend, but for now here are some revealing extracts.

The report in fact says the following:

In this atmosphere of short term turbulence it is important not to lose sight of the longer term trends and the fundamental challenges the EU8+2 continue to face. With the exception of Hungary, growth remains high throughout the EU8+2 and in the case of Latvia represents serious overheating. This growth is sustained largely by consumption and investment. With tightening labor markets, large increases in real wages and employment and very rapid credit expansion, a moderate slowdown in growth may in fact be desirable in the countries showing signs of overheating.

They also have this to say, which is IMHO very important, and to the point:

Unemployment has fallen substantially in virtually all EU8+2 countries since 2004 due to strong growth in labor demand. This has given rise to skill shortages and associated wage pressures, often amplified by out-migration of EU8+2 workers. However, employment/working age population ratios remain relatively low.

Really this is the very point that Claus and I have been making. They then continue:

In contrast to the earlier period of weak labor demand it is now the supply side of the labor market that constrains new job creation. Many persons of working age are economically inactive in EU8+2 either because they lack skills demanded by employers, or because of labor supply disincentives, such as early retirement benefits, generous disability schemes, high payroll taxes, and limited opportunities for flexible work arrangements. These effects are concentrated among the younger and older workers, while the participation rates for middle aged workers are similar to those of the EU15. Hence the main challenge facing now EU8+2 is to mobilize labor supply to meet the demand. Addressing the emerging skills shortages is particularly important, because failure to do so will constrain job creation and future economic growth. To increase the effective labor supply EU8+2 countries need to: (a) improve labor supply incentives through reforming the social security systems, (b) improve worker skills through reforming the educational systems and improving domestic mobility; and (c) import labor with skills that are in short supply by opening labor markets to foreign workers. The weights assigned to each policy depend on the nature of the most binding constraint to labor supply, which vary across countries.

also this is very important, even if I am nowhere near as optimistic as the World Bank is about the possibilities of Eastern Europe staying out of the firing line, especially as the eurozone itself is slowing fast.

The effects of deepening financial turbulence would potentially be more serious for the EU8+2, but are more difficult to predict. The greatest risk is that the countries that have large current account deficits – the Baltics, Romania and Bulgaria – are suddenly less able to finance them through capital inflows and are forced into an economic contraction. This is particularly true for countries like Hungary that are highly dependent on more volatile portfolio inflows than on FDI. Banking sector foreign borrowing which is the main financing source in the Baltics is generally less volatile than portfolio flows, but the extreme surge in the Latvian CAD (to 30% of GDP in the 12 months to end July ) clearly cannot be financed in this way in a sustained manner. There are other potential risks as well. A general retreat from mortgage lending provoked by US experience would lead to broad based credit tightening and weaken the booming construction sector in the EU8+2. Moreover, the increased risk sensitivity may cause the unwinding of carry trades making external finance more difficult for higher interest, carry trade destination countries.


In the latest quarters unemployment rates have either continued to fall or have remained fairly stable despite upward seasonal pressures. In several countries unemployment rates declined to historical minima (the Baltic States, the Czech Republic, and Poland). Employment rates in Latvia, and also in Estonia reached the highest levels since the start of transition and are around 68% for people aged between 15 and 64 years, which is close to the Lisbon strategy target of 70%. Nevertheless, further employment increases may be limited because of structural nature of joblessness due to skills mismatches and unwillingness to relocate or retrain, which is particularly relevant for those who stayed out of the labor market longer.

The recent trends have undoubtedly strengthened the power of employees in the wage bargaining process. Real wages have begun to grow rapidly in Poland where their expansion had been moderate so far. The highest growth is occurring in sectors which suffer most from shortages of workers (for example, construction). Rising employment and strong dynamics of real wages are pushing the growth of the wage bill into double digits. Nevertheless, demands of higher wages for public sector employees come into sight in most countries in the region. In Bulgaria and Poland, trade unions are prepared to resort to strikes or the threat of strikes in wage setting negotiations.

In all countries apart from Slovakia and Slovenia, wages are growing faster than labor productivity. Rising unit labor costs provoke central bankers in the region to tighten monetary policies (Poland and the Czech Republic). Apart from inflationary pressures, excessive ULC growth may undermine competitiveness and prospects for sustained long-term output growth and further labor market improvement.

Hansapank Announces Lithuania Portfolio Diversification

AS Hansapank, effectively the biggest Baltic lender, has announced that it is going to diversify its credit portfolio in Lithuania.

Hansapank, which is owned by Stockholm-based Swedbank AB, will ``at some point'' have to set credit growth restrictions in Lithuania, the biggest of the three Baltic countries, Chief Executive Officer Erkki Raasuke said in an interview in Tallinn yesterday (reported by Bloomberg here). According to Raasuke the only reason Hansapank haf not previously done this was because Lithuania's problems have been longer in coming than those in Latvia and Estonia.

"We don't have any signs or confidence at this point that in Lithuania we would avoid the need for credit restrictions, but we would do it differently there" Raasuke said. "Instead of setting internal limits for absolute credit growth, we should rather set targets on diversifying the credit portfolio. These are the steps we didn't take in Estonia and Latvia."

Hansapank predicted in April that Baltic loan growth will slow to around 35 percent this year from 59 percent last year, helped by lending restrictions it set to lower credit growth to more sustainable levels.

Raasuke did however admit that Hansapank could have acted earlier to cool loan growth in the light of its own forecasts in the second half of 2006.

``We were probably talking more and doing less, there was kind of a frozen state,'' Raasuke said. ``But we are only a part of the market and it seemed that the critical mass was achieved only in February-March so that all market players could start moving in the same direction.''

In April, Hansapank's Estonian unit raised the minimum monthly income requirement for granting a mortgage to 7,000 krooni ($607) from 5,000 krooni, compared with the average gross monthly salary of 11,549 krooni in the second quarter.

Raasuke also said that it was obvious from Hansapank's business that lending behavior had changed within the last four to five months in Latvia and Estonia, and cited a "clear decline" in new loans, compared with peak monthly levels and the average levels of the last three to four years.

Raasuke also said that the recent decline in consumer confidence in the Baltics was not affecting the peoples confidence in the banks, since the Baltic market is small compared with the size of the banking groups involved. (Estonian consumer confidence fell during August to its lowest level in almost two years because of worsening expectations about household and state finances).

Estonian investment gold seller AS Tavid is reported to have tripled its weekly sales to about 60 kilograms in recent months, according to the newspaper the Postimees yesterday, and the paper also cites reports that people are increasingly converting their bank deposits from krooni into foreign currency.

Raasuke however was confident that there was no `"big" risk of a Baltic property sector collapse as the problems of oversupply are only affecting residential property business, with demand expected to remain strong for commercial property and especially civil engineering.

Raasuke is undoubtedly right to point out that the Baltic States for only a small part of their total business, but it is also true to say that the US sub-prime liabilities of many European banks were also only a small part of their total portfolio, and look what a mess that has caused. So I think we need to be rather careful before reaching any strong conclusions here.

