tag:blogger.com,1999:blog-14437201060099571512024-03-14T10:50:35.395+01:00Eastern Europe Economy Watch<br>Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past, the ocean is flat again<br>
John Maynard KeynesUnknownnoreply@blogger.comBlogger295125tag:blogger.com,1999:blog-1443720106009957151.post-76083233490618145902013-02-24T15:36:00.001+01:002013-02-24T17:00:42.100+01:00The Shortgage of Bulgarians Inside BulgariaOh, there's a hole in my bucket, dear Liza, a hole......<br />
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Wenn der Beltz em Loch hat -<br />
stop es zu meine liebe Liese<br />
Womit soll ich es zustopfen -<br />
mit Stroh, meine liebe Liese<br />
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According to Angela Merkel, <a href="http://www.bloomberg.com/news/2013-02-18/merkel-cites-east-german-lessons-for-crisis-wracked-euro-states.html">speaking in the German city of Mainz in mid February</a>, European countries struggling with the fallout of the euro-area debt crisis have much to learn from East Germany’s experience with economic overhaul following the fall of the Berlin Wall. In the main she was speaking about the need for reform, something on which we can all agree. “At the beginning of the 21st century", she said, "Germany was the sick man of Europe and that we are where we are today also has to do with reforms we carried out in the past. That’s why we can say in Europe that change can lead to good.”<br />
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But there was one tiny little detail she forgot to mention. During the post unification period East Germany's population went into melt-down mode. New York Times Columnist Nicholas Kulish <a href="http://www.nytimes.com/2009/06/19/world/europe/19germany.html?_r=0">put it like this</a>:<br />
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Unemployment in the former East Germany remains double what it is in the west, and in some regions the number of women between the ages of 20 and 30 has dropped by more than 30 percent. In all, roughly 1.7 million people have left the former East Germany since the fall of the Berlin Wall, around 12 percent of the population, a continuing process even in the few years before the economic crisis began to bite.<br />
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And the population decline is about to get much worse, as a result of a demographic time bomb known by the innocuous-sounding name “the kink,” which followed the end of Communism. The birth rate collapsed in the former East Germany in those early, uncertain years so completely that the drop is comparable only to times of war, according to Reiner Klingholz, director of the Berlin Institute for Population and Development. “For a number of years East Germans just stopped having children,” Dr. Klingholz said.<br />
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The newspaper Frankfurter Allgemeine Zeitung reported recently that although 14,000 young people would earn their high school diplomas this year in Saxony, only 7,500 would do so next year. Since 1989, about 2,000 schools have closed across the former East Germany because of a scarcity of children. </blockquote>
Now this situation is quite serious, and needs a long term solution, but it is not as serious as what is currently happening to Latvia, or Bulgaria, or a number of the other former communist states. Unless, of course, the lesson Angela would like to draw our attention to is that East Germany managed to salvage something from what would otherwise be population wreckage by sneaking in under the shelter of another state, with a centralized system of support for pensions and health care. Somehow I doubt it, but perhaps this is what we need to think more about. The EU needs a pan European health and pension system, to distribute the burden equitably. This is the conclusion I reached during <a href="http://es.slideshare.net/Edwardhugh/latvias-demographic-future">my last visit to Riga</a>. It isn't just a Euro related issue, it is to do with having a unified labour market, with people able to move to where the jobs exist, and the pay is better. For years people complained about the absence of labour mobility in the EU. Now we have it, the flaw in the institutional infrastructure is obvious.<br />
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Young people are moving from the weak economies on the periphery to the comparatively stronger ones in the core, or out of an ever older EU altogether. This has the simple consequence that the deficit issues in the core are reduced, while those on the periphery only get worse as health and pension systems become ever less affordable. Meanwhile, more and more young people follow the lead of Gerard Depardieu and look for somewhere where there isn't such a high fiscal burden, preferably where the elderly dependency ratio isn't shooting up so fast.<br />
