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Tuesday, March 18, 2008

Hungary Construction Output January 2008

Hungarian construction resumed its long march downwards in January, since year on year output plummeted by 27.4%, according to both unadjusted data and figures adjusted for working days, according to data from the Central Statistics Office (KSH) this morning. This follows the 20.8% yr/yr decline in Decmber and a 4.0% fall in January last year. There was a 5.9% rise in output month on month over December according to seasonally and working day adjusted data. Thia compares with a 1.4% m/m rise in December over November, and a 1.1% fall m/m in January 2007. So there is some slight improvement in the underlying trend, although it would be very premature to attribute any importance to this at this stage, since all sorts of factors - like the weather, and this winter being milder than the last one or whatever - can be having an impact here.

To get a better picture of what is happening we could look at the quarterly construction activity index over the last few years, where - if we take a glance at the chart - we will see that total activity peaked sometime in 2005, since which point the overall trend has been steadily down, and I see no compelling reason why that tendency is likely to change anytime soon.

Now for the details. According to the KSH release:

The building of complete constructions was down by 31.6% yr/yr in January, and this compared to a 28% drop in December and a 14.3% decrease in January 2007. Building installations were down 12.7% yr/yr in January as compared with a 3.9% fall in December and a 16.8% jump in January 2007. Completed buildings dropped by an incredible 43.7% yr/yr, as compared with a 1.9% fall in December and an 18.1% rise in January 2007.

The stock of orders at the end of January (HUF 674.8 bn at current prices) was down by 29% from a year earlier. The stock of orders for buildings (which totalled HUF 334.7 bn in Januray) was down 15.5% yr/yr, which compares with a rise of 9.4% in December and a rise of 6.9% in January 2007. For civil engineering the stock of orders was down 38.6% yr/yr (to HUF 340.1 b), which compared with a drop of 53.2% in December and a 46.1% drop in January 2007.

The volume of new orders in the construction industry as a whole (at HUF 129.1 bn) was up by 49.5% which compares with a 1.2% rise in December, and a sharp drop of 61.8% in January 2007.

The change in the stock of new orders for buildings was much less positive, as this was down by 24.8% in January, following a 4.3% yr/yr increase in December and a decline of 5.4% yr/yr in January 2007. New orders at current prices were down to HUF 42 bn from HUF 116.2 bn in Dec.

At far as civil engineering is concerned the picture was much brighter since there was a massive 185.6% leap as against a drop of 3.8% in Dec and a plunge of 81.8% in January 2007.

Unfortunatley this is the one-off impact of a major contract sealed in January for the extension of the M6 motorway. In this sense we can see why the increase in total orders look vaguely positive, since a one off civil engineering contract to some extent compensated for the continuing decline in domestic housing construction. This is liable to happen from time to time with the arrival of EU funding, but since the general fical direction is towards tightening we should not be expecting to much positive news in this department.

The value of total construction industry production was HUF 87.6 billion in January, down from HUF 205 bn in Dec and HUF 115.3 bn in January 2007.

Wednesday, March 12, 2008

Bulgaria Inflation February 2008 and Q4 2007 GDP

Bulgarian inflation reached 13.2 percent on the year in February, the government said Wednesday.The rate in January was 12.5 percent.

Food prices increased by 1.7 percent in February over January, with prices of nonfood items rising 0.8 percent, and services up 0.2 percent, the National Statistics Institute said.

The Bulgarian harmonized index of consumer prices, used by the European Central Bank, rose by 1 percent in February over January, and by 12.2 percent compared to February 2007.

On another front Bulgaria's economic growth accelerated in the fourth quarter driven by record levels of investment, construction and tourism in the first year of European Union membership. Bulgaria's economy expanded at an annual rate of 6.9 percent, up from a revised 4.9 percent during the previous three months, according to data released by the statistics office.

Bulgaria, which is the EU's poorest member with per-capita gross domestic product of just 37 percent of the EU average, is counting on investment and accelerating growth to help raise living standards. However dependence on food imports and the high global prices of grain and oil prices have fueled inflation and lead to a widening trade deficit. Agricultural output slid by 43% in the third quarter, floowing a drought and then heavy rain storms which destroyed vast areas of crops in the summer. Annual agricultural output declined a record 29.7 percent in 2007, greatly influenced by the third quarter performance and by a 36.4 percent year on year slump in the fourth quarter.