Wednesday, September 26, 2007

Romanian Central Bank Leaves Interest Rates Unchanged

Romania's central bank today left its key interest rate unchanged, after cutting it four times in previous meetings. The decision was taken as a the effects of an extensive drought and a weaker leu threaten to add to pre-existing inflationary pressures.

The National Bank of Romania decided to leave its Monetary Policy Rate at 7 percent at a board meeting in Bucharest today. According to the press statement

"The short-term inflation outlook has worsened due to a prolonged impact of drought on food prices and the evolution of the leu exchange rate, given the difficulty of assessing the duration and effects of the recent world financial market turbulences..

The analysis of recent trends in macroeconomic indicators reveals a slowdown of the disinflation process and of the economic growth mainly due to supply-side factors (the impact of a prolonged drought on the farming sector) but also attributable to persistent domestic demand pressures. These pressures are also highlighted by the widening external imbalance.

Year-on-year inflation climbed to 4.96 percent in August, close to the upper limit of this year's target band, due to a significant increase of food prices and a correction of the leu's exchange rate against the background of recent turbulences on the world financial markets.

Wage dynamics have accelerated well above productivity growth, emphasizing the risks of deteriorating external competitiveness and of labour cost-related inflationary pressures. "

A drought that damaged two-thirds of Romania's crops this year hus pushed up food prices and a weakening of the leu during this month is making imports more expensive. The government also plans to increase spending, moving an eight-month budget surplus earlier this year into a full-year deficit of 2 percent of gross domestic product.

Romania's annual inflation rate rose to 5 percent in August, reaching the upper limit of the central bank's year-end annual inflation target of 4 percent, plus or minus a percentage point.

A weaker leu since mid-August has helped raise the prices of goods and services indexed to the dollar or the euro, including rents, telephone bills and gasoline. The leu has continued it's decline in September, bringing its loss against the euro since Aug. 1 to 6.6 percent and its drop against the dollar to 3.5 percent.

The International Monetary Fund warned last week that Romania's widening current-account gap makes the economy and the currency more vulnerable to external issues such as international investors' reluctance to place money in emerging markets amid the U.S. subprime crisis.

The current-account deficit widened to a record 9 billion euros ($12.6 billion) in the first seven months of this year from 4.9 billion euros in the same period last year as imports rose because of the stronger leu and the scrapping of many trade barriers when Romania joined the EU.

Polish Central Bank Leaves Interest Rates Unchanged

The Polish central bank kept its benchmark interest rate unchanged, following three increases this year, stating that it is awaiting more evidence on whether or not inflation is under adequate control.

The Warsaw-based Monetary Policy Council left the seven-day reference rate at 4.75 percent today, following a quarter-point increase last month.

The central bank raised borrowing costs after inflation reached its medium-term target of 2.5 percent in March and exceeded it in June. The annual rate fell to 1.5 percent in August and the zloty has gained 1.3 percent as compared to the euro during September.

Poland's economy expanded an annual 7.4 percent in the first three months of the year and 6.7 percent in the second quarter.

The Polish unemployment rate fell in August to an eight-year low of 12 percent, while average corporate wages rose 10.5 percent in August from a year ago, the fastest pace in almost eight years.

The zloty traded at 3.779 per euro at 1:10 p.m., unchanged after the rate decision and from yesterday. The yield on the government's five-year bond was also unchanged at 5.582 percent.

Monday, September 24, 2007

Hungarian Central Bank Cuts Interest Rate

Hungary's central bank have just cut their benchmark interest rate for a second time this year. The rate-setting Monetary Council, led by bank President Andras Simor, cut the two-week deposit rate by a quarter of a percentage point to 7.5 percent after having left it unchanged since June.

Hungarian inflation, which is the European Union's second-fastest after Latvia, has slowed ever so slightly of late, after reaching a six-year high in March. In fact the annual inflation rate fell to 8.3 percent in August from 8.4 percent the month before, reaching the lowest level since January 2007. The central bank last month said it expects the pace of price increases to slow further.The Banks is rather caught at the moment in a deep sea between the rock of falling domestic demand and the hard place of having 80% of the outstanding mortgages in swiss francs, and thus needing to defend the forint. Stubborn inflation would occuply the middle ground in this panorama. According to the Bank press statement:

"Our 3 percent inflation target is attainable in 2009, if the increase in agricultural, food and energy prices doesn't lead to second-round effects... the bank....expects inflation to gradually moderate in the next two years. The Monetary Council sees room to lower the benchmark rate."

Forward-rate agreements show that investors have already stepped up their expectations of rate cuts in the next five months. They now expect more than 50 basis points, compared with less than 25 basis points a month ago. We must now wait and see what effect all of this has on the forint.

Estonia Q2 2007 Current Account Deficit

Estonia's current-account deficit narrowed in the second quarter from a 14-year high as slower consumer spending and credit growth cut imports, suggesting the Baltic economy is cooling somewha. The deficit, which offers a braod measure of the evolution of trade in goods and services, fell to 8.5 billion krooni ($770 million) or 14 percent of gross domestic product in Q2 2007, from a revised 21.9 percent of GDP in the first quarter and 15.2 percent in Q2 2006, according to data released by the central bank today.

Estonians it seems spent less on imported cars, clothes and household goods last quarter as interest costs rose and stricter lending requirements by banks took their toll. Lower domestic demand also slowed manufacturing and construction growth, reducing the rate of GDP growth in Q2 to the lowest level in 2 1/2 years.

Exports of goods rose 6 percent from a year earlier, increasing slightly more rapidly than imports which rose 5 percent increase. Services exports climbed 19 percent, while imports went up 18 percent.

Latvia's current-account gap, which is the widest in the European Union, narrowed to 23.5 percent of GDP in Q2 2007 as economic growth there slowed too.

Sunday, September 23, 2007

Why Demography Matters, The Romanian Case

Well, the argument on this blog is about to start developing, since events are now (as Claus and I have been trying to suggest since the early summer), moving quite fast. At least in the East European context they are. The day when all the outstanding checks are called due to see if the books balance is getting nearer, and we have all seen only too recently what happens to banks when you need the liquidity to close your accounting for the day and you simply can't find it. Who would ever have thought that this could happen to countries and their stock of people? Well, as we have been saying, the numbers simply don't add up, and in the same way you can't make your bank solvent by "robbing Peter to pay Paul" and frantically shifting money from one account to another, you can't make your continent "population solvent" by massively shifting people around (600,000 from Poland to the UK, 500,000 from Romania to Spain) if there is an underlying deficit (and there is, remember, our current economic growth models are tremendously "people intensive", that is our economies chew up people almost as fast as they burn oil, and with the same consequence, if the supply is constrained the price soars).