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I am sufficiently concerned about this issue, which I think ultimately endangers possibilities of economic recovery all along the periphery, to have created <a href="http://www.facebook.com/PopulationLossOnTheEuropeanPeriphery">a dedicated facebook page</a>, campaigning for one single issue - that the EU Commission and the IMF give a greater priority to trying to measure these flows, and understand their consequences. I am simply asking that they pressure EU member states to improve their statistics gathering, treat the issue as a priority, and identify an indicator to incorporate in the <a href="http://epp.eurostat.ec.europa.eu/portal/page/portal/excessive_imbalance_procedure/imbalance_scoreboard">Macroeconomic Imbalance Procedure (MIP) Scoreboard.</a> Really it doesn't matter whether you are in favour of austerity, or against it, feel more Keynesian than Austrian, or vice verse, all I am asking for is that this problem be taken more seriously, measured and studied.<br />
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<span style="font-size: large;"><b>Bulgaria The Classic Case?</b></span><br />
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Really there has been a before and after to the financial crisis, at least insofar as awareness of the demographic dimension is concerned. Really, before the onset of the crisis very few people really attached much importance to the question. Since the arrival of the European sovereign debt crisis, and the fiscal cliff debate in the United States, awareness has grown that population ageing probably will slow economic growth, and that previous expectations about levels of pension and health care provision may have been way too optimistic. The latest example of this has been Nobel Laureate Paul's Krugman's comments on how <a href="http://www.bloomberg.com/news/2013-02-05/krugman-sees-japan-s-shrinking-population-as-crimping-growth.html">Japan's demographics may be influencing its growth rate</a>. In a tellingly graphic expression he explains that <a href="http://krugman.blogs.nytimes.com/2013/02/05/the-japan-story/">the root of Japan's ailment</a> might be that the country is suffering from a growing "shortage of Japanese".<br />
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Once you realise that population shortage may be a problem in Japan, you start wondering where else it might be one. And then, once you begin to look you start seeing the issue springing up like mushrooms all over the place. In Bulgaria for example. <br />
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<a href="http://www.euractiv.com/socialeurope/bulgarias-population-shrinking-a-news-503814">According to the 2011 census</a>, Bulgaria has lost no less than 582,000 people over the last ten years. In a country of 7.3 million inhabitants this is a big deal. Further, it has lost a total of 1.5 million of its population since 1985, a record in depopulation not just for the EU, but also by global standards. The country, which had a population of almost nine million in 1985, now has almost the same number of inhabitants as in 1945 after World war II. And, of course, the decline continues.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-Wvh32BWiyun2LSP01DB6LUrGboEslr-5JRXu02_SWhN7lH9oRDH1yejMU2pmoPGvm1xYOHM9eQsHpSR_trA5qyWLvGcBmI-M4mErff25t4-BQOBc0b2ClcbuaJlw2xKAEgNk1RIhs-E/s1600/Bulgaria+Population+Pyramid.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="202" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-Wvh32BWiyun2LSP01DB6LUrGboEslr-5JRXu02_SWhN7lH9oRDH1yejMU2pmoPGvm1xYOHM9eQsHpSR_trA5qyWLvGcBmI-M4mErff25t4-BQOBc0b2ClcbuaJlw2xKAEgNk1RIhs-E/s320/Bulgaria+Population+Pyramid.png" width="320" /></a></div>
