Tuesday, March 31, 2009
The Czech Republic will be holding an early general election later this year - nearly a year ahead of schedule - after the center-right coalition government of Prime Minister Mirek Topolánek was brought down last week in a parliamentary no-confidence vote. Topolánek, who submitted his resignation last Thursday but remains as caretaker head of government and leader of the Civic Democratic Party (ODS) - the largest party in the Central European country's bicameral legislature - subsequently reached an agreement with former Prime Minister Jiří Paroubek, the leader of the Czech Social Democratic Party (ČSSD) - the main opposition force - to hold an early poll next October; a specific date remains to be determined.
Prime Minister Topolánek came to office following a closely fought general election in June 2006, which left the Chamber of Deputies - the lower house of the Czech Parliament - evenly split between left- and right-wing parties. However, in early 2007 Topolánek was able to secure a parliamentary majority with the help of two rebel ČSSD deputies, and he went on to survive four no-confidence motions during the course of 2007 and 2008. Nonetheless, his government depended upon a fragile majority, which was finally shattered when four dissident deputies - two from ODS, plus two recently expelled from the Green Party (SZ) - sided with ČSSD and the Communist Party of Bohemia and Moravia (KSČM) to pass by 101-96 a vote of no-confidence.
Coincidentally, the fall of the Czech government came on the same day that Topolánek - who currently holds the European Union's rotating presidency - made headlines around the world when he criticized the economic stimulus program of U.S. President Barack Obama as "the road to hell." While the vote of confidence was triggered by allegations of abuse of state subsidies by a deputy who left ČSSD to support ODS, some opposition deputies voted to bring down Topolánek as a protest against his government's economic policies, which according to them failed to deal effectively with the global financial crisis; although the Czech economy is not in as dire straits as those of other nearby countries (such as Hungary), the Czech Republic is nonetheless forecast to suffer a recession this year.
Opinion polls have ČSSD ahead of ODS; that said, the gap between the two parties appears to be narrowing down. Nonetheless, the Social Democrats are hoping for a repeat of their performance in last October's regional and Senate elections, in which ČSSD captured 23 of 27 Senate mandates up for renewal, depriving ODS of its absolute majority in the upper house of Parliament. Although it has some ex-Communist members, ČSSD is not a post-Communist party; unlike major left-of-center parties in other Eastern European countries, it traces its roots to the Social Democratic Party that was forcibly merged with the Communists in 1948. However, the Czech Social Democrats have to compete on the left with the Communists, who still command a significant following.
The Czech Chamber of Deputies is elected by party-list proportional representation in regional constituencies - Parliamentary Elections in the Czech Republic has a review of the Czech electoral system - and no single party has ever commanded an absolute lower house majority. Moreover, the ongoing presence of a sizable, unreformed Communist Party has greatly complicated the task of forming stable governments in the Czech Republic. While the Social Democrats have called upon Communist support from time to time (as they did for last week's no-confidence vote), neither them nor the parties to their right regard the Communists as suitable coalition partners, largely for historical reasons: save for the short-lived "Prague Spring" of 1968, the Communist Party governed Czechoslovakia - the now-defunct federation of the Czech Republic and Slovakia - in a totalitarian fashion from 1948 to 1989, when the Velvet Revolution put an end to the Communist regime.
As a result, since 1996 the Czech Republic has been ruled either by shaky coalition cabinets, such as those formed from 2002 to 2006 by ČSSD and the four party coalition headed by the Christian and Democratic Union-Czechoslovak People's Party (KDU-ČSL), and from 2007 to the present by ODS, KDU-ČSL and SZ; or by minority governments dependent upon the good will of the opposition, as was the case from 1998 to 2002, when ODS reached an "opposition agreement" with ČSSD under which the Civic Democrats tolerated Milos Zeman's minority Social Democratic government without supporting it.
In fact, Topolánek may have to reach out to the Social Democrats in order to secure Senate passage of the Lisbon Treaty, which would streamline the functioning of the European Union. While Topolánek is in favor of the treaty, many Euroskeptics in ODS remain opposed to it, as is President Vaclav Klaus, the former leader of the Civic Democrats.
At this juncture, it remains unclear what will happen to Prime Minister Topolánek's outgoing government until the election is held. ČSSD leader Paroubek declared that he is willing to tolerate the government until the end of June (when Sweden takes over the EU presidency) if certain conditions are met, but favors the appointment of an interim government of non-party experts after that date. Meanwhile, Topolánek insists on remaining in office, but he and President Klaus - who has the right to appoint the next government - are political enemies, and not surprisingly Klaus is proposing the formation of a new cabinet without further delay. However, Czech governments require majority support in the Chamber of Deputies in order to remain in office, and in light of last week's events it appears rather unlikely that such support would be forthcoming.
Friday, March 27, 2009
By Claus Vistesen: Copenhagen
WHO is Raising rates? The immediate answer to this question would seem to be; not many. On the contrary, most major central banks and now also their peers in the emerging world seem to have come to the conclusion that to counter the crisis, they need to apply both conventional as well as unconventional monetary policy measures. Especially, among the major central banks quantitative easing is the name of the game with only the ECB still clinging on to the fig leave. So, I ask you again who is raising rates?
Well, it is not yet a done deal but to show what it means to be stuck between a rock and a hard place it would serve us well to have look at Hungary which, even among its CEE comrades, look comparatively battered and bruised. To make matters worse, Hungary received another blow to the kidneys as Prime Minister Ferenc Gyurcsany announced on Saturday that he was resigning his position. On the face of it, it is difficult to blame the guy since with Hungary being the first economy in Eastern Europe to secure a loan from the IMF to the tune of 20 million euros the corresponding budgetary cuts demanded look almost cartoonishly unrealistic relative to the economic situation.
Even as he presided over a reduction of the budget deficit from 9.2 percent of GDP in 2006 to about 3.3 percent last year, Gyurcsany was criticized in February by some opposition parties and the central bank for his proposed 900 billion forint ($4.1 billion) tax shuffle to boost growth. Critics said more spending cuts were needed to stabilize the economy in the short run and boost growth in the long run.
“The government no longer had any room to maneuver,” Gyorgy Barcza, chief economist at KBC NV’s Hungarian unit, said yesterday. “Without new measures, the budget deficit would be more than the target.”Failure to continue austerity measures could result in a downgrade of the country’s credit rating, David Heslam, Director of Fitch Ratings’ sovereign team, said in a statement today. The agency rates Hungary’s debt BBB, the second-lowest investment grade, with a negative outlook.
The Socialist Party is less than half as popular as its biggest rival. Backing for the government started slipping when it introduced austerity measures to close a budget gap in 2006. The resulting economic decline was worsened by the global crisis, forcing the country to seek international aid. The party had 23 percent support last month, the lowest in 10 years, compared with 62 percent for the largest opposition party, Fidesz, pollster Median said on its Web site on March 18. Gyurcsany’s popularity fell to 18 percent, making him the most unpopular premier since communism. The poll of 1,200 people has a margin of error of 2 to 6 percentage points.
As Edward put it recently, it is difficult not to note a irrevocable pattern in the (unfortunate) countries subject to IMF intervention whereby they collapse under the yoke of the measures demanded in trade for the loan. Of course, we should not only shoot at the IMF since in the context of e.g. the EU one wonders the extent to which western Europe can just idly watch a country such as Hungary spiral into the abyss without extending some kind of bilateral help. Note in passing here that Gyurcsany's resignation marks the second case of government jitters in an IMF supported economy. The second would be Latvia where the government resigned recently.