At the present point I am busying myself gathering data on Romania, since Romania, for a variety of different reasons, seems to have been singled out by destiny to be the country where all the roads cross, with everything from the global credit crunch emanating from the US sub-prime crisis, to the export dependence of the German economy, to the difficulties presented by tight currency pegs (read Latvia, Lithuania, Estonia and Bulgaria) to the massive migrations of working age population and long term low fertility all coming to a head at one and the same moment, to produce a huge crescendo of cacophony and disorder. And one that may turn out to be contagious, mind you.

People often say that they don't understand why fertility should be so important, or why the hell Edward is so obsessed with this issue. Demography doesn't matter to economics, now does it? The Economist among others have re-assured us on this point time and time again. Aha! Well just key your eyes on those TV screens in the coming months, since all of this is about to be tested, and bigtime I'm afraid. Hopefully I'm wrong.

Incidentally, and following Claus's example, my apologies for the sparse posting of late, but we have been, as you are about to see, somewhat busy.

First off, let's do something unusual for this blog, and start with a currency curve. The euro vs the Romanian leu last Thursday.

Well one thing to remember (since we are measuring the value of one euro in Romanian leu) is that in this peculiar world up actually means down, and hence the point we might like to notice - since the curve goes spiking up - is that the leu took a hell of a hammering on Thursday, that's what it did.

Indeed, since the start of the sub-prime crisis back mid-August the leu has been the worst-performing of the complete batch of 26 key emerging market currencies against the euro. Here's a one month chart as of the end of last week:

Migration the Key

OK, these are currency charts, so what?

Well the point is that in the coming downturn in the global economy (the US is headed slowly into recession, Germany, Italy and Japan already seem to be following suit, and we will see how long the Chinese export model can survive when all the customers are less able to buy) the Romanian economy is going to be particularly exposed, and the reason it is going to be particularly exposed is its fragile demography. Yes, ladies and gentlemen, I kid you not. This IS the situation.

Now the relevant demography here is long term fertility (ie the number of live births since the late 1980s) and the recent huge hemorrhage in out-migration. On fertility we do have reasonably accurate data (more below), but on migration we are scandalously in the dark, despite the fact that one of the key topics we (the "we here" being not the royal one, but "we the economists") need to know about in order to try to get to grips with forecasts and things like that is the level of potential "capacity" in Romania, ie the level of the available labour force. You simply cannot measure potential output if you don't have an accurate measure of how many people you have available. So, to take one 'trivial' example, a central bank cannot carry out a monetary policy analysis, since to facilitate growth, and set and interest rate, you need to know how fast an economy can grow without producing wage inflation and to do this you need an accurate measure of potential labour force growth.

So if we are to make any sort of informed assessment of the future path of the Romanian economy the level of out-migration which has taken place in recent years is a key data point.This I think has to be obvious to anyone with an ounce of economic preparation. And Romania has certainly its full share of out-migration. In this sense the situation is very similar to the Polish one, with the exception that the Polish situation has had a lot more media coverage.

Well.... in order to try and get some data to put online I took the trouble to go and have a look at what Eurostat actually had (the English language version of the Romanian statistical office site, being, unfortunately, a hopeless mess). So here is a chart showing the migration information the Romanian statistical authorities have found themselves able - to date - to provide to Eurostat.

Well, nothing out of the normal here you might think. Romania is simply a country with a very low level of migrant flows. The data is, of course, for net movement, so there could be larger numbers of people coming and going, but still, the order of magnitude difference cannot be that large, or can it?

Now lets take a look at the data provided by the Spanish national statistics office (the INE) for Romanians resident in Spain over the last few years, and compare this data with the official Romanian numbers.

Wow! Well there certainly does seem to be something happening after all. And we should remember that not all the Romanians who have out-migrated since the end of the 1990s have gone to Spain (there are for example a significant number in Italy), although I dare say a fair proportion of them have. The important thing is that we simply don't know. What we do know - and know since the Romanians in Spain (whether they are working legally or not) have an interest (like access to the health system and future amnesties) in registering with the authorities, and indeed the Spanish authorities have (for their own reasons) an interest in maintaining the data in a very up-to-date condition - is that according to the Spanish Padron Municipal electronic-data there were 524,995 Romanians with active and valid id cards for the Spanish health care system as of 1 Jan 2007. These are not just Romanians who are simply passing through, or just might be around somewhere. The municipal registration which lies behind the data is renewable regularly for those without resident permits, and renewing them is how you get the right to have residence later, so this data is VERY accurate.

But we don't know how many Romanians are currently living and working outside Romania in total (or how many Moldovans are living and working in Romania, which is the other side of the issue) and we don't know because the Romanian national statistics office and the Romanian government don't see the issue as important enough to take the trouble to give this the same sort of priority the Spanish government do, despite the fact that Romania is now a member of the EU, and despite the fact that it is considered normal (even by the IMF apparently, reading the staff reports) that Romanian wages should rise rapidly towards European levels. European levels means European levels in every sense of the word.

Of course Romanian wages should steadily rise to the West European level, but the question is how you do it, and the keyword would be "steadily". If you simply increase them by fiat, or because you have no relevant labour supply this won't work. It is not sustainable, and in this way you cannot maintain an internationally competitive economy. You need to raise wages by becoming more productive - per capita - that this the only sustainable way.

Unfortunately the Romanian authorities will live to regret this failing. They will regret it since, as my analysis in this blog post will attempt to demonstrate, in the coming economic crisis in Romania, the outflow of people, and the reverse inflow of money in the form of remittances, when these are coupled with the subsequent distortions in the kinds of economic activity undertaken as a consequence will, unfortunately, prove to have been a very important factor.

(Incidentally, please, will anyone who may be out there with any reasonably accurate data to offer on the migration situation please get in touch.)

Construction, Did Someone Mention Construction?

Coincidentally with all of this Eurostat has just just published its monthly construction production index for all the EU countries. For our present purposes here I reproduce what is perhaps the most significant extract:

Annual comparison

Among those Member States for which data are available for July 2007, construction output rose in seven and fell in seven. The highest increases were recorded in Romania (+26.3%), Slovenia (+17.9%) and Poland (+17.0%). The largest decreases were recorded in Hungary (-14.6%), the United Kingdom (-6.6%) and Belgium (-4.9%).

So construction in Romania is booming. What a surprise! And not only is it booming, it is booming more than anywhere else in the European Union (at least, better put, it was booming while the banks - globally speaking - were still lending money to low-quality creditors for construction purposes, quite how much this activity will now continue as we move forward is exactly the point I am try to make here).

To get a better overall view of the position here's the construction output index for Romania since July 2006:

What we can see is that even though the rate of expansion has slowed noticeably over the last three months, the general expansion in Romanian construction has been significant. Here's the quarterly index for Romanian construction index going back to 2002 which makes the general evolution even clearer:

Now the result of all this frantic construction activity on an economy with tightly constrained labour force capacity (but which is not, please note, inward-capital-flow constrained) was, of course, not long in coming and it was the one which wascompletely to be expected: the price of construction new construction began to strongly surges upwards (readers in the US, does all of this remind you anything, some recent event or other in your country?).