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As well as shrinking the population is ageing. In 2001 16.8% of the population were over 65. Just 10 years later the equivalent figure had risen to 18.9%. Naturally this means the median population age is rising steadily. It is precisely part of my argument that this surge in median age over 40 has important consequences for saving and borrowing patterns at the aggregate level, patterns which have not yet been adequately measured and identified. Thus the macroeconomic dynamics of a country change. The impact of these changes has not yet been incorporated into the traditional models most analysts use in forecasting.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmZmPIJjjkUM4ww9Oo-AXbF7fIBzjgsZ8BCqEx9jUoIko8ABn_RsktmiOUGL9IZBXkm8Kop0g5Wc5Hiw6YG9pvE3I6APfG0ka-G-mGeV1yKEw92EjslDBqQIBCYo3lEprjnthXBajOLNo/s1600/Bulgaria+Median+Age.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="184" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmZmPIJjjkUM4ww9Oo-AXbF7fIBzjgsZ8BCqEx9jUoIko8ABn_RsktmiOUGL9IZBXkm8Kop0g5Wc5Hiw6YG9pvE3I6APfG0ka-G-mGeV1yKEw92EjslDBqQIBCYo3lEprjnthXBajOLNo/s320/Bulgaria+Median+Age.png" width="320" /></a></div>
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Naturally the workforce itself is in rapid decline.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyQU5aG1Dc0XAJBVTunGas_rlJB3b0TCwx9UTGoLQ6TolP-bsZk5STVSA9PpHTzZSgFE4Gkj_xymZfXNbktiUQtLt_JXnHsLisejy68FtluL-P1NhJalR1OMpe6xHt4QYb7yhb63en2bg/s1600/Bulgaria+Labour+Force.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="163" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjyQU5aG1Dc0XAJBVTunGas_rlJB3b0TCwx9UTGoLQ6TolP-bsZk5STVSA9PpHTzZSgFE4Gkj_xymZfXNbktiUQtLt_JXnHsLisejy68FtluL-P1NhJalR1OMpe6xHt4QYb7yhb63en2bg/s320/Bulgaria+Labour+Force.png" width="320" /></a></div>
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The causes of Bulgaria's rapid ageing and shrinking population problem are twofold, low fertility and emigration. This is what makes the country look more like the old DDR and less like Japan. In fact Bulgaria's situation is an extreme case of what is happening in many East European countries, especially Romania and the Baltics. If you want another reference point, Ukraine would be in this group, but even worse, since it is even outside the EU. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBXQxpj57-fjl8ltrvtZMgSNnhIdgHUdTg2jjk77WC6r9igQhz2FyWw45IML5RXujT045FlXPH_q25DmV7l5e5pJWuJA0tnslzL1BfKu4ez0eaQaWgpL2dlSPR_urf8vPnSfDRG6N4bpE/s1600/Bulgaria+Fertility.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="175" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBXQxpj57-fjl8ltrvtZMgSNnhIdgHUdTg2jjk77WC6r9igQhz2FyWw45IML5RXujT045FlXPH_q25DmV7l5e5pJWuJA0tnslzL1BfKu4ez0eaQaWgpL2dlSPR_urf8vPnSfDRG6N4bpE/s320/Bulgaria+Fertility.png" width="320" /></a></div>
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Details of migrant numbers are scarce, and at best hedgy. The data we have is surely a significant underestimate, <a href="http://www.oecd.org/els/mig/IMO%202012_Country%20note%20Bulgaria.pdf">as the OECD pointed out in its latest country migration report</a>:<br />
<blockquote class="tr_bq">
Figures on declared emigration show an increase from 19 000 in 2009 to 27 700 in 2010. However, actual outflows are considered to be much greater, based on immigration statistics of th e main destination countries. Spain, the most important destination country in recent years, recorded 10 400 Bulgarians entering in 2010, 7% more than in 2009. Outflows of Bulgarian citizens from Spain also increased in 2010, to 7 600 from almost 5 000 in the previous year (+52%). The number of Bulgarians in Spain increased by 14 500 in 2010, and a further 13 000 in 2011. There are no consistent data for Greece, the second main destination of Bulgarian immigrants in recent years, but it seems that the stock increased less in 2010 than in previous years. </blockquote>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhMv2A8rFV8_NqL9rdFWLs7lav6SxBWZIBGxEuOlZQwjqoF1kXggyuMXB6We95D6fo2rBpILKCgl7bRV71cYEmlSIfoNQYJcPz-Bor5Q01c6eQF8n9lTnFcPJxXt9jOw-L6Uyw01uIH15o/s1600/Bulgarians+in+Spain.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="183" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhMv2A8rFV8_NqL9rdFWLs7lav6SxBWZIBGxEuOlZQwjqoF1kXggyuMXB6We95D6fo2rBpILKCgl7bRV71cYEmlSIfoNQYJcPz-Bor5Q01c6eQF8n9lTnFcPJxXt9jOw-L6Uyw01uIH15o/s320/Bulgarians+in+Spain.png" width="320" /></a></div>
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Remittances data gathered by the World Bank give the general picture. Basically there was a large surge following the severe crisis of the late 1990s, and since that time the level of payments has only weakened slightly, on the back of the severity of the crisis in the main destination countries. <br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh22G6Pb8e6oUyptIP4AqJT10i4rYULqXT1ESFtWN8XHt7yWm2Ni_bsaiKGbeeC-C0gMj_HCIEy4RxKIcK-OcUec1VyUXSeyOzv49vUzfZAq9-XQfAnWLyU8bcAQPkzNqPsImXZMKKw58o/s1600/Bulgaria+remittances.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="181" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh22G6Pb8e6oUyptIP4AqJT10i4rYULqXT1ESFtWN8XHt7yWm2Ni_bsaiKGbeeC-C0gMj_HCIEy4RxKIcK-OcUec1VyUXSeyOzv49vUzfZAq9-XQfAnWLyU8bcAQPkzNqPsImXZMKKw58o/s320/Bulgaria+remittances.png" width="320" /></a></div>
