Monday, May 12, 2008

Have the Baltics Entered a Recession?

by Claus Vistesen

As any mildly astute economist will know it is extremely difficult to call the exact turning point in an economic cycle and thus the point in time where a recession starts. Usually, such issues are resolved post mortem when the economic data has been firmly revised. Moreover, the actual determination of a slowdown's or a recession's starting point also quickly turns into a battle royal between economists as the alphabet soup of different national account measures easily ties up the discussion as we end up comparing apples and pairs. However, at this point in time I don't think we have the luxury to engage in such a battle among economic gentlemen. I don't think so because the Baltics' (and many of the other Eastern European countries') situation is a bit more complex than your average US type recession where a you clean up the mess with a couple of quarters of negative growth. What we consequently need to understand is that, depending on the turn of events and response from markets, the current slowdown may turn out to have quite far reaching consequences for the region. With these ominous remarks let us turn to the evidence suggesting that the tide is now finally turning in the Baltics.


In fact, we can only at this point say something decisive about Latvia and Lithuania since Estonia has not yet posted Q1 08 figures. The pace of growth however has been consistently lower in Estonia throughout 2007 compared to 2006 and in Q4 Estonia posted a growth rate of 0.9% q-o-q which is of course more than respectable but a significant slowdown in relative terms. What remains to be seen now is whether Estonia will kick off 2008 with negative growth rates or just eek out a positive showing. Indicators for retail sales suggest that Estonia may be lagging Latvia so I would not be surprised if Estonian Q1 is positive on a q-o-q basis. In the context of Latvia my colleague Edward Hugh has been keeping a watchful eye. Back in March he asked the question of whether we were heading into a recession in Q4 2007? At the time, strong circumstantial suggested that this was the case and now with the recent flash estimate from Q1 it is safe to say the coffin has now been supplied the final nails;

(...) in constant price terms - Latvian GDP hit a peak at some point between Q2 and Q3 2007 (lets say August 2007) and since that time has been steadily CONTRACTING. Now I know there are probably hundreds of different ways of skinning a chicken, and of course you can read data everywhichway you want to, and there are seasonal factors to take into account, but as far as I am concerned there is no getting away from it, on any reasonable criterion the Latvian economy is now in recession, and has been since the middle of last year.



This leaves us with Lithuania. Since we just recently got Q1 2008 GDP figures (provisional estimates too) we should have a fairly strong picture of what is going on. First, we will have the visual inspection;









As can be observed in the figure above Lithuania stalled sharply from Q3 to Q4 and now posting a contraction in Q1 08 on a q-o-q basis. On a y-o-y basis the economy is still growing but this figure is basically pointless in so far as goes the determination of where the economy is at in the present time. The first graph speaks for itself and in this context the two additional graphs plotting the indexed values of GDP do not really add much to the general picture. I still think they have merit though. Especially the last one is interesting as it shows the 'momentum' of the slowdown. Basically the chart shows the rate of expansion relative to the previous period without saying anything about the level of growth (which is shown in graph number two).

In Summary

I have been very cautious in pulling out the R-word in connection with the Baltics let alone Eastern European in general. I still am. However, what is clear at this point is that we are now observing a hard landing. The rate of the slowdown since it began in the middle of 2007 leaves no other conclusion I think. What happens next then? This question is not at all insignificant. What we now have on our hands in the Baltics is, in macroeconomic terms, quite a predicament. Basically, the economic momentum now seems to be unwinding far too fast relative to the pace by which the inherent imbalances present in these economies can be expected to respond. Large external deficits and pegging currencies here are important since it means that the latter cannot adjust. The only possible alternative if the rout continues is consequently a transition into price and wage deflation. It is still early to say whether this will materialize but it is now a real risk rather than a theoretical possibility. Additionally, we now need to watch all those foreign banks who have set up shop across the Baltics helping to finance all those credit inflows. Will they stay or more specifically can they afford to? This is also now a question which must be considered as more than an academic question.

I am really sorry to start this week on such a nasty note but I do think that the genie is out of the bottle in the context of the Baltics. Now we need to watch carefully where it goes from here. If economic momentum (or lack thereof) continues to linger in the current territory we should be a prepared for a rapid change of fundamentals in the Baltics.
Posted by Admin at 9:04 AM

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Spotlight On Hungary

Welcome to the Eastern Europe Economy Watch Blog. By clicking the older posts link (at the foot of the page) you will be able to leaf through the normal chronological blog posts. But first we have our country of the month feature where we would like to present some charts which provide background data we hope will help the first time reader better assess and get to grips with the general argument being presented on the blog. Below you will find charts for Hungarian male life expectancy, fertility, quarterly GDP growth, inflation, household demand, retail sales, and import and exports growth. Please click on thumbnails for better viewing.

On the left you can see a chart for Hungarian male life expectancy, and on the right there is one showing Hungary's population development. Just why such factors are important, and need to be taken into account along with more standard macro economic data in order to understand what is currently happening in Hungary and what might subsequently spread across Central and

Eastern Europe can be discovered by reading my Hungary analysis:Just Why Is Hungary So Different From the Rest of the EU 10?The basic arguments being advanced here are that long term fertility and life expectancy do matter, since in the long run they condition the labour force and consumption patterns, and with these inflation and internal demand.



Above left you can see Hungarian ferility, and above right the evolution of the population median age, which are also key parameters, since they influence saving and consumption, and with these internal demand growth. On either side here you can see charts for inflationand quarterly GDP.


Next on the left we have a chart for recent movements in private internal consumption (which shows us the state of internal immediate consumption demand) while on the right we can see changes in constuction activity, (which serve as a nice proxy for fixed capital formation). Finally the chart on the bottom left shows a comparison of Hungary's trade balance 2006 and 2007,


while on the right you can see the evolution in non-forint mortgages for immediate consumption purposes. Arguably these are all the data points you need to understand my lengthy post on why we face a possible recession in Hungary, and why post-recession Hungary may be converted into yet another export dependent economy.


2008 Forecasts: The OECD in December revised their 2007 Hungary forecast down to 1.8%, and 2008 to 2.6%. These numbers are very hard to accept. I will be very surprised if we see calendar year 2000 as high as 1.8%, but more to the point 2.6% seems to be assuming a strong rebound, an assumption for which there is no real substantive evidence. In particular even to get what growth we have been getting in 2007 the Hungarian govenment has been running a deficit of around 6% of GDP. This is going to tighten yet further in 2008, so there is no supportive fiscal environment. And as I keep arguing, it is very hard to see a supportive monetary one. The IMF in their October World Economic Outlook also put a similar figure of 2.7%, while the EU commission in November 2007 came in with the same 2.6% as the OECD.

Perhaps the prize for the most exaggerated prediction here must go to GKI Gazdaságkutató Zrt, who argue that Hungary should expect the incredible annual growth rate of 3.5%. My own view is much more nuanced. I think I am reasonably confident in holding to my recession forecast for 2008, although of course, "recession" does not mean negative growth for the whole year (technically it is simply 2 consecutive quarters of negative growth), so we might then go on to see what, between 0.5 and 1% growth over whole year 2008 (and the only really doubt is whether the contraction starts in Q4 2007, or in Q1 2008). But it is what happens in 2009 and 2010 that matters really, and at this point so many variables are in play (and interrelated ones to boot) that I can only say I envy those who have the courage - or the temerity - to stick their necks out). And of course, if we get a large correction in the value of the forint, then all those carefully weighed and weighted forecasts will, without a shadow of a doubt, go straight and directly off into the bin.