The effect on wages and salaries should also not surprise us too much either, and here I present the index of construction salaries which only serves to confirm our worst suspicions:

Now as we have already noted, and despite the inability of the Romanian government to face up to the implications, there are currently around half a million Romanians working in Spain, and logically these Romanians are not available to work in construction in Romania, so, when you come to think about it, it is hardly surprising that we should find that wage inflation in construction has been enormous. The quarterly year on year chart makes this even plainer. The rate of salary increase in the first quarter of this year, for example, exceeded the astonishing level of a 50% annual rate.

The immigration data is only, of course, on part of the picture here. The other part of the story is the money which the migrants send home, much of which is then diverted into construction. Data on remittance transfers is available from the Romanian national bank, and as can be seen remittance flows have been rising steadily in the last few years, and are currently running at a rate of more than 500 million (or half a billion) euros a month.

This steady upward rise in the volume of inward remittances can also be seen in the following annual chart:

Now one of the central points I want to make here is that this flow in remittances also encourages an increase in the expansion of domestic credit (since the new income can be used to fund the repayments), and this can be seen from in the chart below.

Private credit in Romania is not at preoccupying levels (in terms of % shares of GDP), but it is important to note the steady increase in the quantity of these loans and in the quantity which are foreign currency denominated (normally in euros). In fact foreign denominated loans have been running neck-and-neck with domestic ones in as a share of total credit. This trend of course adds significantly to the vulnerability of the Romanian economy to any currency correction like the one we are beginning to observe in the charts which I presented at the start of this post. And it isn't only the private sector, since foreign currency loan indebtedness is more or less equally distributed between the private and the corporate sector.

General Wage Rises

So OK, wages and costs are going up in construction, but again: so what? Romania is a poor country, wages can rise, they can stand this, can't they? Well unfortunately, they can't, since among other problems the sudden surge in internal demand that all this construction related activity has been producing has created a big hole in Romania's international trade position, and the current account deficit is ballooning, and with this the dependency on international capital glows (and hence on global risk appetite) . Romania is no longer an independent actor here, it depends on the "whims" of its creditors.

But lets look a bit more at some of the general implications of the construction boom. The problem is that the spike in construction wages has not been confined to construction. Here we have the quarterly index for Romanian wages and salaries since 2000. The trend is pretty clear I think. General wage inflation is now an important phenomenon in the Romanian economy.

If we look at the annual rates of increase we will see that from 2001 to the end of 2005 a strict monetary policy from the Romanian central bank was steadily bringing a bad situation under control. But since the start of 2006 this position has once more started to turn round, and has been gradually getting out of control.


So my big argument is that all of this is, in part, driven by a very structurally distorted underlying demography. Let's now take a closer look at this, and to get the ball rolling let's start off with the fertility situation:

Despite the fact that we have a gap in the data during the late 1980s we can see that after falling steadily to replacement level during the 1960s and 1970s, the Romanian fertility rate dropped well below replacement in the 1980s and has been hovering round the 1.2/1.3 "lowest-low" TFR since the start of this century. This is a level in which the population cohort size nearly halves with each generation, so it is no laughing matter.

Now if we look at the drivers of short term fertility, as most of the regular readers of this blog will be aware, they key indicator here is the birth postponement process, and this process revolves around the rising rate of age at first birth of the mothers who have children. In the Romanian case we do not have specific data for this age, but (again thanks to Eurostat) we do have data for mean age on childbirth, and since most Romanian mothers now have only one child this is not a bad indicator.

As we can see, the median age at childbirth has been rising slowly but steadily, and this process is, in part, behind the very low fertility readings which have been registered in Romania in recent years. But at the current level of 27 (and this is an average for ALL births and not just first births, so the first birth median age will be somewhat lower) it is still significantly below the Western European norm, which is around the 30 mark. So more years of very low fertility are to be anticipated as postponement continues, and if Romania hits a major economic crisis in the meantime (which is, I am afraid, a very distinct possibility) then we may get stuck in exactly the kind of low fertility trap which Wolfgang Lutz has so ably identified.

If we now move onto the natural evolution of the Romanian population, I think it is worth starting by taking a look at the live births' chart, because there is, at first sight, a rather strange phenomenon to observe there. This phenomenon is the sudden jump in births in 1969:

Now this jump is undoubtedly the result of one of those rather notorious incidents in Romanian history, the Ceaucescu pro-natality campaign. Perhaps it isn't necessary to say this (it shouldn't be!), but those of us here on this blog who advocate pro-natalist policies along the Swedish or French pattern would obviously wish to completely dissociate ourselves from the type of coercive pro-natalism advocated by Ceausescu and his ilk. What we ARE arguing for is a collective effort on the part of the whole of society (organized collectively and via the state) to transfer resources to those women who would like to have children (Adam Smiths "hidden hand" seems to have gone "missing" at just this point, societies and economies guaranteeing their own reproduction). This is a policy to support choice, but based on the secure knowledge that our collective interest as societies lies in the direction of doing this, and of reproducing ourselves on a stable trajectory. It lies in this direction since otherwise.... well, unfortunately we are just about to find out what the otherwise alternative is in the present Romanian case.

Another import point which comes out of this analysis is the sharp drop in the number of births which took place around the end of the 1980s. To put this in some perspective we might point out that in 1988 some 380,000 children were born, while in 1991 this number was down to 275,000. This is a drop of over 100,000 children a year in just 3 years (and of course the annual rate has subsequently only dropped further). So in 2009 there will be 100,000 young people of 18 years of age LESS than might otherwise have been the case, and the Romanian labour market is BOUND to notice this sharp adjustment, out-migration or no out-migration.

But if we now come to look at the balance of births and deaths, and especially for those which took place in the late 1960s, we will again notice something strange, since we should be able to see that the number of registered deaths rose quite sharply in 1967 and it is plain from the way in which the birth and death curves track one another here that the pro-natalism policy which lies behind the rise in births does seem to have been somehow linked to the dramatic rise in the number of deaths.

Perhaps in comparison with the huge spike in live births the increase in deaths does not seem too significant, but if we look at the chart for deaths a bit closer up, the increase is readily apparent. Deaths in 1967 were up 21,000 on 1966, in 1968 they were up 31,000 and in 1969 they were up by 43,000 over the 1967 figure.

So we have a phenomenon - yet one more time in the Romanian case - which is different from the typical one, in that the numbers of births fell below replacement very early on, and then this fall was followed by a subsequent huge spike which distorted the whole age structure, and then finally the annual number of live births dropped below the number of annual deaths in the early 1990s, and since that time the Romanian population - even ignoring the net loss from migration - has been falling. And if we look at the theoretical population position we will see this confirmed:

Turning to life expectancy at birth, we will see, despite a decline in the early 1990s (which may have been associated with high infant mortality) the headline number is now rising, but it is still low in comparison with Western Europe, and this is going to have important economic implications, not least because it places severe limitations on one of the favourite economic recipes for getting out of the kind of problems Romania is getting into, namely raising participation rates in the over 55 age group. Looking at all this data it may well be that the health of the older Romanian population is just not up to taking this kind of strain. I suspect we are going to hear a lot more of this kind of issue in the East European context in the months and years to come.