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Bulgaria is also pretty much what the old DDR would look like if it hadn't fused with Western Germany, namely it much more similar to Hungary than it is to Japan (in the sense I discussed <a href="http://hungaryeconomywatch.blogspot.com.es/2013/02/hungarys-matolsky-joins-japans-abe-in.html">in this post</a>) as it has a significant negative balance on the net international investment position (though not as large as Hungary's), which means as well as being quite poor it is totally unprepared for rapid population ageing (since the text book way to sustain pension and health benefits in a context of increasingly weaker headling GDP growth is normally thought to be to draw down on overseas assets).<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOOS2pbEd-sSiMphYB91QeZFa6KEocQMpzFSs-wCpv7g4xsPpA2hDcqHXArTYlmJqKtGn47X_KzoJW1g50MVmA_dLI3eClXQNGHOFa4syk7_YjSt7iGmzcCgSUZQXxFj_RqqCQVscYXc8/s1600/Bulgaria+NIIP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="181" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOOS2pbEd-sSiMphYB91QeZFa6KEocQMpzFSs-wCpv7g4xsPpA2hDcqHXArTYlmJqKtGn47X_KzoJW1g50MVmA_dLI3eClXQNGHOFa4syk7_YjSt7iGmzcCgSUZQXxFj_RqqCQVscYXc8/s320/Bulgaria+NIIP.png" width="320" /></a></div>
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Bulgaria also bears comparison with Hungary for the way it has carried out a rapid correction on its external position. This is due largely to remittances and services exports, since the goods balance is still in deficit. But still, the turnround is impressive.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiksdzOjoRt5qwHFsNrP3onmgR-kLgxjOgtuapjbTV_X0qDd5UrfsAi_o1h64wUvgNf9kHa-o1s6ZdgNyg2u-qR50ijw3Mq4X-HdvckXU_JEKgroaj131tUJWUXedmGYwsnntw_MFGGwsQ/s1600/Bulgaria+Current+Account+Annual.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="178" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiksdzOjoRt5qwHFsNrP3onmgR-kLgxjOgtuapjbTV_X0qDd5UrfsAi_o1h64wUvgNf9kHa-o1s6ZdgNyg2u-qR50ijw3Mq4X-HdvckXU_JEKgroaj131tUJWUXedmGYwsnntw_MFGGwsQ/s320/Bulgaria+Current+Account+Annual.png" width="320" /></a></div>
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As elsewhere exports have performed very strongly.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg52YWsDpsQghPObbfuNrPv11ldSLP8B4i5ehGIxJ04jrx7Mo85BX68JOKdFmO-vg6iW8bvLxshFzuoaebkc7YePqao_SbNsjUVTRvBOrRX7LqnALb3UhISfzyZcViTpgsIo_HlpIj2djg/s1600/Bulgaria+Constant+Price+Exports.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="191" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg52YWsDpsQghPObbfuNrPv11ldSLP8B4i5ehGIxJ04jrx7Mo85BX68JOKdFmO-vg6iW8bvLxshFzuoaebkc7YePqao_SbNsjUVTRvBOrRX7LqnALb3UhISfzyZcViTpgsIo_HlpIj2djg/s320/Bulgaria+Constant+Price+Exports.png" width="320" /></a></div>
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But again to no real avail, since domestic demand is deflating so strongly that the economy struggles to find air...... and growth. In this sense it is hard to agree with the IMF Executive Directors when they state in their latest <a href="http://www.imf.org/external/np/sec/pn/2012/pn12140.htm">Public Information Notice,</a> following conclusion of the Fund's 2012 Article IV consultation, they "broadly agreed that the currency board arrangement has served Bulgaria well". If allowing a country to drift towards long term melt-down is doing well, I would hate to see what something which they thought was an impediment would do! Some thing is rotten in the state of Denmark, and that something isn't being identified or dealt with.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhehTHeI8DgfQOXsL8jUMBZMPlG2fs3V7cXJDAE5nGvLFqhny4-A4NHBUQTlFoiruYGta7a2l8-uXZhftFYki3yl81DmR2oasOuvergO9NruQfLhSELos5aF5CtQ-pzGgZ6rFPbnJ4B82s/s1600/bulgaria+retail+two.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="173" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhehTHeI8DgfQOXsL8jUMBZMPlG2fs3V7cXJDAE5nGvLFqhny4-A4NHBUQTlFoiruYGta7a2l8-uXZhftFYki3yl81DmR2oasOuvergO9NruQfLhSELos5aF5CtQ-pzGgZ6rFPbnJ4B82s/s320/bulgaria+retail+two.png" width="320" /></a></div>
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Naturally part of the problem is that the flow of credit has dried up.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEieRO30ST5L_6MsAU3lZIZO8XqRMxgXLGR9XqOpWEbcmflOOXflkU7zljO1zpdS1n9zDVlBuw-fnBvqJEwaOr5ludYDEm8KyVfmkkczkn6FxcG1wZCez_2hZjSJYTauadNSCIDzwe_kaeQ/s1600/Bulgaria+Total+Loans.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="190" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEieRO30ST5L_6MsAU3lZIZO8XqRMxgXLGR9XqOpWEbcmflOOXflkU7zljO1zpdS1n9zDVlBuw-fnBvqJEwaOr5ludYDEm8KyVfmkkczkn6FxcG1wZCez_2hZjSJYTauadNSCIDzwe_kaeQ/s320/Bulgaria+Total+Loans.png" width="320" /></a></div>