For whole year 2007 the Bulgarian economy grew by 6.2 percent, following revised growth of 6.3 percent in 2006.

Record foreign investment of almost $10 billion spurred the construction of hotels, offices and residential buildings, the data showed. Industry rose 18.2 percent, driven by a 17 percent growth in construction and 15 percent growth in manufacturing, as Western car makers moved production to Bulgaria to take advantage of low taxes and cheap labor.

Growth in gross fixed capital formation rose 14 percent, following a 19.7 percent rise in the third quarter. End-user consumption growth rose to 4.5 percent from 4.3 percent, of which individual consumption slowed to 3.4 percent from 4.9 percent, while public consumption was up 13.3 percent after a 2.5 percent decline in the previous quarter.

Exports rose 6 percent in the fourth quarter, after a 5.4 percent increase in the previous three months, while import growth slowed to 5.7 percent after a 9.3 percent increase in the previous quarter.

Monday, March 10, 2008

Latvia's Economy Enters Recession in Q4 2007

Well the great Baltic economy overheating debate is now gradually drawing to a close as it becomes increasingly clear in each of the three cases (Latvia, Lithuania and Estonia) which way the cookie is eventually going to crumble. Today it is Latvia's turn as we now have a more complete set of data on Q4 2007 Latvia GDP from Latvijas Statistika (following the preliminary release covered here), and the most important detail is that they have revised their year-on-year growth estimate down to 8%. Unfortunately in the actual release the statistical office don't enter into any detail about the quarter itself, and in particular don't give a number for quarter on quarter growth. So, since the number looked very small and I was curious to know what the actualy quarterly performance was I went and checked in the database, and here is a summary of what I found.

Basically if you look at the last two bars on the above chart you should be able to just make out that - at constant prices - Latvian GDP actually declined between Q3 and Q4 2007, down to 2.222 billion Lat from 2.227 billion lat in Q3 2007. That is a DROP of 0.23% (my own calculations) which might seem small but we should bear in mind that in Q3 the Latvian economy was still growing at a quartery rate of 2.8% (or around 11% annualised) so movin from this to an annualised negative growth rate of around 1% is not at all small beer, and constitutes very rapid deceleration indeed. So while the actually data point may not seem like much, the implications are really quite profound. Technically we could consider a recession as two quarters (back to back) of negative growth. Well, we just had one of them it seems, and with all the dials continuing to show negative we are surely now in the third month of the second one. Which means, on my call, that Latvia is fully in recession at this point, and the only question really left is how long and how deep the recession is going to be.

Of course you can get some idea of the speed of the slowdown from looking at the year on year growth chart, but this doesn't really give us enough detail at this particular point in time to get hold of the actual process taking place.

To answer one small potential quibble in advance, the Latvian Statistics Office do not seem to publish seasonally adjusted quarterly data, so I am working from original series numbers (corrected for constant prices). However, if we look at the cahrt from GDP on a quarterly basis since 2000, we can see that the seasonal variance is not large, and that in no previous Q4 so far this century has GDP actually fallen, and if there has been any notable seasonal impact it is in a slight slowing in Q1, when bad weather will presumeably have affected construction activity, and retail sales may be slow in the post xmas period. The current slowdown in construction has little to do with seasonal factors, and everything to do with the cutting off of the credit supply by the Scandinavian banks back in the late spring.

Moving on to look now at the Q4 "uses of GDP" side, the only area which showed positive movement was in fact the much berated area of government spending, which I think basically vindicates both me and the Latvian government for saying that during the last quarter of 2007 it was ridiculous to continue talking about trying to run a fiscal surplus since the economy had already turned (six months earlier, and then previous to that was a very different matter). If we start by looking in detail at private consumption for Q4 we will find that this was down from 1.637 billion Lats in Q3 to 1.612 billion in Q4 (or by -1.55%).

On the other hand gross capital formation was down from 920 million Lat in Q3 to 873,2 million in Q4 (a reduction of 4.69% - all numbers at constant prices).