As it could have been expected the market was none to happy about the PM's resignation which brings us to question of raising those rates. Consider consequently that the Forint which have already been pounded relative to the Euro completed a 2.6 percent drop to 308.62 against the euro (click on image for better viewing).
Consequently and following the Prime Minister's resignation the central bank was forced to move with comments that all tools would be deployed to avoid the Forint depreciation to spiral out of control. Now, I would not want to contradict myself here and let me very clear then; I think that a weak Forint is a fundamental part of whatever future Hungary may have but in the near term and with the rating agencies thoroughly marking the outlook for Hungary with the negative label it is a tightrope walk for policy makers not least because we still have the unresolved issue of translation risk whereby liabilities are denominated in foreign currency (mostly swiss francs though) and assets in Forints. Conclusively, it is difficult to see why, given the economic reality, the central bank would want to raise rates, but it is also difficult not to concur that they need to do something with respect to ensuring some kind of order vis-à-vis Hungary's stakeholders not to mention investors. Perhaps this duality more than anything shows us the almost impossible situation Hungary now finds itself in.
Raising the Stakes?
Meanwhile and moving across the pond for a minute it appears that US authorities have just raised the stakes in the dramatic jeux d'horrible that is the unfolding economic crisis. Thus and following the Fed's shock and awe treatment of the markets last week as Bernanke rolled out measures to buy treasuries (presumably) in the primary market we got the long awaited details in Timothy Geithner's plan on how to deal with those toxic assets and consequently how to restore confidence in markets so that we just might go back to normal whatever that is these days.
Quite naturally, the plan (see also here and here) which includes most notably a public-private partnership scheme designed to take care of about 1 trillion USD worth of toxic asset has been parsed by many of the most astute economic pundits. From the horses own mouth this is how it is described;
The Public-Private Investment Program will purchase real-estate related loans from banks and securities from the broader markets. Banks will have the ability to sell pools of loans to dedicated funds, and investors will compete to have the ability to participate in those funds and take advantage of the financing provided by the government.
The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors. Second, the Public-Private Investment Program will ensure that private-sector participants share the risks alongside the taxpayer, and that the taxpayer shares in the profits from these investments. These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.
Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.
The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets. The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.
This program to address legacy loans and securities is part of an overall strategy to resolve the crisis as quickly and effectively as possible at least cost to the taxpayer. The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses. Our approach shares risk with the private sector, efficiently leverages taxpayer dollars, and deploys private-sector competition to determine market prices for currently illiquid assets. Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.
Macro Man offers nothing but a sigh, Paul Krugman is in despair, Calculated Risk also seems skeptical that this is the right approach and finally Yves Smith also chimes in with a "thumbs down". I tend to agree with the skeptics and even though I have not really studied the proposal in detail the principal problem for me is that the government is putting up money for assets of which some are surely worthless and others may be work significantly less than current book value. In this way, it does nothing to solve the underlying issue and the risk for the taxpayer seems substantial.
Ah well, perhaps I and the rest of the gang above are just party poopers. What is certain is that the markets liked it and in fact Macro Man may have hit the proverbial nail on the head when he recently, and once again, evoked March Madness (click on image for better viewing).
Of course, if there ever was something resembling a sucker rally it is this but so far things look as they are working. Also we cannot rule out that this initiative may just be what it takes to allow these assets to be marked to (a credible) market which would mean that we had taken one important step in moving forward. One thing which I do like by the activism in the US is that it is just that; activist which flies in the face of ostrich attitude prevailing on this side of the pond.
Rates and Stakes
So, what do Hungary and the US have in common here? Except being in the midst of their worst economic crisis of, arguably, all time not a whole lot I guess. However, they are both being forced to move into uncharted waters when it comes to fighting off the current mess in the global economy and her financial system. It will be very interesting to see whether raising rates as well as the stakes will bring forth the intended effects.
Last Saturday's announcement by Hungarian Prime Minister Ferenc Gyurcsány that he was stepping down after almost five years as head of government may have come as a surprising turn of events, given that he had stubbornly clung to office despite his growing unpopularity over the course of the last three years. However, what turned out to be completely unexpected was the method he chose to end his mandate: a constructive vote of no-confidence in the National Assembly (Parliament) against his own government.
Under a constructive no-confidence motion, Parliament votes to replace a sitting prime minister with another person, rather than simply bring down the government. This mechanism was introduced in the former West Germany after World War II, in order to prevent a recurrence of the parliamentary deadlock that contributed to the demise of the 1919-33 Weimar Republic.
Constructive votes of no-confidence have been adopted by other European countries - Hungary being one of them - since they ensure cabinet stability by preventing Parliament from removing a government from office without having agreed upon a replacement; in Germany there has only been one successful constructive no-confidence motion, which took place in 1982 when the Bundestag voted to replace Chancellor Helmut Schmidt with Helmut Kohl, after the liberal Free Democratic Party - at the time the Social Democratic Party's junior coalition partner - switched sides and formed an alliance with the Christian Democratic Union/Christian Social Union.
However, Gyurcsány plans to use the constructive vote of no-confidence to install another Socialist-led cabinet, and his government - which has become the third casualty of the global financial crisis, joining the ranks of Iceland and Latvia - appears to have resorted to this unusual maneuver for one simple reason: to avoid an early election.
Gyurcsány's post-communist Hungarian Socialist Party (MSZP) won Hungary's 2006 general election in coalition with the liberal Alliance of Free Democrats (SZDSZ), but in September of that year a leaked tape revealed that the prime minister had lied about the state of the Hungarian economy to secure re-election. Gyurcsány never recovered from this revelation, which triggered widespread protests that degenerated into rioting. Despite mounting calls for his resignation after the ruling parties suffered a heavy defeat in municipal elections held the following October, Gyurcsány refused to step down and subsequently won a vote of confidence in the National Assembly.
The Socialist-Liberal coalition government then went on to impose fees for visits to the doctor, hospital stays and university tuition, as part of an austerity package intended to reduce the country's large budget deficit (the highest in the European Union as a percentage of GDP) and pave the way for Hungary's adoption of the euro as its currency. However, Gyurcsány suffered yet another stinging defeat when the measures were soundly rejected by voters in a March 2008 referendum. Shortly thereafter, the Liberals left the government after Gyurcsány sacked the SZDSZ-appointed Health Minister; nonetheless, the Socialists remained in power as a minority government with external support from the Liberals. Meanwhile, Hungary's already weak economy took a sharp turn to the worse, which left the country no choice but to take a $25 billion international rescue package from the International Monetary Fund, the European Union and the World Bank.
Recent opinion polls have Hungary's main opposition party, the right-of-center Fidesz-Hungarian Civic Union ahead of the Socialist Party by more than forty (40) points; not surprisingly, Fidesz continues to press for an early vote, while the Socialists are hoping that a new prime minister will turn the party's fortunes around before a general election is held by the spring of 2010 at the latest. However, barring some completely unforeseen development it is highly unlikely the Socialists will be able to overcome Fidesz's massive lead, although they could conceivably reduce it. At any rate, Fidesz's large advantage would almost certainly be amplified by the complicated electoral system used to choose members of Hungary's unicameral Parliament (reviewed in Elections to the Hungarian National Assembly), which combines French-style runoff voting in single-member constituencies with regional-level party-list proportional representation and a cumbersome top-up national list.
By resorting to a constructive vote of no-confidence, which will be submitted to the National Assembly next April 6 (with a vote scheduled for April 14), Gyurcsány has left President László Sólyom out of the process. Hungary's head of state has made it clear he favors holding an early election, noting that the new prime minister would be in office for at most one year before the next general election would have to be held; nonetheless, he cannot intervene unless Gyurcsány actually resigns.