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But the other part is surely the one Krugman identified in Japan, the growing shortage of Japanese (sorry, Bulgarians). It is hard to see how you can get serious retail sales growth in a population that is shrinking so rapidly. The end result is that the economy grew steadily into the global crisis, and subsequently has stagnated. This stagnation isn't simply conjunctural anymore, it has become structural, as the decline in domestic demand associated with ongoing deleveraging and population ageing and shrinkage precisely offsets the positive impact of all that export growth.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwxeYhtZacXrdTTFfvnubSfmGRzi01gbVzgTGqdnAxfJYw-yNY5-mWiD7eMJDhc_PeeFVRYLziVSqK6Ezk5unTetTUkSYbfeMW46CkXx6V58kLKZJrMA-VYF-MO3OPSnlJW3VZfExzn_c/s1600/Bulgaria+Constant+Price+GDP.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="189" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjwxeYhtZacXrdTTFfvnubSfmGRzi01gbVzgTGqdnAxfJYw-yNY5-mWiD7eMJDhc_PeeFVRYLziVSqK6Ezk5unTetTUkSYbfeMW46CkXx6V58kLKZJrMA-VYF-MO3OPSnlJW3VZfExzn_c/s320/Bulgaria+Constant+Price+GDP.png" width="320" /></a></div>
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Not everyone is convinced, of course. The IMF expect the Bulgarian economy to return to a rate of growth of between 3% and 4% after 2014, but looking at the demographics and comparing it with what we are seeing elsewhere that seems pretty unrealistic. What is the expression Christine Lagarde would use? "Wishful thinking" perhaps?<br />
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In any event, in the short term the country looks set to significantly underperform any such rosy expectations. <a href="http://www.focus-economics.com/index.php">FocusEconomics</a> Consensus Forecast panellists expect the economy to expand 1.4% this year. In 2014, the panel expects economic growth to reach the impressive rate of 2.4%.<br />
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<span style="font-size: large;"><b>Growing Political Discontent </b></span><br />
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Since Bulgaria is a small country, and a poor one to boot, most of the above had been going on virtually unnoticed by the rest of the world. Then last week the Bulgarian government <a href="http://www.reuters.com/article/2013/02/20/bulgaria-government-idUSL6N0BK1FG20130220">suddenly resigned en bloc</a>. The immediate cause of the crisis which lead to the resignation was the continuing rise in energy costs, a rise which was largely blamed on the Czech provider CEZ. To appease the street protestors the government has now initiated<a href="http://www.bloomberg.com/news/2013-02-20/bulgaria-regulator-holds-hearing-on-cez-license-april-16.html"> a procedure to revoke the company's licence</a>, a move which has started to raise concerns about institutional protection in the country. <br />
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According to <a href="http://www.bloomberg.com/news/2013-02-20/bulgaria-regulator-holds-hearing-on-cez-license-april-16.html">the report in Bloomberg</a>:<br />
<blockquote class="tr_bq">
Bulgaria’s State Financial Inspection Agency started a probe into CEZ’s Bulgarian units last year and submitted a report on Feb. 8, saying that CEZ ‘‘evaded requirements of the Law for Public Tenders,” the Energy and Economy Ministry in Sofia said on Feb. 18.
The ministry asked the authority to conduct a similar investigation into the local units of Austria’s EVN AG and Prague-based Energo-Pro, it said.
Bulgaria sold seven power distributors in 2005 to EON SE, CEZ and EVN before joining the European Union. EON sold its Bulgarian companies to Energo-Pro in 2011.
</blockquote>
Czech Prime Minister Petr Necas <a href="http://www.bloomberg.com/news/2013-02-19/bulgarian-police-clash-with-sofia-anti-government-protesters-1-.html">was not slow to respond</a>:<br />
<blockquote class="tr_bq">
“I regard the statements by Bulgarian officials about CEZ and other foreign companies as very non-standard and see the whole issue as highly politicized because of the approaching parliamentary elections,” Necas said. “I expect Bulgaria, as a member of the European Union, to stick to its international obligations, European law and its own laws on protection of foreign investments.”