External trade was also less of a drag in Q4, although the deficit was still substantial, dropping from 582.5 million Lat in Q3 to 561.4 million in Q4 (a reduction of 3.6%) .

As I say the only really strong point in all of this was government consumption, which increased from 303.5 million Lat in 343.3 million Lat in Q4 (or up by a hefty 13.1%). Since the Latvian economy now needs a very heavy and rapid blood transfusion if it is not to swoon completely, more power to the elbow of government spending in the short term should be the watchword from where I am sitting. The economy now urgently needs some sort of platform placing firmly underneath it, since otherwise with this rate of contraction the danger is that as the inflation peters out it will be followed by sharp and severe deflation.

So as a say at the start of this post, the great "hard landing - soft landing" debate is now effectively over, and a hard landing it is (although I haven't seen the touch judge raising his red flag yet). The only real outstanding issues now are how long the Lat peg can hold, and what to do now to drag the economy out of the mire into which it is steadily sinking.

Friday, March 7, 2008

Black Friday in Budapest?

Question: how do you know they are holding a referendum on the government's difficult and unpopular economic adjustment package in Hungary on Sunday? Answer: take a look at what happened in the Hungarian financial markets on Friday.

It should not have been too difficult to see all this coming, yet financial analysts seem to have been strangely silent on the potential implications of the latest political twist in Hungary's ongoing economic agony. And where they have not been silent they have generall been trying to downplay its importance. Only last week Goldman Sachs' Hungarian analyst István Zsoldos was busy reassuring us that the coming referendum would have no lasting impact on the evolution of Hungary's long drawn out economic crisis (although he did admit that the short-term political noise was “likely to intensify"). I beg to differ. I think the consequences of Sunday's vote are going to be important and long lasting (indeed I had the referendum pencilled in in this post as the third of my potential tipping points for Hungary's economy, with the the second one being the last interest rate setting meeting of the central bank, when, of course, they did scrap the currency band), and they are going to be important and long lasting regardless of whether or not the Hungarian authorities manage to plug the now growing breach in their credibility and the value of HUF denominated instruments in the short term.

So why is there a problem? Well, anyone with even a passing and cursory knowledge of political and financial crises should know by now that you can't forever fill the growing disatisfaction of a population with their lack of nice fresh bread by sending them over cake for ever. Basically, any government has a limited amount of ammunition stacked in the chamber (which is why you need to be careful how you fire it off) and once your bullets are spent, or you get to fire off as many as you are able before your voters finally get mad, then you need to watch out, since events have a nasty habit of moving swiftly. And this is what is starting to happen right now, before our very eyes in Hungary.

Basically Hungary had a sudden financial crisis back in the summer of 2006, on the back of a massive "twin" deficit (ie fiscal and current account) problem, and subsequent to this the government introduced a series of "austerity measures" principally designed to try and correct the fiscal deficit situation. The core of this package was a downsizing of government spending (including a reduction in services and employment in the public sector), and an increase in social security contributions, charges for the state administered utility sector, and individual charges for clients in the state health and education system. The first two of these have played no little part in generating the dynamic which means that Hungary is now labouring under a 7% inflation rate, while the latter (the health and education charges, and their constitutionality) constitute the core of the issue for Sunday's referendum.

Basically the government has become highly unpopular on the back of the package and its evident lack of success in resolving the underlying issues facing Hungary (see chart below, Fidesz is the opposition and MSZP the government) and the opposition are trying (pretty opportunistically in my view) to create a climate of "no confidence" in the government in the hope of achieving early elections.

What I am not saying is that voters will be right to reject the parts of the austerity package they are being asked to vote on on Sunday. Far from it. The new social welfare charges may or may not be an intelligent way of adressing the issue to hand, but they do now constitute the symbolic core of the adjustment process, and rejecting them will be tantamount to rejecting the whole process which lies behind them. Hungary is poor, and has a rapidly ageing and steadily declining working population, and you can't give yourself a five star welfare service if you only have a two star economy. There is just no way you can pay for it, whatever the politicians say. So somewhere or other along the line the Hungarian people are going to have to accept that they will have to cut their coat according to their cloth, and this is what Sunday's vote is all about in my book.