In the meantime, the Socialist Party - still chaired by Gyurcsány - has proposed three candidates for prime minister: former National Bank governor György Surányi, former president of the Hungarian Academy of Sciences Ferenc Glatz, and András Vértes, president of the GKI economic institute. The Liberals have already indicated their willingness to support Surányi; poll findings suggest SZDSZ could be wiped out in the next election, so the party has little appetite for an early vote. The Socialists have also been courting the moderately conservative Hungarian Democratic Forum (MDF), whose votes could prove to be crucial if they can't secure support from SZDSZ.
While an early general election remains somewhat unlikely, it should be noted that voters will still go to the polls next June to choose Hungary's representatives in the European Parliament, and the outcome of that poll could be indicative of what lies ahead.
Tuesday, March 24, 2009
During January-February 2009, indices of industrial products were 67.2% as compared with January-February 2008. This means there was a 32.8% drop in output year on year over the two months. In fact output was up slightly month on month (by 5.4%) in February, in part as a result of the demand for steel exports produced by the sharp Hyrvnia devaluation, and February output was "only" down by 31.6%, following January's 34.1% annual fall, so you could say that things were getting better, but frankly, and at this stage of the game, such finesse is a little but lost on me.
Construction output in January-February 2009 was just 42.7% of the level hit in the same period last year
In the January-February period, cargo shipments were 97.4 mln. tons, that is to say they were just 66.5% of the volume of goods transported during January-February 2008.
In January 2009, Ukraine exports were 2439.6 million dollars while imports were 2041.8 million dollars. This means that exports were down 33.4% while imports were down 56% over January 2008.
In February 2009, the consumer price was up 1.5% over January, up 4.4% so far this year, and up 20.9% over February 2008.
In January 2009 real wages and salaries of employees were down by 19.4% when compared with December 2008. Also total wages in arrears stood at 1525.1 million UAH as 1 of February 2009, up from 1123.5 million UAH on 1 January 2009 (35% increase on the month)
The unemployment rate (using the ILO methodology) for January-September 2008, on average, was 6,5% of economically active working age population. Unfortunately this is the most recent labour force survey data we have. Undoubtedly these numbers have increased significantly over the last 5 months.
In 2008, the Ukraine GDP was up 2.1% when compared with 2007, which means, if the so-called "experts" prediction is anywhere near right (and it doesn't look that unrealistic) the GDP growth chart since 1993 will look something like this, which for a comparatively poor country struggling to catch up is little short of a disaster.
Ukrainian still has not received the second installment of a $16.4 billion loan from the International Monetary Fund although Ukrainian Prime Minister Yulia Timoshenko said last week that "she is confident" it will be agreed to.
One of the sticking points with the IMF had been the projected 2009 budget, but Ukraine’s Parliament last week changed the 2009 state budget law to strengthen the central bank’s independence, meeting one key IMF demand for getting the second installment of the loan (we will remember the Parliament was debating sending the governor to prison for allowing the currency to float, again another one of the key IMF demands). Lawmakers need to pass two more bills to qualify for the $1.9 billion installment of the IMF loan, which originally was expected on Feb. 15, according to Oleksandr Shlapak, the first deputy head of the president’s staff, with the central bone of contention being the 5% budget deficit projected for 2009, and on a lot lower contraction forecast than the current "most realistic case" scenario.
Really looking at all this, what we have here is a country in total monetary, financial, and economic disarray, and this is before we even start to think about the demographic unwinding which lies ahead. No wonder Dominique Strauss Kahn recently warned of the catastrophe which looms before us. I seriously doubt any knows what to do about all this, I certainly don't. Tear my hair out perhaps. But I already have precious little left.
Monday, March 23, 2009
Certainly if we come to look at the purchasing managers indexes we can see that things were better in February than in January. The VTB services index rose to 40 in February from 36.8 in January, although since any reading under 50 indicates contraction, it is clear that Russia's services industries are still shrinking at a pretty hefty rate.
The manufacturing PMI also improved slightly, rising to 40,6 from January's record low of 34.4.
This impression gained from the PMIs is also confirmed by the latest data for Russian industrial production, which dropped an annual 13.2 percent in February, the fourth month of decline, but still rather better than January's 16% decline.
And there are other signs of stabilisation, since job losses are now flatlining at 300,000 per month, while nominal wages have risen from January's eight month low. Even a 14.1 percent fall in capital investment in January was less than expected.
However, whatever the improvements, the Russian economy continues to contract, and the February reading for the Markit GDP Indicator fell to an annual contraction of 4.7%, down from a revised 2.9% drop in the first month of the year.
And indeed the contraction may be even sharper, since Economy Minister Elvira Nabiullina informed the Russian government last week the Russia's gross domestic product is likely to contract by 7 percent year-on-year in the first quarter, according to Ministry estimates. However the ministry is still sticking to its forecast for a full-year contraction of just 2.2 percent, suggesting they continue to hope for a dramatic turnaround in the second half of the year.
So the data we now have to hand for the first two months of 2009 point to a further outright contraction over the first quarter, following on the back of the sharp growth downturn in the final quarter of last year. The PMI-based Indicator of year-on-year GDP has now fallen continuously since hitting 7.4% last June and has been in negative territory for the past three months.
The Total Activity Index rose to 38.8 in February from 32.1 in January, indicating a further sharp decline in output, although this was the weakest rate of deterioration since last October.
Russia's economy will contract 2.2 percent this year after 5.6 percent growth in 2008, according to Economy Ministry estimates, and the government anticipates a budget deficit equal to 8 percent of gross domestic product, its first in a decade.
However a number of factors lead towards the conclusion that this estimate for 2009 GDP growth may be rather over optimistic. Only today Ford Motor Co., whose Focus is the top-selling western car in Russia, cut its industry forecast for the country, saying sales may plummet as much as 50 percent this year in what used to be their second-fastest growing auto market. Ford, which stopped production at its St. Petersburg plant for one month from mid-December to mid-January, is looking at further adjustments to “plan realistic inventories,” according to the company statement.
Russian car sales in the first two months of 2009 were down 36 percent to 252,314 vehicles.
The Russian government has responded to the fall in car sales by pledging to spend about 220 billion rubles to aid the industry, offering to subsidize loans on car purchases and making plans to upgrade at least 12 percent of the federal car fleet. The government also raised import duties on cars and trucks to encourage domestic production.
On another front Russian wage arrears climbed by 16 percent in February, the second consecutive month that this figure has risen. Total unpaid wages were 8.09 billion rubles ($235 million) on March 1 following a 49 percent in January, according to the Federal Statistics Service. Half a million people were affected by the delayed payments, with 47 percent of the money overdue coming from the manufacturing sector. The unemployment rate rose 8.1 percent in January, the highest level since March 2005, with the total number of unemployed up by 300,000 and reaching 6.1 million people.
List Of Companies Approved
The work of trying to contain the damage continues on an almost daily basis. Earlier this week it was announced that Russia’s Trade and Industry Ministry have approved a list of 600 companies who may apply to receive state funds during the economic decline. The ministry, whose budget before the crisis reached 120 billion rubles ($3.59 billion), is already “actively” involved with a third of the companies on the list.
The biggest declines (15 percent) will be in Latvia and Lithuania. Poland is forecast to contract by 3 percent. The Polish decline will be lead by a drop in industrial output that will help push the unemployment rate to close to 15 percent. Falling tax receipts will widen the fiscal gap to 5 percent of GDP, making the goal of euro adoption in 2012 unlikely.