</blockquote>
Naturally energy prices are not the only issue. The population is tiring of austerity, and living standards that don't rise even as unemployment does.<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg4xcfRc1W7ibYmKYuAg7UDK5tbsmIV-TcpRmX2MCM0C186V_And_t-3to3nhc23quJ8v_yNFyIHpk1UE2UEPVo5lLWi07n0yJQcAkQ7853dwbLShYCJTExzLpmsgEvdbUCkl2ljdiz16E/s1600/bulgaria+unemployment.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg4xcfRc1W7ibYmKYuAg7UDK5tbsmIV-TcpRmX2MCM0C186V_And_t-3to3nhc23quJ8v_yNFyIHpk1UE2UEPVo5lLWi07n0yJQcAkQ7853dwbLShYCJTExzLpmsgEvdbUCkl2ljdiz16E/s320/bulgaria+unemployment.png" /></a></div>
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One symptom of this is that Bulgaria's government <a href="http://www.reuters.com/article/2013/02/18/us-bulgaria-government-idUSBRE91H0KS20130218"> sacked Finance Minister Simeon Djankov</a> at the start of last week. Djankov was closely identified with austerity policies, and it isn't hard to read his departure as an attempt to curry favour with voters in elections which are due this summer.<br />
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Having said that, the country's government debt at under 14% of GDP is incredibly low, so there is room for flexibility, if it wasn't populist flexibility. The real issue is that simply spending more this year, or next, won't fix the underlying problem, and that problem is unlikely to be addressed until it is recognized as a problem by the institutions responsible for economic policy formulation. As someone once said, de-nile is not only a river in Egypt.<br />
<br />
This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".<br />
<br />
<span style="font-size: large;"><b>Postcript</b></span><br />
<br />
<a href="http://en.wikipedia.org/wiki/There%27s_a_Hole_in_My_Bucket">According to wikipedia</a>: "There's a Hole in My Bucket" (or "...in the Bucket") is a children's song, along the same lines as "Found a Peanut". The song is based on a dialogue about a leaky bucket between two characters, called Henry and Liza. The song describes a deadlock situation: Henry has got a leaky bucket, and Liza tells him to repair it. But to fix the leaky bucket, he needs straw. To cut the straw, he needs a knife. To sharpen the knife, he needs to wet the sharpening stone. To wet the stone, he needs water. However, when Henry asks how to get the water, Liza's answer is "in a bucket". It is implied that only one bucket is available — the leaky one, which, if it could carry water, would not need repairing in the first place.<br />
<br />
<br />
The origin of this song seems to go back, oddly enough, to the German collection of songs known as the Bergliederbüchlein. Ironically Henry's Q&A with Liza fits the quandry facing the countries on Europe's periphery and their lack of constructive dialogue with their core peers about the roots of their problems to a tee.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-88571828844613094592011-08-18T18:26:00.054+02:002011-08-22T18:25:33.028+02:00Eastern European Growth - Coming Rapidly Off The Boil?The latest round of EU GDP data, brought to light a reality which many who have been closely following the economies of Eastern Europe already suspected: that the heavily export dependent economies in the region would almost inevitably be dragged down by the rapid slowdown in Europe's principal economic motor, the German economy (<a href="http://www.economonitor.com/edwardhugh/2011/08/04/could-there-really-be-a-recession-risk-in-germany/">see this post</a> for background).<a name='more'></a>
<br />
<br />The Czech Republic, Hungary, Slovakia, Bulgaria and Romania all reported slower GDP growth in the second quarter, due in large measure to the disappointing performance of their German neighbour, central Europe’s most important trading partner.
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<br />As <a href="http://www.economonitor.com/edwardhugh/2011/07/27/a-hungarian-waltz-on-the-wild-side/">anticipated on this earlier blog</a>, the Hungarian results were especially weak. Analysts had widely predicted interannual growth of just under 2.5%, but in the end the result came in at 1.5%. Even worse, the economy completely failed to grow in the second three months in the year, since quarter on quarter growth was effectively zero. Thus the increase in industrial activity which accompanied the increased demand for exports was only sufficient to compensate for the drop in internal demand, and this at a time of near record export levels in many European countries. This is doubly worrying since the government, while continuing to reduce the deficit, has appropriated something like 9% of GDP from a one off pension move, paying down debt and, in addition, adding some support to this years spending programme. This factor will not be there to assist growth in the years to come.
<br />
<br />This post will examine the growth performance in a number of the region's economies, and attempt to extract some useful conclusions for what we can expect to see in the region in the future.