The problem now is that there are various kinds of realism at work here, one of these is the dynamic needed to face up to a hard and complex reality, and another is the kind of political realism that economic analysts have to factor in to their policy packages, since once citizens and voters get fed up with promised results which continually fail to arive - and this is what is starting to happen now in Hungary and why it is that all those "ever so optimistic" and rosy forecasts which have been busily going the rounds in Brusssels and Budapest of late are really so very very dangerous - then what were once upon a time sobre and calculating people may well become irrational, and economic policy has to take this kind of irrationality into account just as much as it takes the more normal kind of rational inflation expectations into account. Basically I think the Hungarian voters are reaching the limit of their endurance with being sold cake when all they really want is bread, and it is this weariness that we are about to see expreesed on Sunday, after which point, unfortunately, the credibility and legitimacy of the whole present adjusment process may well be increasingly called into question.

So Why Black Friday?

So why do I call it black Friday? Well yesterday morning the corridors of Budapest were as thick with rumour as they normally are with smoke. Things got off to a very early start (around 10:00 am Budapest time) with Portfolio Hungary announcing that an emergency meeting had been convened between the National Bank of Hungary (NBH), the Finance Ministry and the Government Debt Management Agency (ÁKK). The reason for the meeting was apparently that an "emergency situation" had arisen on the foreign exchange market, with liquidity having become "practically non-existent" and ... "even if contracts were being made, they would normally signal unrealistically high yield levels," as one Portfolio Hungary source is quoted as saying. (This description is so reminiscent of the Paribas statement on August 9th 2007 that liquidity in the european securitised wholesale money market had practically evaporated).

The purpose of the tripartite emergency meeting was ostensibly to decide on how to stabilise the market situation by making purchases on the bond market. Effectively this could be construed as being an emergency meeting of the Monetary Council of the central bank in advance of the next scheduled rate meeting due on 31 March.

No sooner had Portfolio Hungary made this announcement than one hour later (around 11:00 am) Judit Iglódi-Csató, communications director of the central bank, was out and about denying that any such meeting was taking place:

"The NBH has not held an extraordinary rate meeting and there was no extraordinary joint meeting by the NBH and the ÁKK,....The central bank has not intervened into fixed income market processes"
Ferenc Pichler, press chief at the Finance Ministry, was also entered the fray, issuing a statement to Portfolio Hungary rejecting the rumour about a joint meeting. He did acknowledge, however, that ÁKK officials had visited the NBH, but emphasized that talks were on a completely different matter.

Later the same morning, however, Hungary's Finance Minister János Veres accepted that the ministry did in fact hold talks with the Government Debt Management Agency (ÁKK) and the central bank (NBH) about the situation in the fixed-income market. He denied, however, knowledge of any central measure - like buying bonds - to be implemented in the secondary market. "There is no need for concern, experts are dealing with the situation," he is quoted as saying.

What has provoked all this concern has been the sudden jump in the benchmark three-year bond yields, which rose yesterday to the highest level since November 2004. Traders and analysts were busy speculating that this rise might force policy makers to raise the central banks benchmark interest rate, which is already (at 7.5%) the European Union's second-highest (after Romania), or to start buying back bonds to jumpstart the market after bond trading had suddenly dried up.

Bloomberg quote Marian Trippon, an economist at the local unit of Intesa Sanpaolo SpA, as saying "There is no market...Everybody is waiting on the sidelines, afraid to get in. If this is sustained and the government securities market ceases to exist, then the central bank can't watch idly."

Hungary's forint was down by more than 1% against the euro late yesterday afternoon and government securities yields leaped by some 20-30 basis points, partly as stop-loss contracts kicked in (forced sales). In the secondary market, yields leaped by 40-70 basis points from late Thursday levels (to levels which are currently around 10%).

The forint weakened further during the morning to 266.20 to the euro by 1:30 p.m. in Budapest from 264.44 late on Thursday, but it firmed again in late afternoon trade to around 264 although at the peak of negative sentiment in the morning session it was almost as weak as 267.