Hungary and Romania, which is negotiating external aid, will both shrink by 7.5 percent. Turkey will also shrink 7.5 percent, while Ukraine’s and Estonia’s output will decline by 10 percent. Bulgaria, expected to shrink 5 percent this year, is likely to follow its neighbor Romania in applying for an IMF loan as a collapse of exports and inward investment will shrink the money supply, forcing the government to drain its fiscal reserves to restore liquidity. Capital Economics argue Bulgaria's reserves will only cover their needs for a further six to twelve months.
The plight of the region is summed up by the situation in the Czech Republic, widely regarded as one of the stronger economies. The Czech Republic could see its economy contract by as much as 2 per cent this year if the recession worsens in western Europe, Central Bank Governor Zdenek Tuma warned in an interview published in the Financial Times this morning. As recently as January the bank were forecasting an expansion of 2.9% for this year (in a post at the time, I was already forecasting a recession and zero per cent growth, and by mid February I was in the 2% contraction range, now I would be more pessimistic, and think we could see a contraction of between 4% and 5% ).
The driving force behind the contraction is the implosion of Czech industry, and it was announced today that industrial output fell the most in at least 16 years in January, the fourth successive month of contraction. Output was down 23.3 percent following a revised 12.8 percent slump in December. The drop was the highest since Czech Reublic came into existance in January 1993.
The slowdown in the euro region, which is the main market for Czech goods, is really hurting exports, and both the central bank and the Finance Ministry are cutting their 2009 forecasts.
“The slump of industrial output confirms fears that the economy may contract 3 percent to 4 percent this year,” said Vojtech Benda, senior economist at ING Wholesale Banking in Prague, in a note to clients. “For the central bank, it presents quite a clear argument for another lowering of interest rates, which could be outlined after the Thursday meeting.”
The central bank, which has cut the benchmark repurchase rate to 1.75 percent, meets again this week Most analysts feel they will keep rates unchanged, but as we see above Vojtech Benda is not so sure, and looking at today's data I am inclined to agree with him.
Sunday, March 22, 2009
FDI flows (which are generally considered more stable and less susceptible to rapid outflows than other capital flows) have been the main form of financing for current-account deficits in recent years, but such inflows are set to slow sharply in 2009. The Economist estimates that between 2003 and 20007 FDI inflows (on average) covered almost 100% of the current-account deficit in the ten EU member states. In 2008, this coverage fell to an estimated 55%
As FDI has fallen back, debt - particularly intra-bank lending - has become the main financing vehicle for the current-account deficits. Nevertheless, intra-bank lending – that is, lending between foreign parent banks and their subsidiaries in the region – is falling back sharply in 2009, with nett bank lending to emerging Europe, excluding Russia, being projected at around $22 bn in 2009, down from $95 bn in 2008 (according to the Institute for International Finance)
Now the central issue is that such corrections in external imbalances can take pplace in one of two ways - either domestic demand drops sharply and/or the currencies weaken significantly. In the case of those countries with an exchange rate peg the second route is not open, hence what we are likely to see is a very sharp contraction. Such contractions are already evident in the Baltics, but what about Bulgaria. How sharp will the correction in Bulgaria be? Only today capital economics have come in with a forecast of 5% contraction over the year. But how realistic is this, let's look at some data.
Well, we could start with this little deatil: retail sales down 25.7% month-on-month in January, according to the national statistics office. For an economy which has been driven by a consumer borrowing and lending boom, that looks like dramatic evidence of some kind. It looks like dramatic evidence, but it isn't really quite so dramatic as it appears at first sight, and the first warning I would issue to anyone who wants to study the Bulgarian economy is never to believe anything you see at first sight.
The data came from a Bulgarian press source (see extract below), but they evidently had no idea what they were talking about, since they confused the basics of year on year and month on month, and obviously non seasonally adjusted sales are down massively January over December, every year. Actually according to Eurostat, seasonally corrected sales were down only 0.15% month on month, and were even still up 4.79% year on year, although this is still a very large drop from the 20% rate of increase registered earlier in the year. So the basic point would seem to hold, that Bulgaria's economy is now in freefall, but I have learnt something: never, ever, cite material from direct Bulgarian sources without checking.
Retail sales revenue in Bulgaria declined by 25.7% in January from the same month of last year, the National Statistical Institute (wwwo.nsi.bg) said in a statement. The slump was attributed to a sharp decrease in retail sales of larger consumer goods, although a decline is normal for the beginning of each year. A major 31.5% drop was reported in sales of vehicles and technical maintenance. Revenue generated by non-food sales went up by 3.0% year-on-year, the data showed. Revenue from food, beverages and cigarettes sales showed a minor increase of 0.5%
European Monetary Affairs Commissioner Joaquín Almunia recently, and possibly totally inadvertently, stumbled on a very interesting argument. Here it is:
"Who is crazy enough to leave the euro area? Nobody," Almunia said. "The number of candidates to join the euro area increases. The number of candidates to leave the euro area is zero."
Reductio Ad Absurdum
Now you don't need a PhD in economics to understand what follows, although a little bit of basic logic would help. What we have here could be construed as a kind of syllogism (and from now on let's christen this one "The Almunia Syllogism"). The Almunia Syllogism has the following form:
a) Anyone leaving (or aiding and abetting the departure of someone from) the Eurozone is crazy
b) The EU Commission, The ECB and The National Leaders are not crazy
c) Therefore no one will leave, or be allowed to leave, the eurozone (at least under current conditions)
Q.E.D. We Will Have A United States Of Europe.
Well, ok, I do need to add a lettle lemma here to the effect that the only way to enforce (c) is to build the necessary architecture, and there is room for debate about this, since this lemma is neither proven, nor is it self evident. You also need to accept that there is an excluded middle here, and we do not have a "now either the EU leaders are crazy ot they aren't" fork which we can get diverted down.
As I say, the lemma is not self evident, although my own opinion is that in the weeks and months to come its validity will become extraordinarily clear even to the most reticent among us, but this still needs to be established. The thing about the lemma is that it focuses the debate. Those who do not agree with it need to be able to show how we can have (c) within the present architecture (since here there is a middle to exclude, either we can or we can't). The results coming out from the "we can" camp are not entirely encouraging. For example, ECB Executive Board member Lorenzo Bini Smaghi's recent attempt to argue that Krugman has it wrong, and that (we can manage with what we have) fails stupendously to convince, in my opinion, and especially the extract I reproduce below (which exemplifies precisely the point those who want new achitecture are making).
For instance, for the period 2009-10, discretionary measures adopted in Germany total 3.5% of GDP, compared with 3.8%in the United States. In some European countries, such as Italy, the size of such stimulus measures is relatively limited owing to the high levels of debt, but in other countries the total fiscal stimulus is larger than in the United States.
The whole issue is that we need a mechanism to average out the stimulus, is that so hard to understand? Is this obscurantism, or simply stupidity?
A Literary Trope Not A Syllogism
On the other hand, the formal validity of the following "utterance" from Almunia is rather more questionable.
"Don't fear for this moment," he said. "We are equipped intellectually, politically and economically to face this crisis scenario. But by definition these kinds of things should not be explained in public."
The first phrase is an exhortation, one which I would agree with (but not for the same reasons), the second is an assertion whose truth content is, at least, questionable, while the third is an admission, one which would perhaps better not have been made, or a piece of advice, which the unfortunate Otto Bernhardt seems never to have received.