<br />
<br /><strong>The Czech Republic Shows Its Weaknesses</strong>
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<br />
<br />Mirroring what just happened in Germany, second quarter GDP growth in the Czech republic slowed from what had been the fastest pace in almost three years achieved in the first three months of the year, to a mere 0.2%, the slowest rate of increase in two years.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgP3Myou9AKZI5RylmEbRoDXhM48AJqAn0qdQbpQF-T7eVX43NyES-8xk5WTWgh1xtGnKZDhXX3KigKD5-MRAnx-9BCEcaFkM0zHYdReVs9GJlJVDdnytr6B6N5sIugwFsVjOMutOnKDsE/s1600/gdp+two.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgP3Myou9AKZI5RylmEbRoDXhM48AJqAn0qdQbpQF-T7eVX43NyES-8xk5WTWgh1xtGnKZDhXX3KigKD5-MRAnx-9BCEcaFkM0zHYdReVs9GJlJVDdnytr6B6N5sIugwFsVjOMutOnKDsE/s400/gdp+two.png" /></a>
<br />While the economy grew 2.4 per cent from a year earlier, compared to 2.8 per cent in the first three months of the year.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgKsq9Yw10q45_DzNE6ctmlPCLnl_Plgpqv6K68Y_e9x99Gcz0e_5h1mQHn3DR7RprattTwjFc5Qhovw7zvQLAGj3y6zkB2CwnR1YXRsxiTH35-3iUb4A6t4I4JWO76N6mihbRokFIBpH0/s1600/gdp.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgKsq9Yw10q45_DzNE6ctmlPCLnl_Plgpqv6K68Y_e9x99Gcz0e_5h1mQHn3DR7RprattTwjFc5Qhovw7zvQLAGj3y6zkB2CwnR1YXRsxiTH35-3iUb4A6t4I4JWO76N6mihbRokFIBpH0/s400/gdp.png" /></a>
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<br />Like many economies in the region, the Czech one is now strongly dependent on foreign demand for its products. Exports have surged back up and beyond pre-crisis highs, while industrial output has grown strongly.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmlu2GpDnRbU4VfCBvdfWS9SschOhxD2_G3DlBm5qpDHb9OiRjIO-_89ECs6-4jMcB8D2LQ5kAhC_8j1IJTR2WUd3POGBLoOShm67tb7636h5_tkqg3dedgPhxlq1D9LSPiT8VM1U1LIs/s1600/Czech+exports.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmlu2GpDnRbU4VfCBvdfWS9SschOhxD2_G3DlBm5qpDHb9OiRjIO-_89ECs6-4jMcB8D2LQ5kAhC_8j1IJTR2WUd3POGBLoOShm67tb7636h5_tkqg3dedgPhxlq1D9LSPiT8VM1U1LIs/s400/Czech+exports.png" /></a>
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9YaBW491vw7pvBMVgzlW113X91cy1LvNcYjq0x0sijlM9mitYxvlH5n_3O1RrJW3e1trOeXFewRnpejceeV04tFqOMLGWqOhMCbBNXN_nAB0ChRSmnDub-ku1Ie10rrEAhMW2MQJcM9I/s1600/Czech+IP.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh9YaBW491vw7pvBMVgzlW113X91cy1LvNcYjq0x0sijlM9mitYxvlH5n_3O1RrJW3e1trOeXFewRnpejceeV04tFqOMLGWqOhMCbBNXN_nAB0ChRSmnDub-ku1Ie10rrEAhMW2MQJcM9I/s400/Czech+IP.png" /></a>
<br />What makes the Czech case interesting is that neither the private nor the public sector is heavily indebted - public sector debt was only 41.3% of GDP in 2010, and the country's external debt was only 46.7% of GDP. Nor is the country facing an "investor strike", the central bank policy rate is currently 0.75% , and far from this deterring people from holding the currency, the Koruna has gained nearly 2.4% against the euro so far this year, as compared with a decline of around 10 per cent in the Polish zloty. Indeed some are even talking of the Koruna <a href="http://blogs.ft.com/beyond-brics/2011/08/18/the-czech-koruna-a-new-star-in-the-foreign-exchange-sky/#axzz1VgLKIOQ7">as a potential safe haven alternative to the Swiss Franc</a>.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcHOm458UqeJ4S5-c3NA0Ohkd4pU2iMCUjvgxsA86VqtMlzFMfSMV2brjNMuFs4cXffHckW4mqBfqJttzWApkBPMvzL-l2xm7sRgO2L21eD66NnbblbK_qgmdmddRBgMdfzhIiYUNghTM/s1600/cZech+Interest+rates.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcHOm458UqeJ4S5-c3NA0Ohkd4pU2iMCUjvgxsA86VqtMlzFMfSMV2brjNMuFs4cXffHckW4mqBfqJttzWApkBPMvzL-l2xm7sRgO2L21eD66NnbblbK_qgmdmddRBgMdfzhIiYUNghTM/s400/cZech+Interest+rates.png" /></a>
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<br />The government deficit has been over the EU 3% limit (it stood at 5% of GDP in 2010) and recent government austerity measures to reduce this level have undoubtedly played some part in the slowdown, but this on its own is not enough to fully explain the velocity of the reduction. As I argue <a href="http://www.economonitor.com/edwardhugh/2011/08/04/could-there-really-be-a-recession-risk-in-germany/">in my most recent post on Germany</a>, export driven economies are inherently volatile, and what has happened in the Czech Republic is an almost classic example. But why is the country export dependent? Well, there are probably as many answers offered to this question as there are economists, but my own personal view is that demography is the key. After decades of very low fertility, the country's population is ageing rapidly, and by 2020 the median age will be nearly 45, making the Czech Republic the second oldest nation in the region, after Slovenia.
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<br />Many will see no significance in this fact, but from where I am sitting the association is not simply coincidental (see <a href="http://mpra.ub.uni-muenchen.de/17655/1/MPRA_paper_17655.pdf">this working paper from Claus Vistesen</a>).