Finally, to complete our demographic round up, we could look at the median age of the Romanian population. This age is - at a current level of 36.9 - very young by modern standards, but it is hard to know what interpretation to put on this, since Romania is hardly a "young" population in the sense that Iceland or Ireland are, since the whole structural configuration of the demographic panorama is so uniquely skewed and distorted, and in part the comparatively young median age is a reflection of the comparatively low level of life expectancy.

Now I appreciate that most of you reading this blog are not economists, and hence even if you can see that there is something preoccupying and even deeply disturbing about the demographic profile I have outlined, you can't necessarily see why this is economically important. Maybe you can even see that all this construction activity, and wage push inflation isn't especially positive (and even less so in the wake of the US sub-prime blow-out) but still, why should things be about to go so wrong? Well you need to think about Romania's external position, and the ability of Romania to export its way out of trouble at the same time as the huge wage push inflation means it is experiencing a major loss in international cost competitiveness. Simply put, it is much harder to sell Romanian products abroad. As evidence what I am talking about, here is the chart showing Romania's growing trade deficit:

And here's another one showing the Current Account deficit.

Now this point about the rise of foreign indebtedness brings us directly back to the issue of remittances and construction, and in particular to the high proportion of current mortgages which are being taken out in foreign currency (87% of the total of Romanian mortgages were in foreign currency in July 2007 according to data supplied by the Romanian central bank). This exposure not only to external interest rates, but to the relative values of currencies) makes the individual Romanian household (not to mention their corporate peers) especially vulnerable to any sudden change in the value of the Romanian currency, as the cost of the associated loan repayments would obviously rise significantly. Here's another charts, this time showing the inexorable rise of foreign currency mortgages in Romania.

The point is of course that not only will the repayment on these loans become unbearable for Romanian households if the leu continues its downward decline, the external banks who have these households as clients in their portfolios will also become increasingly exposed (which is why I keep mentioning sub-prime here, it isn't just for the fun of it). Indeed the problem is even worse, since given that these loans are regulated by interest rates established by external banks, the Central Bank in Romania will effectively have little control over monetary policy in the event of a severe downturn. So, simply put, things look bad on all fronts.

And unfortunately - I'm afraid history is just like that, it comes and hits you smack in the face just when you least expect it - just right now we seem to be entering a significant downturn in the global economy whose depth and extent is yet to be determined. And during such downturns the chains normally crack first at their weakest links. Unfortunately for the citizens of Romania their country seems to currently be the weakest link in that 26 key emerging market chain which is chafing at the bit waiting to see who will be the first to fold. So it is to Romania I would be looking if you want to watch that first, initial, blow-out. And the reason why the blow-out will come here, why, "it's the demography, stupid!".

Friday, September 21, 2007

Migrants and Hungary

The BBJ ran this article this morning:

EC: Hungary needs more immigrants

Thanks to an aging population, Hungary will have to get ready to attract a great amount of immigrants over the next years – the European Commission said.

The EC added that migration is the solution for the EU as a whole, as it is facing acute shortage of workforce in the near future. The Commission also pointed out that Germany, Italy, Hungary and Latvia will be hit by the heaviest shortage of qualified workers. In the next 20 years the EU – currently the home to 18.5 million non-European immigrants - will need an additional 20 million immigrants to ensure its work force.

The article is covering a speech by Justice, Freedom and Security Commissioner Franco Frattini which is well summarised here. Among other things - and over and above the fact that Hungary was specifically singled out as having a specific problem which needs addressing - Frattini said the following:

"Countries with rapid economic growth in recent years, such as Spain and Ireland, have clearly benefited from the in-flow of skilled workers from both within and outside the EU. Across the EU all skill levels are required. The challenge is to attract the workers needed to fill specific gaps. Working together makes the EU stronger not just when dealing with problems such as illegal migration and border management, but also in seizing the opportunities which migrants embody. Common action at EU level also gives member states a stronger voice on the international stage, bearing in mind that there is competition between different countries and regions of the world for skilled migrants, especially with high qualifications."

Now I have recently been advocating increased migration as one of the ways to reduce the massive wage pressure that is building up in Latvia and the Baltic economies generally. I also have a post here on the more general underlying demographic issues in Hungary here.

The strange thing is perhaps that at the present time all of this seems to be a bit "unworldly" in the Hungarian context, since with the dramatic slowdown which is taking place Hungary is presently the only EU 10 economy where there is NOT a serious labour shortage developing (although there may, even in Hungary, be skill shortages in some specific areas). But we need to think in the longer term here, and look to an eventual economic recovery, and try to consider the specific problems Hungary will be facing given its demographic profile. So changes are needed. Changes in paperwork, changes in regulations, and above all changes in the way people see this particular problem.

Thursday, September 20, 2007

Another bad day for the Leu

Well as might have been expected following all the political argument, today was another bad day for the Leu. Of course the euro passing through the $1:40 won't have helped any either.

Bulgarian Inflation Accelerates

Bulgaria, which joined the European Union in January, recorded an annual inflation rate of 12 percent in August, the highest in the EU, pushing it further from its goal of joining the euro mechanism, and from entering a two-year currency stability test which was scheduled for 2008, and intended as a preparation for making the switchover to the common currency in 2010. This now seems to be a very unlikely eventuality and timetable.

Bulgaria, which is the EU's poorest country in terms of per-capita income, is struggling to contain rapidly rising wages and and handle the volume of inward investment which is arriving. Bulgaria's EU membership has spurred consumer spending, fueling imports and pushing up prices as people took out loans to buy cars, apartments and household appliances in a mad rush to try to bring living standards closer to those of western Europe. As a result, the current-account gap has widened to record levels and will exceed 18 percent of GDP by the end of the year, according to Standard & Poor's. All of this - including the low fertility and migrant outflows producing labour shortages at home - mirrors problems which are already being experienced in the Baltic states of Latvia, Lithuania and Estonia.

As with the Baltic currencies, the lev is pegged to the euro under a currency board system, and while this has helped to keep a lid on government spending and lower public debt to the current 20 percent of GDP level (one which is well below the 60 percent of GDP criteria required for euro adoption), the rigidities involved with currency pegs are now being generally exposed, as the countries involved are having great difficulty adjusting to the rapid burst of inflation, since the currency cannot be devalued.

Indeed it is hard to know what the Bulgarian government can do in the face of all this, since they have posted budget surpluses in each of the last 4 years.

For what it is worth, here is the monthly chart showing the recent evolution of the harmonised CPI.

Possible Romanian Elections?