A senior German lawmaker said euro zone states stood ready to come to the aid of financially fragile members of the currency bloc, sparking furious denials from European leaders that a specific rescue plan existed. Otto Bernhardt, a leading lawmaker in Angela Merkel's Christian Democrats (CDU), told Reuters in an interview late on Thursday: "There is a plan."
and then Bloomberg let us know a bit more about the details of the plan.
The German Finance Ministry has no knowledge of a rescue fund organized by the European Central Bank for troubled euro-region members such as Ireland and Greece, spokeswoman Jeanette Schwamberger said.
Otto Bernhardt, finance spokesman for Chancellor Angela Merkel’s Christian Democratic Union, said in an interview with Reuters today that the ECB has a fund at its disposal to help troubled countries and can make money available at 24 hours’ notice.
Voters in Slovakia went to the polls today for a presidential election, but the outcome will almost certainly be decided in a runoff vote next April 4. Normally, a second round between the candidates arriving in first and second place would be held if no candidate won an absolute majority of valid votes in the first round of voting, but last February the Slovak Central Election Commission (UVK) ruled that an absolute majority of all eligible voters was required in order to secure a first round victory.
Election results links are now available at the bottom of this posting, under Update.
Like most European countries, Slovakia - which attained independence in 1993, following the peaceful dissolution of the Czechoslovak (or as the Slovaks had it, Czecho-Slovak) federation - has a parliamentary form of government, under which executive power is exercised by the prime minister and a cabinet of ministers responsible to the National Council (Slovakia's unicameral parliament), while the presidency is a largely ceremonial office. Originally, the president was elected every five years by a three-fifths majority in the National Council, but direct presidential elections were introduced ten years ago, following repeated unsuccessful attempts to choose a new head of state during the course of 1998.
Opinion polls indicate incumbent President Ivan Gašparovič - who has the support of the ruling, leftist Direction - Social Democracy (SMER-SD) party of Prime Minister Robert Fico and one of its coalition partners, the ultra-nationalist Slovak National Party (SNS) - leads a field of seven candidates and is likely to obtain an absolute majority of the votes cast in the election, but will nonetheless fall short of the higher threshold recently established by the Central Election Commission.
Gašparovič was first elected to the presidency in 2004, when he unexpectedly made it to the runoff election along with his erstwhile boss, former Prime Minister Vladimír Mečiar. However, the latter was (and remains) widely reviled by many Slovaks for his autocratic ways as head of government during three periods in office between 1990 and 1998, and Gašparovič - who parted ways with Mečiar in 2002 - prevailed largely because he was perceived as the lesser of two evils.
The change in the election rules could benefit sociologist Iveta Radičová, the joint candidate of three center-right opposition parties which held office from 1998 to 2006: the Slovak Democratic and Christian Union (SDKÚ), the Hungarian Coalition Party (SMK) and the Christian Democratic Movement (KDH). Radičová - a former Labour, Social Affairs and Family Minister - has emerged as President Gašparovič's major challenger, although opinion polls have her trailing by a substantial margin; nonetheless, she hopes to score an upset victory in the runoff election and become Slovakia's first female head of state.
Meanwhile, the remaining five candidates - Dagmara Bollová, a former Communist Party of Slovakia (KSS) parliamentarian; Free Forum leader Zuzana Martináková; Milan Melník, a university professor supported by the third party in the ruling coalition, the Movement for a Democratic Slovakia (HZDS) of former Prime Minister Mečiar; František Mikloško, a former parliamentarian backed by the Conservative Democrats of Slovakia (KDS); and KSS candidate Milan Sidor - are stuck in the single digits, well behind Gašparovič and Radičová.
Since Prime Minister Fico and his government (with the exception of HZDS) have given their full backing to Ivan Gašparovič, and the three major opposition parties are lined up behind Iveta Radičová, it should come as no surprise that the presidential vote has become an early dress rehearsal of parliamentary elections that will be held by next year at the latest.
With all 5,919 polling districts reporting, President Ivan Gašparovič won the largest number of votes in Slovakia's 2009 presidential election, but fell well short of an absolute majority of registered electors (as well as valid votes). Consequently, there will be a runoff election next April 4 between President Gašparovič and Iveta Radičová, who came in second place with a stronger than expected showing.
The official Election to the president of the Slovak Republic 2009 website has detailed results in Slovak; nationwide results are available in English on Presidential and Legislative Elections in Slovakia.
Sunday, March 15, 2009
This simple fact was brought home only last week by January's export figures, which show the dramatic nature of the recent decline in Hungary's external trade, since both exports and imports were down at a rate of around 30% year-on-year. The decrease was slightly higher for exports than for imports, and consequently the trade balance was once more negative. Exports were down by 31% compared with January 2008, showing the extent to which Hungary's export driven economy has been affected by the recession in the rest of Europe.
Imports were also down, but slightly less than imports (minus 29% in euro terms). What is quite striking if you look at the chart below is how the drop in imports has been more or less tracking the drop in exports in recent months.
Most analysts were rather disappointed by the news, since they had been hoping for evidence of a decline in Hungary's external financing requirement, with the mechanism for this being an improvement in the foreign trade balance. In reality what we have seen in recent months has been a modestly increasing foreign trade gap.
Industrial Output Down
Hungary’s industrial production has also been slumping on the back of the decline in export demand. Output fell a workday-adjusted 21 percent year on year in January, following an annual 23.3 percent decrease in December. The December contraction had been the biggest since 1991. Output however was up 2.5 percent on December's horrible low point, even despite the gas crisis.
February's output level looks to be much the same, since the manufacturing purchasing manager index, despite coming back slightly from its all-time low of 38.5 in January to hit 39.7 in February, was still well below the 50 reading which marks the frontier between expansion and contraction.
The extent of the fall in output in the industrial sector since the start of 2008 can be seen in the seasonally adjusted output chart (see below).
January's export results are doubly disappointing since, as is well known, the forint has been falling lately, and is down around 25% since last summer, although the impact of the most dramatic fall - which was in February - is still to be noticed in the export numbers (that being said I am not especially optimistic at this point).
Unsurprisingly inflation surged in February, and was up 1.0% month on month over January even though the annual rate still nudged downwards, reaching 3.0% year on year, falling marginally from January's 3.1%.
The drop in the annual rate was less the consensus estimate (2.8%) and was most obviously a result of the weak Hungarian forint which brought a halt to the disinflation process, despite the very weak level of consumer demand.
In addition recent fiscal measures -like the VAT and excise duty hike- will likely put upward pressure on the inflation path from mid summer. On the other hand the month on month number is unlikely to alarm the NBH unduly at this point, since growth and financial stability issues are much more pressing concerns. Thus, from a monetary policy perspective the release is more or less neutral, with the future interest rate trajectory depending much more on financial market developments.
Shocking GDP Numbers
Hungary's gross domestic product dropped by 2.5% year on year in the fourth quarter of 2008 following an increase of 0.7% in the thrid quarter, according to revised data from the Central Statistics Office (KSH) last week. This is the worst performance since the turmoil experienced during the early days of the transition. The downward revision from the preliminary 2.1% estimate was largely the result of a lower evaluation of the performance of the financial intermediation and real estate sectors. Looking at the chart below, the collapse in Hungarian output expansion since mid 2006 could not be clearer.
In fact GDP was down by 1.2% in the fourth quarter of 2008 as compared to the previous quarter. Agriculture and construction activity actually increased (by 4.6% and 2.1% respectively), while industrial ouput dropped by 3.4% and services by 0.6%. Household consumption was down by 1.8% and goevrnment spending by 2.5%. The quarterly impact of external trade was positive, since exports (which declined by 6.5%) fell less than imports (which fell by 7.3%).