The yield on the benchmark three-year bond rose to 9.86 percent from 9.27 percent. The yield has now climbed more than 2 percentage points in a month. Market participants generally seem to be now pricing in a rate hike of around 100 bps within the next month. According to data from the Government Debt Management Agency (ÁKK), the yield on the 3-m T-bill jumped by 34 bps to 8.60% today (the base rate is 7.50%).

Hungarian bond yields started soaring a little over a week ago following the decision on Feb 28 by Peloton Partners LLP, a London-based hedge-fund firm, to begin liquidating its ABS Fund following "severe" losses on mortgage-backed debt. Then last Friday (29 February) a local bank was unable to sell a bond portfolio which lead the yield on the three-year bond to rise 46 basis points in a single day.

Following this the Hungarian debt management agency AKK revealed on March 3 that it was going to decrease the volume of government bonds it offered for sale by as much as 30 percent, while at the same time increasing its auctions of Treasury bills, which are closer to cash and viewed as safer. The agency made the decision after a joint meeting the biggest local bond traders.

The current situation has been described by Portfolio Hungary as a tsunami of risk aversion. Another indication of the growing scarcity of liquidity in the Hungarian market came on Thursday when the AKK sold HUF 35 bn of 12-month discount T-bills at an average yield of 8.51%. This yield was up another 6 basis points from Wednesday's benchmark fixing and was 28 bps higher than at the previous auction of the same instrument two weeks ago.

Hungarian central bank (NBH) Governor András Simor and MPC member Gábor Oblath have both been working hard to try to maintain the central banks credibility in the present situation, in particular by vigourously stressing earlier in the week that the national bank remained strongly committed to achieving its present inflation target. This is viewed as being important, since it is an indication of the bank's intention to remain firm on interest rates in the face of what must be growing political pressure to do something to support weakening domestic demand and to slow down the steady rise in unemployment.

Reacting to recent rumours about the possibility of the bank abandoning its target Simor said that such rumours were “ridiculous and unfounded", while Gábor Oblath stressed that the National Bank would obviously need to resort to monetary tightening if prolonged weakness of the forint began to threatenen the target. This may well be where we are now. And central bank policy may well be driven by the need to support the forint rather than address the economic stagflation position - rising inflation and falling growth, see chart below - which is resulting from the collapse of internal demand.

But the bank will only be able to maintain this stance for as long as the voters are willing to accept the medicine. Hence the importance of Sunday's vote. We are in the garden of the forking paths, where political and economic dynamics both intercept and separate, and who knows at this point just what pace of evolution we will see in each of them.

Household Currency Risk

The principal preoccupation of the central bank, and the spine stiffner for their resolve to defend the currency value, comes of course from household exposure to rapid currency adjustments via their loan portfolio. Nearly 60% of the outstanding loanscurrently being paid by Hungarian households were FX-based at the end of January, and any forint weakening, and especially any weakening against the Swiss Franc (the euro is in fact virtually irrelevant here), represents a substantial potential distress burden for all of those involved. According to figures provided earlier this week by the National Bank of Hungary (NBH) the weakening of the HUF in and of itself boosted household debts to banks by HUF 189 billion in January alone (since with the loans being measured in Swiss Francs, as the forint goes down the loans go up).

Loans granted to the household sector rose by HUF 274.1 bn or 4.5% (to the new high of HUF 6,190.9 bn) in January. Forint loans were down in fact down (by HUF 16 bn) and all of the increase was in foreign currency loans (up by HUF 290.1 bn). Exchange rate valuation effects directly contributed HUF 189.2 bn, to the increase in the value of foreign currency loans held. This latter development is largely due to the fact that the HUF weakened by nearly 5% against the CHF between end-December and end-January. The forint's depreciation versus the euro was 2% during the same period, but as I said the euro is virtually irrelevant here.

Since the HUF weakened by further 4% vis a vis the CHF in February we can be pretty sure that the household burden grew further simply due to the weaker forint in the second month of the year too. If we look at the HUF-CHF chart for the last couple of years we can see that while the forint has deteriorated against the CHF since June last year, HUF values are still well above what they reached in June/July 2006.

So anyone who took out CHF loans in mid 2006 would still be well protected at this point in time. Unfortunately, if we come to look at the term profile of the contracted loans we will see that foreign loan mortgage finance is heavily weighted towards the second half of the two year period (2006 - 2007).