Well, as if Romania didn't already have enough problems, this news today is hardly going to help:

Romania's opposition Social Democrat Party, the largest group in parliament, said it will put forward a no-confidence motion next week aimed at ending the minority government of Prime Minister Calin Tariceanu.

``We have decided to move forward with this no-confidence motion on Monday, Sept. 24,'' Mircea Geoana, the Social Democrats' president, said in a statement late yesterday televised on Realitatea television. ``We don't see how a new government can be formed and we think the possibility of early elections is becoming more likely.''

The Social Democrats, formed by ex-communists after the anti-communist revolution in 1989, have about 150 seats in the 465-seat parliament and would need to ally with other opposition parties to get the motion passed.

Some prominent Social Democrats, including former Romanian President Ion Iliescu, said they oppose the motion, which could force elections a year earlier than scheduled.

Infighting between the main political parties since Romania joined the European Union on Jan. 1 has delayed programs meant to speed up the absorption of EU funds and fight corruption, a key EU demand. Tariceanu and President Traian Basescu, former allies, split early this year amid mutual accusations of corruption.

In April, Tariceanu ousted the Democratic Party, which supports Basescu, from the government, firing all ministers loyal to Basescu. The Democrats joined the opposition with their 100 seats in parliament, leaving Tariceanu's supporters with about 100.

Basescu has repeatedly called for Tariceanu's resignation and has indicated his party may support a no-confidence motion.

Wednesday, September 19, 2007

Romanian Migration: Lies, Damn Lies, and Statistics

Well, the argument on this blog is about to start developing as I gather the data together on Romania.

One of the important topics to get to grips with in trying to assess the future path of the Romanian economy is the level of out-migration which has taken place in recent years (in this sense the situation is very similar to the Polish one, with the exception that the Polish situation has had a lot more media coverage.

So to try and get some data to put online I took a look at what Eurostat had. Here is a graph of the information the Romanian statistical authorities have provided to Eurostat.

Nothing out of the normal here you might think. Simply a country with a very low level of migrant flows. The data is for net movement, so there could be larger numbers of people coming and going, but still, the order of magnitude difference cannot be that large, or can it?

Now lets take a look at the data provided by the Spanish national statistics office (the INE) for Romanians resident in Spain over the last few years, and compare this data with the official numbers.

Wow! Well there does seem to be something happening after all. And not all the Romanians who have out-migrated since the end of the 1990s have gone to Spain, although I dare say a fair proportion of them have. The thing is we don't know. What we do know - and we do know since the Romanians in Spain have an interest in registering - whether they are legally working or not, and due to the fact that the Spanish authorities have an interest in maintaining up to date data - is that according to the Spanish Padron Municipal electronic data there were 524,995 Romanaians with active and valid id cards for the Spanish health care system as of 1 Jan 2007. These are not just Romanians who are simply passing through, or just might be around somewhere. The municipal registration which lies behind the data is renewable regularly for those without resident permits, and renewing them is how you get the right to have residence later, so this data is VERY accurate.

But we don't know how many Romanians are currently living and working outside Romania in total (or how many Moldovans are living and working in Romania, which is the other side of the problem) and we don't know because the Romanian national statistics office and the Romanian government don't see the issue as important enough to take the trouble to give this the same sort of priority the Spanish government do, despite the fact that Romania is now a member of the EU, and depsite the fact that it is considered normal that Romanian wages should rise rapidly towards European levels. European levels means European levels in every sense of the word.

But the Romanian authorities will regret this failing. They will regret it since, as the analysis on this blog will attempt to demonstrate, in the coming economic crisis in Romania, the outflow of people, and the reverse inflow of money in the form of remittances, and the subsequent distortions in the kinds of economic activity which are undertaken will, unfortunately, turn out to be very important.

So, please, will any one out there with any reasonably accurate data to offer on this situation please get in touch.

Hungary Wages and Employment July 2007

The latest wages and employment report is now out from KSH. Real wages in Hungary dropped by 5.2% year on year in July when compared with the harmonised CPI, but this was a slight improvement over a 5.3% decline registered in June. What is obvious is that there has been a severe process of wage deflation in Hungary since the start of this year, although the pace is now slowing somewhat, with he sharpest fall in real wages being registered in February (-9%).

Here is the relevant chart:

Public sector gross wages have maintained a slightly higher rate of increase than last month (9.3% y/y up from 8.6% y/y last month) as expected due to a jump in bonus payments. Private sector gross average wages were up to by 10.8% y/y slightly under 11.4% y/y last month.

Despite the ongoing drop in real wages, employment has remained stubbornly stationary all this year, as the following chart illustrates.

IMF in Romania

Bloomberg is reporting that the IMF is beginning a week-long tour of Romania. Juan Fernandez-Ansola, the IMF's senior East Europe representative, is quoted as saying that:

"We will look at the question of exchange-rate development and see what impact that will have going forward"

And well he might, of course. Strangely the Leu seems to have bounced back a bit today, after a really horrible day yesterday. I am not exactly sure what the reasons for the rebound are, but I am not anticipating that this will be any sort of sustained trend. All the markets have been thrown a bit by Bernanke's decision yesterday, but the initial relief may well soon be followed by growing preoccupation about theactual impact of the impending US recession that the rate decision was in fact a response to. The question in this context is, when will the next Federal Reserve move down be, and how much will it be?

As Bloomberg note the recent drought damaged 4 million of the six million hectares of crops planted in Romania this year, and this has helped push-up food prices significantly in August, leading the inflation rate accelerated to accelerate to an annual 5 percent, from 4 percent in July.

According to Fernandez-Ansola Romania's economy is vulnerable to the subprime mortgage crisis in the U.S. due to Romania's dependence on capital inflows to cover a widening current-account deficit. Ansola in fact said during a visit to Romania last May that the central bank's interest-rate cuts this year had been ``premature'' because of potential inflation pressures which might impact towards the end of the year.

The National Bank of Romania maintained its benchmark Monetary Policy Rate at 7 percent on July 31 after cutting it at four consecutive meetings this year, citing slowing inflation as the main reason for the pause. The rate was 8.75 percent at the end of 2006.

The central bank, which is scheduled to make its next interest rate decision on Sept. 26, targets a year-end annual inflation rate of 4 percent this year, from 4.9 percent last year.

Romania's current-account gap in July swelled to 8.97 billion euros from 4.9 billion euros a year earlier. Imports surged as the leu strengthened on the year and Romania's entry to the European Union obliged the country to eliminate many trade barriers.

The other big issue is the government deficit. Fernandez-Ansola pointed out earlier this year that Romania's government risked violating EU conditions that limit members' state budget deficits to a maximum of 3 percent of gross domestic product. In fact in January the Romanian government targeted a budget deficit of 2.8 percent of GDP but Fernandez-Ansola strongly argued that this overestimated potential revenue and underestimated expenses. However, on Sept. 6, Finance Minister Varujan Vosganian lowered his year-end budget deficit estimate to 2 percent of GDP, citing higher-than-expected revenue as rising wages increased income tax collection.