Within gross domestic product, industrial production dropped 8.5 percent on the year and financial services declined 7.8 percent. Household consumption dropped 3.3 percent, according to today’s figures from the statistics office. So the composition of the quarterly preformance is pretty worrying as the 2.5% output decline was accompanied by a 71% leap agricultural output, a result of excellent crops. If you strip agriculture out, you find that the rest of Hungary's economy contracted by nearly 5% in only one single quarter.
Year on year household consumption was down by 4.4%, but household consumption growth has long been in decline (see chart below) and is now more of a brake on GDP than a driver.
Retail Sates Just Keep Falling
And retail sales just keep dropping. Hungary's retail sales fell by an annual 3.9 percent in December based on working day-adjusted figures following a 2 percent decline in November. Food sales were down by 1.5 percent in December from a year earlier and fell by 1.2 percent in all of 2008. Non-food sales were down by 5.6 percent in December and 2.8 percent over the whole of 2008.
And in December - using seasonally and calendar-adjusted data - the volume of retail sales was down by 0.8 percent compared to November, when they fell 0.4 percent over October. In 2008 overall retail sales fell by 2.1 percent. In fact Hungarian retail sales have now been in decline since the summer of 2006 (see chart) and I doubt we will ever see the heady levels of July 2006 (in real, price adjusted terms).
The reason for this is simple - Hungary's population is in steady long term decline 8see chart below), and less people will evidently consume less, especially when you consider that the age structure of the population is steadily changing, and there will be a higher and higher proportion of elderly people to support, which means that real disposable income for the ever smaller working population will be progressively squeezed.
Employment Falling, Unemployment Rising
Some evidence for this hypothesis can be found in the recent Hungarian employment data. Hungary's rate of unemployment rose to 8.4% year on year in the November-January period, up from 8% in the October-December period. There were 3.838 million people employed, while the number of unemployed was 351 thousand. The first thing to notice, obviously, is that unemployment is rising, which is what we would expect with the crisis taking place.
According to Eurostat harmonised data (based on a slightly different methodology) January's unemployment rate was 8.6%.
Now participation rates in Hungary are historically low - the participation rate of the population in the 15-74 age group was 54.7% in Q4, down from 55.0% in the previous 3 month period and 54.9% in the same period a year earlier, and undoubtedly changes are needed in the tax and employment law to facilitate higher participation rates, but as we have seen in Germany and Japan, in ageing populations labour reforms which raise the participation rate among older less qualified groups has not had as great an impact on real personal disposable income and consumtion as many anticipated. And the working age population is now declining in Hungary much more significantly than it has been in either Germany or Japan.
While the number of those employed, while fluctuating seasonally, has been trending down.
GKI Confidence Index Falls To New Lows
Hungary’s economic sentiment index plunged to another record in February as businesses struggled with falling orders and consumers braced against job losses as the recession deteriorated, according to the GKI institute report. The overall index fell to minus 43, the lowest since measuring began in 1996, from minus 39.8 in January. Both the measures of business and consumer confidence also fell to new lows.
The outlook for industrial production and orders led a decline in the business confidence index to minus 34 from minus 30.5 in January. Fifty-eight percent of Hungary's exports are sold in the euro region, which is in its worst recession since the single currency began trading a decade ago.
Concern about future job losses dragged the consumer confidence index to a record of minus 68.5 from minus 66.1 in January.
Short Term Outlook Bleak, But With Adequate Reforms Exports Could Drive The Economy
As I am indicating, I am not optimistic at all that domestic consumption can ever return as a major driver of Hungarian growth. However with the right mix of reforms and inward investment, the situation could be turned round, at least to the extent of keeping imminent disaster away form the door. Hungary's economy is far from being what some would call a "basket case". Clearly education quality is vital, as is the fomenting of a critical spirit which can take maximum advantage of the declining numbers of young people Hungarian society has at her disposal.
Export driven growth is far from perfect, as we are seeing now in countries as diverse (and in some cases) distant from Hungary as Germany, Japan and China, who are all suffering severe slowdowns. It is however better than the perpetual threat of sovereign default, and breakdown in the pension and health systems.
The danger at the present time is that the sharp contraction in GDP can lead to continuing budget shortfalls at fiscal level which produce cuts in public spending which themselves fuel further contraction, and so on, in a vicious spiral which only works to drive up Debt to GDP levels and spreads on Hungarian sovereign bonds.
The greatest threat from the continuing pressure on the HUF is the danger of growing defaults on CHF denominated personal loans and mortgages, defaults which themselves only pile the pressure on the banking system and intensify the credit crunch. The difficult situation this problem puts Hungary’s central bank in was made even clearer last week when bank President Andras Simor said the bank was using loans from the European Union to buy forint for euros to support the currency. Simor declined to comment on the size and timing of the intervention. But the central bank did issue a statement on March 8 to the effect that it would start converting European Union grants on the currency market to support the forint - Hungary is expected to receive more than 1.4 billion euros in EU grants this year. Obviously things have to be pretty desperate when you get to this stage, since while the bank may be able to make an impact in the short term, it is unlikely to have significant long term impact, so a solution must still be found to the CHF loan problem.
Reports in the Hungarian daily Népszabadság on Friday suggested that a solution is now being actively sought. According to reports, the basic idea is that the state would share some of the costs of conversion. As ever in Hungary, politics are in play, since the idea was originally put forward by Viktor Orbán, President of Hungary's main centre-right opposition party Fidesz.
The government itself then stepped in and Socialist Prime Minister Ferenc Gyurcsány reacted to Orbán's proposal by saying “The need to convert foreign currency loans to forint loans is rather obvious; the Finance Ministry has been discussing it for weeks,". Really, given that the country is in the middle of a very significant crisis, it would be better for everyone if all the bickering about who had an idea first could come to an end, and people put their heads together to look for the answer. Again it is "rather obvious" that the costs of conversion need to be split between the state, the mortgage holder and the bank, but in what proportions, and through what mechanism. Come on, enough studying, let's have some answers and go to work on the problem, then the forint can quietly be left to find the level which is most appropriate for attracting investment into Hungary's export sector, so when Europe's economies start to recover the export sector can be up and running, and ready to sell.
Sunday, March 8, 2009
At the same time it is estimated that nearly 250,000 Estonians are currently living in homes whose market value is insufficient to cover the outstanding mortgage loans which their owners have taken out, making "exposure risk" a growing problem for the country's banks. During the boom, house sale transactions were commonly financed with a 90% loan to value (LtV) ratio. This is a very dubious practice at the best of time, but in the face of a sharp fall in both house values and wages it becomes well nigh disastrous.
Once boasting one of Europe's fastest-growing real estate markets, property prices in Estonia fell by a whopping 23% in 2008 (following an 18% increase in 2007) according to data in the latest edition of the Royal Institution of Chartered Surveyors European Housing Review. The RICS tracked 2008 year-on-year house price inflation in 18 West and East European countries, and found that Estonia's fall was the most substantial in the entire group.
Take, for example, a 50 sq metre apartment bought in the spring of 2007 for a price of around EEK 1.3 mln. This apartment is currently worth around EEK 790,000, but the outstanding loan balance is of the order of EEK 1.1 mln. Should the once proud owners of that lovely appartment now find themselves among those unfortunate enough to be queueing up outside the offices of the Estonian Labour Board and need to sell it, then even assuming they could find a buyer they would not only lose their home, but they would still end up owing the bank EEK 300,000 under Estonia's "full recourse" lending laws (which are of course very different from those operating in the United States). With an average net monthly salary in the region of EEK 10,000 this means that the unfortunate ex-property owners would in all probability end up with a debt worth more than two years their total income.