In fact in recent times the share of foreign currency loans within the total has only risen and risen. In January it was up to 57.3% from 55.0% in December. This ratio has been rising continuously over the past two years, and in January 2007 it was nearly twice the level of January 2005. Within aggregate loans to households, housing loans expanded by 4% to HUF 3,260 billion, and foreign currency loans rose to 48.8% from 46.4% as a percentage of housing loans. Of particular note is the fact that the stock of mortgage loans for consumption grew by nearly 13% in January over December, to HUF 1,383 billion, and this increase can be attributed almost exclusively to a rise in the stock of CHF-denominated loans.

So basically domestic consumption demand in Hungary is now very much being held to ransom by future movements in the valuation of the forint vis a vis that of the Swiss Franc, with the Hungarian Central Bank's ability to do anything meaningful to soften the severity of Hungary's current economic crisis being reduced to an effective zero. Hungarian citizens should consider themselves lucky in the coming months if they do not face a sharp tightening in monetary conditions simply generated by the need to protect the currency (as a say above the markets a currently pricing in at least a 100 base point increase in the central bank rate). Since movement in the value of the CHF is particularly hard to forsee, and doubly so given its potential role as a safe haven currency in times of global uncertainty, I basically still can't really understand how what would appear to be otherwise reasonably rational and intelligent people (the central bankers and those responsible for Hungary's financial affairs) allowed private debt exposure to currency movements to reach this state of affairs in the first place.

Wednesday, March 5, 2008

Romania GDP Q4 2007 - Evident Signs of Strong Overheating

Romania's economic expansion accelerated in the last quarter of last year, raising expectations of further interest rate increases from the central bank in an attempt to contain a strong upward movement in inflation which has been fuelled by a Romanian government increase in end of year spending and a steady household consumption boom. Gross domestic product (according to preliminary data, fuller details on March 12th) rose at an annual rate 6.6 percent in the fourth quarter, the fastest since the last quarter of 2006, and up from 5.7 percent in the previous quarter according to data released by the National Statistics Institute (INSSE) on Tuesday.

Romania's entry to the European Union on Jan. 1 2007 has seen a sharp increase in foreign investment and inflow of bank funds (and remittances as Romania's workers have moved abroad), and all of this has served to boost wages, lending and consumption to rates which are hard for the Romanian economy to absorb and sustain. Around 10% of Romania's workforce of around 10 million are currently working outside the country (largely in Italy and Spain), and of course many of these potential workers who have been lost are skilled and in the most economically productive age groups.

Spain and Italy have in fact been the principal destinations for Romanian migrants, athough surprisingly, and as can be seen in the Spain chart below, far from attempting to actually measure the extent of the problem, the official data - which only identifies those who have formally declared themselves to be permanent migrants - bears little relation to reality. According to the Spainsh national institute of statistics, the number of Romanians in Spain has increased in the following fashion in rcent years:

More detailed explanation of this phenomenon can be found in this post). The number of Romanians in Italy has also increased dramatically as the following chart from the Italian statistics office makes clear.

The problem is that while all these Romanians may be working out of the country, they are at the same time busily sending remittances home, and these remittances in their turn only serve to fuel domestic demand even further. Basically it is hard to get an accurate picture of the actual volume of remittances which are being sent home. One estimate comes from the World Bank, who openly recognise that what they provide is absolute minimum data. Noththeless, and even if the true numbers do not accelerate quite as sharply as the IMF data seem to show (which may be rather an indication of better data in more recent years), a sharp uptick has obviously taken place.

Another way of looking at the remittances issue is to take the current transfers item in the monthly balance of payments data published by the National Bank of Romania, and since this shows a rather smoother upward curve, and one which seems to be closer to the actual pattern of migrant outflow, perhaps it gives us a better general indication.

While such data is of limited validity in absolute terms - since it includes other kinds of transfer - in relative terms it can give us a much better appreciation of how the remittances situation has evolved over the years than the World Bank data can.