The IMF Romania page can be found here, for those who wish to follow the outcome of this review.

The "New" Latvian Stabilisation Plan :Too Little Too Late?

Bloomberg reports that Latvian Prime Minister Aigars Kalvitis was on the Latvian Independent Television program 900 Seconds last night. His message, that "new government measures to slow inflation and cut the current account deficit will mean ministries must trim spending and plan for larger surpluses". Ministries, he said, will have to ``tighten their belts'' and the budget surplus will have to be ``much bigger'' than the planned 0.5 percent for next year.

The government is apparently planning to introduce a (another) stabilization plan. At the end of the day, I cannot help having a certain sympathy for the Latvian politicians and bankers concerned. Not that they couldn't have been doing more, but this situation - which is way beyond the "know how" of even the IMF and the EU commission - it seems, certainly can only find them wanting before the challenge. They are, at the end of the day, only human, and they should not be blamed for that fragility.

No one could really have anticipated the extent of the problems Latvia was destined to face back in 1990 when the wall came down and fertility suddenly plummeted. Now we all know better. There will be a lot to be learnt from what happens next, unfortunately the on-cost of the education process will be paid for by the Latvian and other East European peoples, who, lord knows, have already suffered enough.

History is far from kind in this case. In fact it seldom is.

Tuesday, September 18, 2007

Hungary Construction Activity July 2007

Well, the construction index was up 1.3% month on month, but that is about the only good thing which can be said about the latest set of construction activity data released by the statistics office. The whole sector remains in a deep recession.

In July 2007 the volume of the construction activity decreased by 13.7% according to unadjusted indices and by 14.6 according to ones adjusted by working days related to July 2006. In the first seven months the output was by 5.8% under level of the same period of 2006. In comparison with the previous month the production grew by 1.3%, according to indices adjusted seasonally and by working days.

Given that the drop was so substantial in June it is really quite hard to know how to interpret this data. It could, I suppose have been worse. We really need to see some more industrial output data and some more retail sales data before we can get a clearer indication of what Q3 GDP is going to look like.

Anyway, here are the charts:

Hungary August 2007 CPI

I'm a bit late posting about this, but somehow or other I didn't find the time. Hungary's CPI surprised on the upside last week, according to data released last week by the statistical office, rising 8.3% year on year in August from 8.4% in July. Core inflation fell to 5.4% from 5.6% yr/yr. Food prices seem to have been the main culprit and they continue to remain a key inflationary risk.

“The surprise came entirely from food prices, with other categories behaving as expected," Silja Sepping of Lehman Brothers said. The closely watched market services price fell modestly on an annual basis, as did tradable goods.

Inflation in unprocessed foods seems to have ticked up to 12% yr/yr from 9% in July while processed food inflation (that's part of core CPI) remained broadly unchanged. There are two main factors at work: i) sharp rises globally in wheat and maize prices; and ii) adverse weather conditions in Hungary over spring/summer this year.

Global trends have started to be reflected in items such as flour prices (up 7.1% m/m), egg prices (up 6.9% m/m), poultry meat (up 3.2% m/m, milk (up 4.3% m/m) etc. Given the modest increase in bread (1.7% m/m) in August. According to the Hungarian press, bread prices could rise by as much as 10-15% in the autumn.

This is obviously going to complicate the work of the central bank in terms of interest rate policy. As if things weren't already complicated enough.

Here is the chart of the annual rates by month, and as we can see annual changes in the CPI are remaining stubbornly high:

Bulgaria Q2 2007 GDP

Bulgarian economic growth accelerated in the second quarter, driven by consumer spending and investment according to the Bulgarian statistics office today.

Bugaria's $31.5 billion economy expanded at an annual 6.6 percent in the April-June period, compared with 6.2 percent in the first three months of the year. Bulgaria's second-quarter growth rate is the sixth-fastest in the EU, following Latvia, which had an 11 percent expansion in the second quarter, Slovakia, Lithuania, Estonia and Poland. Bulgarian growth was 6.1 percent in the 2006 and a6.2 percent in 2005.

Gross fixed capital formation grew 24.7 percent in the first quarter after increasing 36 percent in the first quarter on imports of equipment and new cars. End-user consumption slowed to 5.7 percent, after 7 percent growth in the fourth quarter, the statistics office said today. In the first seven months, foreign investment rose 12 percent to 2.6 billion euros ($3.6 billion), 1 billion euros of which went into real estate, fueling a construction boom for a third year. Second-quarter exports rose 5.7 percent and accounted for 68 percent of GDP, after a 2.2 percent rise and 60.1 percent share of GDP the previous quarter. Imports rose 11 percent and were 88 percent of GDP in the second quarter after a 13.2 percent increase, comprising 88.8 percent of GDP the first quarter. The trade deficit amounted to 24.2% of GDP.

Gross value added by industry rose 10.5 percent and accounted for 27.6 percent of GDP, the office said. Services' GVA rose 9.5 percent, comprising 50 percent of GDP. Agriculture's gross value added fell 5.3 percent, while its share of GDP expanded to 5.3 percent from 3.8 percent in the first quarter.

Monday, September 17, 2007

The Leu Continues To Come Under Pressure

Romania's leu fell to a more than six-month low against the euro this morning. The leu in fact declined for a fifth consecutive day, extending losses after recording the biggest daily decline in almost two weeks on Friday. The leu fell 0.9 percent to 3.3905 per euro by 11:08 a.m. this morning in Bucharest, its lowest since March 5. This was a decline from 3.3599 late last Friday.

The leu is now the worst-performing of 26 emerging market currencies against the euro since mid-August.

Here is the one day chart I prepared for last Friday:

and here is the one month chart (again as of last Friday).

Basically the Romanian currency seems to be the weak chink that currency market operators have found in the emerging market defence system, and I feel that the decline in risk appetite will start to really show its teeth here. In this sense the issue is longer term and structural as my colleague Claus Vistesen explains here.

But there are short term "movers" of the situation. One of these is undoubtedly the climate, and the dependence of the Romanian economy on agriculture. In this sense it is significant - despite the fact that the most pressing problem the country is likely to experience in the mid term is an acute labour shortage as the effects of longer term low fertility and large scale out migration of working age population really start to bite - that Romania's unemployment rate rose in August as a drought that damaged most of the country's crops reduced the need for manual laborers to collect the harvest. The proportion of the workforce out of work rose to 3.9 percent, from 3.8 percent in July, according to data released by the National Labor Agency today.

A drought damaged four million of the six million hectares of crops planted in Romania this year, completely destroying at least one million hectares and reducing the need for workers.

The other big downward driver is the current account deficit. The Romanian central bank has said that the current account gap swelled to 8.97 billion euros in July, from 7.81 billion in June.