Of course, in this climate buyers are likely to be scarce, and it is more probable that the banks themselves end up with a substantial direct interest in Estonia's property market. And this would only add to the problem they are already having with overdue loans, which are rising and reached 3.6 percent of total credit in January, according to the most recent data from the central bank which now forecasts bad loans will hit 6 percent before the year is out. Of course, as is by now well know, more than 95 percent of Estonian banking assets are held by Nordic banks, and despite the fact that the banks don't cease to reassure us that their Baltic operations form a “key part” of their business and that they have a “long-term commitment” to Estonia, this doesn't stop them getting downgrades. Swedebank, for example, had its credit rating cut to A1 from Aa3 by Moody’s Investors Service last month, citing the risk of a “substantial increase in impairments” (read loan defaults and deteriorating asset quality) from the bank's Baltic operations.
Meantime output and employment simply keep on falling, with Estonia's industrial production dropping by the most in at least 14 years in January - 26.8 percent year on year, the most since 1995 (following a 22.4 percent slump in December).
Of course, as output drops and people are sent home to remain inactive, the one thing Estonia does have at the moment is a lot of loan offers. Thus the central bank recently announced that they will be able to borrow as much as 10 billion Swedish kroner against Estonian krooni from their Swedish counterpart in an attempt to boost confidence in Estonia's financial markets. As Riksbank Governor Stefan Ingves said in the statement “The financial systems in Estonia and Sweden are closely linked”. But what Estonia needs is not more loans, and more debt, and people lying around idle, it needs work, and output, and exports to pay off all that debt which has been accumulated. And it is just at this central point that the current solutions are being tested and found wanting.
The Price and Wage Correction Is Too Slow
In order to understand what is wrong with the path on which Estonia has set itself we need to bear fully in mind that the problem is that the country (or its households) have become excessively indebted in relation to the economy's competitiveness, and the consequent ability to pay. Estonia has a current account deficit, and this does not help things, but Estonia's problem is not, in the longer run, a simple balance of payments and financial crisis one (against which external loans can of course help), but a problem of competitiveness and the ability to pay off debt.
And even despite the recent sharp fall - almost all of which is produced by a fall in imports and a reduction in living standards - Estonia's current account deficit was still running at slightly over 9 percent of gross domestic product in 2008 (following the 18.1 percent shortfall achieved in 2007).
Estonian central bank data show an estimated current account defict for last December of 943 million kroons, down from a revised 1.87 billion kroons for November, and from around 3.5 billion kroons in December 2007, but since exports were down 6% year on year in December, it is obvious that the reason for the contraction in the deficit is the 17% drop in imports. Ouch!
Now, as I say, basically the problem here is to restore competitiveness and, although not everyone will be prepared to agree with me, I would argue that the only solution for Estonia is to export its way out of trouble. Given the problems the banking system is having and is about to have, it would be sheer fantasy-land (and very foolish) to imagine we are going to see a return at any point in the forseeable future to consumer credit driven growth (we are talking everywhere about more, not less, regulation), so as Estonians work hard (once they finally get a job again) to pay off their debts and try to save for their increasingly uncertain old age, the only really valid way to try to go for growth is by exporting. Saying that this is not possible, well... this is simply defeatism before you start, and I don't imagine the Estonian character that way somehow, not after so many years of fighting to gain a hard won independence.
So if you want to export, you have one benchmark to work againt - Germany. And if we look at the chart below, we will see the extent of the competitveness gap which has opened up since 1999. Now Reel Effective Exchange Rates (REERs) are a nice measure of competitiveness, since REERs attempt to assess a country's price or cost competitiveness relative to its principal competitors in international markets. Since changes in cost and price competitiveness depend not only on exchange rate movements but also on cost and price trends the specific REERs used by Eurostat for its Sustainable Development Indicators have been deflated by nominal unit labour costs (total economy) against a panel of 36 countries (= EU27 + 9 other industrial countries: Australia, Canada, United States, Japan, Norway, New Zealand, Mexico, Switzerland, and Turkey). Double export weights are used to calculate REERs, reflecting not only competition in the home markets of the various competitors, but also competition in export markets elsewhere. A rise in the index means a loss of competitiveness, and as we can see Estonia's index has risen sharply against Germany's in recent years.
Well, just in case anyone thinks that the comparison with Germany is not an appropriate one in Estonia's case, here (see below) is the equivalent chart for Finland, which shows an equally strong loss, and let us remember that the worst year in this sense (2008) is still not included, since Eurostat have not processed the data yet.
And of course, I am only looking at eurozone comparisons here, we won't enter at this point into the embarassing fact that Sweden and the UK have both devalued sharply in rcent months, as have Eastern EU rivals, Romania, Poland, Hungary and the Czech Republic, as well as non EU rivals like Ukraine and Russia. Really hanging on to the peg blindly in these circumstances is not only foolish, it is ridiculous, and I hardly see how following a ridiculous policy (which for sure won't work) is going to enhance your credibility, which is what the decision not to devalue was all about in the first place. It won't even shield the Nordic banks from the slew of incoming defaults.
Now, "plan A" is supposed to involve a very sharp downward adjustment in prices and wages, something of the order of 20% during 2009 and 2010. (Incidentally, talk of a V shaped recovery is misleading here, since the V shaped recovery only comes with a one-off devaluation, say getting the 20% out of the way all at once, and doing it over two years can only bring a U shaped process, as you simply spin the same thing out over two years, think about it, the issue isn't that hard to see). Anyway, over two years it is, so how are we getting on? Well up to December last year (which is the latest data we have) not very well, since average hourly wages (the key number here) were still up 9.9% in the last quarter of last year, and so this is really another 10% or so to add to the 20% we were just talking about above (based on the 2007 REER). True, hourly wages did peak in Q2 at 78.26 kroon, and were down to 75.58 kroon in Q4 (or by 3.4% in six months), but this was only really taking back some of the excess from H1 2008, and the real hard work is still to come.
But if we move away from wages and take a look at prices, we find the situation is not much better, since while Estonia’s inflation rate fell in February to its lowest level in more than three and a half years it was still running at an annual rate of 3.4%. We need to see average price declines in the region of 10% in both 2009 and 2010, and not only am I not convinced we are going to see that, none of the major bank analysts or multilateral organisations are currently forecasting anything like this. Or are we going to run our correction from now till 2015 (and have something which looks more like an L-shaped correction)?
Of course, as many will point out, the price index has been falling in recent months (see chart below), but the question is: is it falling fast enough?
What we really need to think about here is not the general index, however, but the so called "core" index (the one that excludes volatile items like energy, food, alchohol and tobacco). Now as we can see in the chart below this index has stabilised, and has even started falling slightly, but if we keep in mind the rule of thumb idea of a 20% decline, and note that the core level peaked at 118.37 in December, then for the correction to have any hope of working we would need to be looking at a reading in the region of 95 come December 2010.
And the situation may be even more complicated than we imagine, since the Eurozone itself may fall into deflation, and if so every percentage point drop in the Eurozone index will need to be matched by an extra percentage point drop in the Estonian one. Unfortunately your leaders and advisers are a long way from explaining this harsh reality to you.