Be all this as it may, the world bank estimate the 2006 volume of remittances to have amounted to some 4.1% of GDP, and that is very large, and with significant macroeconomic consequences as we are currently seeing. I think what no-one had thought about before all this started happening over Eastern Europe was the way in which these remittances could be treated as an income stream and used to finance mortgage borrowing to fuel construction, with all the distortionary consequences we are now observing. Basically, the lesson from Romania (and elsewhere in the CEE) has to be that if you have very low fertility over a long period you certainly cannot live by exporting labour in the same way that high fertility societies like Philippines, Pakisatn or Ecuador do.

Signs of Overheating Everywhere

As a result of these pressures on capacity, Romanian inflation accelerated to 7.3 percent in January (up from 6.6 percent in December). Obviously the National Bank of Romania now looks set to raise and raise its main interest rate throughout the first half of this year.

More strength to their elbow will come from this weeks PPI reading which showed that producer-price growth in January accelerated for the fifth consecutive month, reaching an annual rate of 13 percent, the fastest pace since August of 2006, according to a separate INSSE report today.

The central bank raised its main interest rate to 9 percent from 8 percent at its last meeting on Feb. 4. This was the third consecutive increase, and the bank cited "inflationary pressures that have been amplified by persistent excess demand as a consequence of strong wage increases and fast growth of credit to the private sector".

The central bank next meets on March 26 to discuss its main interest rate.

One of the problems they will need to be thinking about is private indebtedness since this grew an annual rate of 66.8% percent in January, while foreign exchange loans to households grew at an astonishing and alarming 143.4% annual rate.

At the same time net monthly wages have been rising rapidly, with the rate slowing slightly in December but still increasing at an annual rate of around 15 percent.

Further indication of the kind of overheating which is currently going on can be found in the fact that retail sales grew in December at an annual rate of 20 percent in December while the construction industry increased its activity by 28 percent on the year.

Central Bank Double Bind and Currency Risk

In the face of all of this it is evident that the Romanian central bank will continue to increase its benchmark lending rate, which is already the highest in the European Union. The question is, what will be the objective of these increases? If we look over our shoulders a little to see what has been happening in Hungary, we can begin to see that the Romanian central bank will now be increasingly faced with conflicting policy objectives. Looking just a little further ahead - oh why is it that so many people have so much difficulty seeing what must be coming only round the next corner - at some point what can't continue won't, bank lending criteria will change (indeed it may well already be doing so, since only last week Hungarian mortgage bank OTP announced it was ceasing to offer unsecured loans in the Romanian market due to the high level of loan delinquency) and overheating will transform itself into its opposite, "rapid overcooling", or engine seize-up if you prefer (as we are now seeing in the Baltics).

At this point the central bank will face a dilema: whether to lower interest rates to give support to what at that point will be crumbling internal demand, or to pump rates up to defend the currency given the level of exposure to foreign currency loans. There are already signs that just this development may now be taking place. The leu has been under almost continuous downward pressure since last August (see chart below) and JPMorgan Chase are now predicting that by the end of the second quarter the central bank will need to raise its Monetary Policy Rate by at least 1 percentage point to 10 percent simply to keep the leu from dropping to the "never mind the quality feel the pain" level of 4 per euro. This point was made by Miroslav Plojhar, an emerging-market economist with JP Morgan in London in a client note earlier this week.

"Problems in the financial markets can cause banks, mainly in Central Europe, to cut credit lines causing problems in financing the current-account deficit and sparking a sell-off in the leu....The fuse needed for it keeps getting shorter" Plojhar said.

I would add to the problems in financial markets the issue of fears about levels of exposure as tthe overheating turns into its opposite, and the currency exposure of Romanian clients starts to mount. Certainly few would want to repeat the experience the Swedish banks appear to be starting to have as a result of the lending practices of their subsidiaries in the Baltics.

Conclusion. Romania is overheating strongly, not far from a "correction", and needs watching carefully from now on.


More details about Romanian background demography can be found in my Romanian Demongraphy at a Glance post,

more details on the argument about catch up growth, overheating and demographics can be found in Claus Vistesen's Catch Up Growth and Demographics post,

and some more elaboration of the central argument in this post can be found in my Alarm Bells Ringing in Romania post.