Saturday, September 15, 2007

Latvia Wages and Salaries Q2 2007

Well Latvijas Statistika had the latest wages and salary data up last week, and they don't make especially pleasant reading, even if you do consider that Latvians are basically much poorer than their Western European counterparts, and that wage (and productivity) convergence in the longer run would be a thoroughly good think. The question is, can we get from here to there, and if so, how? Since one thing is plain enough, the present situation just isn't sustainable.

According to Latvijas Statistika compared to 2nd quarter of 2006, in the 2nd quarter of 2007 the average hourly labour costs increased by 31.6%. Hourly labour costs in this period increased from 2.46 lats to 3.23 lats or by 78 santims per hour.Quarter on quarter this was a rise of 6.2%.

Here are the charts. First the development of the annual rate, which is, quite simply, horrific.

Now here is the quarter on quarter rate. And we can, of course, notice some very slight slowdown in the second quarter, and this is consistent with other data - GDP, housing - that we have been seeing. The question is now how rapidly and how far this will slow.

Clearly these wages increases subsequently have a knock-on impact on costs, and this impact can be seen in the producer price index. This can be seen in the charts that follow. First the index itself.

Now the annual rate of increase each month. This has now been accelerating since about July 2005, although the rate of acceleration has slowed recently.

Then we have the rate of increase in export prices component. As we can see these prices have also risen considerably, although the rate has now, fortunately, been slowing down since April. The damage, however, is being done, and it is considerable.

The impact of all of this is reasonably predictable, Latvia is finding it harder and harder to export:

as we can see, since May the value of Latvia's exports each month has been falling. If we look at the monthly trade balance we get a similar picture:

As we can see, the deficit is not reducing in any systematic way, and indeed deteriorated a little in July, which is the last month for which we currently have data.

So all of this is unsustainable, and the end result will probably be an impact on the peg. Why?

Well economics isn't such a difficult subject as it sometimes seems really. Basically you have two key drivers of economic growth, domestic consumption and exports (in this sense both government spending and investment are secondary variables). Now if at some stage domestic demand is going to be reduced - as it has to be - then Latvia will have to live from export growth. But if you can't increase exports because your prices are too high, then the only real move left is to change the value of your currency. Its as simple, or as hard, as that really.

Friday, September 14, 2007

Estonia Government Spending Outlook

Estonia will increase spending by ``about'' 3 billion krooni ($270 million) next year after reaping higher-than-forecast tax revenue, according to Prime Minister Andrus Ansip at a news conference in Tallinn this morning.

Next year's expenditures will rise to about 93 billion krooni, compared with 89.7 billion krooni in a four-year budget forecast prepared in May. Ansip declined to specify the amount of extra spending which was involved this year, saying only that one of the ``additional items'' will be 284 million krooni to purchase embassy buildings abroad. The government is due to complete its budget proposals on Sept. 17.

According to Ansip:

``Next year's government sector budget surplus will definitely be 1.3 percent of gross domestic product......We promised this level to the European Union in our last convergence program.''

Estonia's central bank argued last month that the government must avoid additional spending to help keep economic growth, which was running at an annual at 7.6 percent in the second quarter, under control. Managing government spending is among the few tools available to Estonia to curb price increases because the local currency, the kroon, is pegged to the euro in the EU's exchange-rate mechanism.

Central bank spokeswoman Livia Kulm is quoted today as saying the bank would give a detailed comment when the budget proposals are completed.

``The Bank of Estonia is still of the opinion that the budget surplus in 2007 must remain on a comparable level with last year and expenditure should not be boosted through a supplementary budget,''.

Standard & Poor's in July lowered Estonia's ratings outlook to negative from stable, citing a wide current-account deficit and accelerating inflation. The planned loosening of fiscal policy would ``likely compound the pressures on the creditworthiness'' of Estonia, it added. Moody's Investors Service also lowered its outlook for Estonia and Latvia to stable from positive only yesterday, citing similar reasons.

The Estonian Finance Ministry last month raised its forecast for surpluses in 2008-2011 to between 1.8 percent and 2.2 percent of GDP due to higher tax revenue expectations. It said the surplus would reach 3.4 percent of GDP this year, compared with 3.8 percent last year and the previous forecast of 1.9 percent.

No Change in Latvian Interest Rates

Latvia's central bank, unsurprisingly, left the benchmark refinancing rate at 6 percent today. According to the press release:

The Bank of Latvia Council maintains that substantial risks of economic overheating are still in place and in some sectors even becoming stronger, including an upsurge in inflation rate. At the same time, there are certain trends signalling that consistent implementation of the economic stabilisation measures is likely to result in a gradual further "cooling" of the economy in the upcoming periods, with the so-far buoyant pace of growth slowing down. The anti-inflation or economic stabilisation plan is producing first results and requires further action.

The bank called on the government to continue and intensify its efforts to achieve a budget surplus.

"The efforts to implement other measures under the plan and, in some areas, to render sustainable previous achievements should continue. In the area of fiscal policy, immediate activities should focus on a budget with a surplus in the amount of 1% of GDP instead of the currently projected balanced budget position for the current year and a considerably larger budget surplus (2%) than the projected 0.2% of GDP for the next year. An urgent action is needed to address the measures under the anti-inflation plan related to enhancing export competitiveness and labour market problems. Step by step, this will lead to both adjustments in the country's external imbalances reflected in the current account deficit and internal instability or inflation rate."

Basically the absence of any change in the interest rate is hardly surprising given that Latvia's currency is pegged to the euro, and that most internal credit expansion is driven by non-Lat denominated loans the power of the central bank to influence the situation is extremely limited.

Higher than capacity economic growth, high inflation and a widening current account deficit all prompted Standard & Poor's and Fitch to cut the sovereign debt credit rating to BBB+ earlier this year, and only yesterday Moody's changed the rating outlook for Latvia and Estonia from positive to stable.

Annual inflation was up again in August to 10.1 percent, a 10-year high, from 9.5 percent in July as domestic demand, fueled by rising wages and loans, continued to grow.

Central bank Governor Ilmars Rimsevics said at a press conference in Riga today that inflation isn't expected to slow in the coming months and he ``hopes'' to see a decline in the rate next year. Inflation is being driven by advances in core inflation, Rimsevics said.

Interestingly Rimsevics stated that Latvia should consider importing skilled labor to fill job shortages: ``Urgent action is needed'' to address labor market shortages and competitiveness of the country's exporters.

Economic growth has been driven by a domestic demand boom which has sucked in large quantities of imports, leading to a negative dynamic on the trade balance and widening the current account deficit, which was 25.7 percent of GDP in the first quarter.

The economy is showing signs of slowing (although not very strong ones, see here) according top Rimsevics statement at the press conference. Real-estate prices have stabilized and the current-account gap is expected to have reduced to "only" 21 percent of GDP in the second quarter.

Latvia has the somewhat unusual twin distinction of leading the European Union in economic growth and in the size of its current account deficit.

The economy grew 11 percent in the second quarter, the ninth consecutive three-month period in which gross domestic product expanded more than 10 percent.