But there is reason to fear that this may actually be what happens, since if we look at Eurozone headline HICP inflation on an annualised basis, we will find that it fell more than expected in January - to 1.1 per cent, according to Eurostat data - down quite dramatically from the peak of 2.7 per cent hit in March last year. This was the lowest level we have seen since July 1999, and a sharp drop from the 1.6 percent rate registered in December. On a month-to-month basis, prices were down 0.8 percent. The "core" inflation rate - that is consumer inflation without the volatile elements of food, energy, alcohol and tobacco - we find it still stood at 1.6%, since the biggest impact on headline inflation comes from the decline in food and energy costs. But if we look at the monthly movement in the core index, we find that it dropped by a very large 1.3% (see chart below).
Now if we come to look at the core inflation rate over the last six months, we find that the index has only risen 0.1% (or an annual rate of 0.2%). This gives us a much more accurate reading on where inflation actually is at this point in time, and where it is headed. The chart below shows the six month lagged annualised rate for the last twelve months, and the sharp drop in January is evident. If things continue like this, then the eurozone as a whole is headed straight into deflation, for sure.
Retail Sales Dropping Sharply
Basically, to get economic growth, and thus to be able to pay down debts, you need one of three things: an increase in government demand, and increase in export demand, or an increase in private domestic demand. Now the first two of these are categorically excluded in the present situation (especially since the government is cutting, and not increasing, public spending as part of the crisis response package (the so called "plan A" strategy). However, private domestic demand is falling like a stone at the moment. According to the latest data from Statistics Estonia, retail sales were down 10% year on year in January (at constant prices).
As we can see in the chart below, Estonian retail sales peaked in February 2008, since which time they have been steadily falling.
So what are the chances that domestic demand can make a recovery? Well, according to some, quite substantial. According to a recent report from UBS bank on Eastern Europe Lending:
We retain our firm view that convergence is a ‘sure thing’ for those economies already in the EU – it is just a question of time before levels of GDP per capital approach those of the established members. If convergence is perhaps a thirty or forty year process, the most advanced are perhaps half way through (Poland introduced its free market reforms on 1 January 1990). The uncomfortable period we are entering is one where local growth goes from above-trend to sharply below. It may well take a number of years before nominal GDP (in Euro) recovers the levels of summer 2008, but we believe markets can be forward-looking when outcomes are predictable.
So the issue is convergence, and the justification for "plan A" is essentially based on this idea, as UBS analysts
Why does convergence matter so much? Because equity markets – and therefore companies – are essentially about growth. And convergence drives excess growth. The new EU members offer legal systems becoming increasingly like those in old EU states, with labour productivity comparable and labour costs a fraction of those back home – particularly following recent currency declines. Margins on banking products are typically higher than in ‘old’ Europe and levels of penetration much lower.So we are putting all our money on the "convergence" bet, but just how realistic is this? Unfortunately, not very, since one key argument it simply fails to take into account is the effect of demographic processes. Basically, the whole of Eastern Europe has one large and little discussed problem, birth rates fell dramatically, but life expectancy did not rise: Latvia and Estonia are not only (along with Slovakia) the EU countries with the lowest per capita income, they are also those with the lowest life expectancy. Male life expectancy in Estonia is just 67.16, and for Latvia it is 66.68, compared to 76.11 for Germany, and 77.13 for Italy. Let's not beat about the bush here, this means that each adult working male can contribute roughly ten years work less to paying down the country's debts, and of course, extending the working age to 70 (25% of the Japanese population still work at 75) impossible. This is why the whole idea of "convergence" is a non-starter. And again, you don't need to be an economics PhD from MIT to see this.
These arguments were a staple of a thousand corporate presentations through the good times and we suspect will be little mentioned except where necessary over the next twelve or eighteen months. But we believe them to remain essential to an understanding of likely outcomes in the region: they raise the bar for all stakeholders faced with a challenge of whether to prioritise the long-term or the immediate. It is an active debate what the Ukraine will look like several years hence; we believe it is not for the EU members: they will look more like the old EU states, in form and substance.
In the real world Estonia's population is currently shrinking, which, with fertility around the 1.4 Tfr range is hardly surprising.
The birthrate has been rising (slightlly) in recent years, but as Afoe's Doug Muir explains in this post here, this is more than likely going to unwind during the recession.
Interesting Fact #1: birthrates tend to drop during recessions, and the drop tends to correlate with both the severity of the recession and the speed of its onset. The current recession is looking to be a bad one, and it happened pretty quickly, so we can reasonably expect a sharp drop in birth rates. Makes sense, right? Babies are expensive; more to the point, babies limit your options. They make it harder to move to a different city, change careers, stop working for a while. When times are hard and uncertain, babies become a luxury. For individuals and families, a recession is a good time to put childbearing on hold.
Interesting Fact #2: all across Communist Eastern Europe, birth rates declined slowly through the 1970s and ’80s… and then crashed after 1990, dropping to very low levels and staying there through most of the decade. In some countries they bounced back a bit, in others not, but in almost all cases there’s a big “birth gap” from about 1991 until at least 1997, and often later.
Put these two facts together, and there’s a problem.
Indeed Statistics Latvia have already reported a 25% year-on-year drop in births in January 2009 (from 2310 in Jan 2008 to 1860 in Jan 2009), and looking at the Estonian Statistics we find that in January 2008 there were 1493 births and in January 2009 there were 1232. Again about a 20% drop year on year. Of course, one month's data don't prove anything, but since, as Doug points out, this is what the theory predicts, we should all be taking it seriously, and it should be taken into consideration when we talk about which kind of "correction" we want. It is no good saving the stream of external funding coming into your banks if you "meltdown" your population as you do it.
Unfortunately I haven't noticed one single European leader who is seeing fit to even mention this issue - or the other, pending, one that when the recovery does come, if the Baltic countries are still stuck struggling with their pegs, the additional haemorrage out will be in young people looking for money to send home to their ageing and impoverished relatives, thus giving the whole demographic thing another turn of the screw.
The future already looks bleak enough in human capital terms, as this recent report from Statistics Estonia makes evident:
According to the Statistics Estonia, at the beginning of academic year 2008/2009, 154,481 pupils were acquiring general education, 27,239 vocational education and 68,399 students were acquiring higher education. The decrease in the total number of pupils is influenced by the number of pupils acquiring general education, which has decreased during the last decade. The decrease in the number of pupils in general education is related to the decrease in the number of births, which began at the end of the 80s and lasted till the end of the 90s. At the end of the 90s more than 220,000 pupils were acquiring general education, thus the number of pupils in general education has decreased by about a third during the last decade. In academic year 2008/2009, 147,519 full-time and 6,962 part-time pupils were acquiring general education. In autumn 2008, 12,426 children started school, which is over a third less than ten years ago.
So Is There A "Plan B"?
Well, of course there is, and everyone, no matter which side of the argument they are on, knows only too well what this is: devaluation. Of course of devaluation of the Baltic/Latvian pegs contains implied sovereign liabilities, and these need to be thought about. You cannoy do this alone, but you are members of the EU and you can ask for help with the process. But if you don't start to ask for the help, then naturally you aren't going to get it.
Technically the pegs can be maintained. The question which faces Estonians is quite simply which alternative – keeping or changing the peg – implies the greatest cost. The main stakeholder here is the EU, and you should be leveraging that for all you are worth. The capital erosion for Western European lenders would not be insignificant if you (and others) simply sink.
Naturally small open European economies like Latvia and Estonia can only hope to gain very minimal monetary autonomy outside currency board type arrangements, so the only realistic exit strategy is devaluation and Eurozone membership, as I explain in this post (and this one).
Of course this change in EU policy won't arrive tomorrow (but it might come next week, or the week after). It's just that you have to push for it. Stopping work and going home (as unemployed) while your country borrows more and more money is not going to bring the future you all so badly want. There is another path, choose it!