Tuesday, March 4, 2008

Estonia Retail Sales January 2008, and Sweden's Banks in the Baltics

According to Statistics Estonia retail sales grew at a 1% annual rate (in constant prices, ie real terms) in January 2008 when compared to January 2006. The growth rate of retail sales has been decelerated significantly during the last part of 2007 - as can be seen in the chart below - and this deceleration has now continued into January 2008. We have no sign at this point of any slowdown in the rate of deceleration, and if things continue like this we will evidently enter the contraction phase as of February.

Basically, if you keep following this blog you will one day get to see when a process of sharp deceleration finally gets to "bottom out", but that day evidently has not yet arrived.

On another front the Swedish banking sector is evidently begining to notice the wear and tear associated with its exposure in the Baltics. We have already reported on the decision by Moody's Investors Service to cut its ratings for Estonian banks on concerns of "weakening asset quality due to high exposure to the cooling property market". Moody's assigned a negative outlook to Estonian banks, including AS Sampo Pank, fully owned by Danske Bank A/S, and Balti Investeeringute Grupi Pank AS. This followed hard on the heels of their decision on Jan. 18 to lower the outlook of AS Hansapank, the top Baltic lender and a fully owned unit of Swedbank AB, to ``negative'' from ``stable.'' Hansapank accounts for more than half of Estonia's banking industry assets.

At the end of last week, in a revealing article in the Financial Times entitled Uneasy Calm At Sweden's Banks, David Ibison argued that all is not as straightforward as it seems in Sweden's banking system, and one of the reasons it isn't is the exposure out in the Baltics.

At the same time, the share prices of two of the banks – SEB and Swedbank – have been hit hard over misplaced concerns over their exposure to the emerging Baltic markets of Latvia, Lithuania and Estonia. Particular attention is being paid to the depressed valuation of Swedbank, whose Baltic operations are conducted by Hansabank, a wholly owned subsidiary.

Fears of a sharp slowdown in the Baltics and a related contraction in bank lending to the housing market have sparked worries that Hansabank will suffer and that its problems could have a knock-on effect on Swedbank.

At Swedbank's current price, Hansabank is valued at almost nothing, in spite of the fact there are no signs of problems with its Baltic loan book, which is well capitalised and where non-performing loans are well in hand.

Ronit Ghose, an analyst at Citigroup, said: "Hansabank has gone from a multiple in the mid teens to close to zero . . . The market is taking a negative view of these countries and of Swedbank's share price and is overlooking the positives."

Finally, and for those of you interested in comparative charts and urban legends, here is a retail sales comparison for Latvia and Estonia (Latvian retail sales actually declined slightly in January).

Now I mention urban legends here, since I think that in the Baltic context we have had two:

1/ The Baltic countries were so small that Nordic banks would have no difficulty keeping them supplied with funds, so there wasn't too much to worry about.

2/ Estonia was running along the same path as Latvia, only one year ahead (or was that behind?).

The first of these legends, as is shown by the material posted above, is now evidently false, the Nordic banks are now going to have to think very carefully about every move they make in the Baltics.

And the second also looks to me to be a bit ridiculous when you look at the two charts for retail sales movement, since what is striking is how similar they are, and given the level of external trade interlocking, and hence the dependence of export performance on internal demand in the other, this shouldn't surprise us terribly. Latvia's downturn is accelerating slightly more rapidly at this point than Estonia's, but the difference is secondary, and not one of substance. Certainly the credit crunch must have been applied at roughly the same moment last spring in both countries, and now a very similar process is working its way through the two systems. And in neither case, it seems, do the political authorities have any sort of coherent emergency "plan B" to deal with what is now an all too evident emerging eventuality.

And for those of you who are addicted to comparative charts, here is the latest EU economic sentiment indicator for the Baltic states. Here we can see that it is the case, Estonia did take off downwards rather earlier than Latvia, but Latvia has been fast catching up, while in the last couple of months sentiment in Estonia does seem to have stabilised. Whether or not this stabilisation constitutes an early indicator of "bottoming out" we will get to see over the next couple of months from the real data as it comes in. Certainly one to watch for. On the other hand it does seem that Lithuania WAS a "late developer" which is now also, and in its turn, in the process of catching up.