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsleas_lJO1upghEw6ahpybk6U7UcTkUAE_QRwbvGEsL1kjP8GPvxVG1iTnHyEn9pTHo2ceyb6Qs2Nv8JuzTVIcFb9s42Szjyieu-Vc38YokhW_S1qkr4pqLv1X67K1Hy64g4xTu8kUxs/s1600/Cxech+median+age.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsleas_lJO1upghEw6ahpybk6U7UcTkUAE_QRwbvGEsL1kjP8GPvxVG1iTnHyEn9pTHo2ceyb6Qs2Nv8JuzTVIcFb9s42Szjyieu-Vc38YokhW_S1qkr4pqLv1X67K1Hy64g4xTu8kUxs/s400/Cxech+median+age.png" /></a>
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<br />A number of "<strong>stylised facts</strong>" can be extracted from the Czech example. <strong>In the first place,</strong> if we look back at the q-o-q GDP chart (the orange/red one), what is most noteworthy is how the rate of quaterly growth since the crisis has fallen to about half its prior level. This, in an economy without major debt problems and with a fairly competitive economy must give us some idea of <strong>what the "new normal" looks like</strong>. GDP growth is much lower, and likely to remain lower (on average) as far ahead as the eye can see.
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<br />In the second place, <strong>construction output is down</strong> (and falling). This also seems to form part of the brave new world we now live in, at least as far as most of Europe, the US and Japan are concerned. A house is once more becoming something you live in.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8lNr8GAnDauFA-7zYw3bo2DddVrrpre6K9X2GRcvYFbue99s1wi_jGJusjeg9EvzD0ryIWRNSRDcvJWte8Bjoxp4rwL5NKAbuWfx8ltDKLyMV3k8r_eLDJCtIrfBlRr7aetaCqPTrUVg/s1600/Czech+construction.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8lNr8GAnDauFA-7zYw3bo2DddVrrpre6K9X2GRcvYFbue99s1wi_jGJusjeg9EvzD0ryIWRNSRDcvJWte8Bjoxp4rwL5NKAbuWfx8ltDKLyMV3k8r_eLDJCtIrfBlRr7aetaCqPTrUVg/s400/Czech+construction.png" /></a> And thirdly, as I say, <strong>domestic demand is falling steadily</strong>, as reflected in retail sales (naturally in the more heavily indebted economies this situation is worse). This weakness in domestic demand is unlikely to be temporary, and those waiting for a turnaround would do better going and waiting for Godot.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgIm-0SFSPqQT47oFA-MZULcqxrLk9q1XgsUrFV4KD-cUA2ZuLFYrDE3p_pkkt74R8TRWzURE5NOqZd3JghPyXwGABpBk9tv38v2yiCRBuW-1YHJI4bnagmOwgJgHCXw7Y5LpGJr6YUpoc/s1600/Czech+Retail+Sales.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgIm-0SFSPqQT47oFA-MZULcqxrLk9q1XgsUrFV4KD-cUA2ZuLFYrDE3p_pkkt74R8TRWzURE5NOqZd3JghPyXwGABpBk9tv38v2yiCRBuW-1YHJI4bnagmOwgJgHCXw7Y5LpGJr6YUpoc/s400/Czech+Retail+Sales.png" /></a>
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<br />This persistent weakness in domestic consumption is all the more striking in the Czech case, given that real GDP is now almost back at pre-crisis levels.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBG4wlo7MWjksurMrrVi62lOXAzRpW5CLsvmpbKfT7IsgzSoW_Kyn7WsCzcIowo2DqGHajiU_ESi0k1gJaS1gX9QpQx5gsr4BusumEtmIRF0BCg40nYJS_zl5WIMvmLf-aLGEiWJN2wuM/s1600/Czech+constant+price+GDP.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBG4wlo7MWjksurMrrVi62lOXAzRpW5CLsvmpbKfT7IsgzSoW_Kyn7WsCzcIowo2DqGHajiU_ESi0k1gJaS1gX9QpQx5gsr4BusumEtmIRF0BCg40nYJS_zl5WIMvmLf-aLGEiWJN2wuM/s400/Czech+constant+price+GDP.png" /></a>
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<br />The Czech example is illustrative, since it is one of the best case scenarios, and unfortunately, when we look at the regional neigbours, we find that in general things only get worse.
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<br />
<br /><strong>Romanian Growth Holiday</strong>
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<br />Romania has struggled far longer than any other CEE economy to emerge from recession, only grew (q-o-q) by 0.1%, following a 0.7% quarterly rate of increase in the first quarter.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSxNTv9ftAeqZ3ZmOA5ed7_li1gGHv2Pf9Rj6LwjpWRSwYZzYzI8QRcHepnzXxtuDLdtaJ4St2jvg0zTGiZIDET5rdBAupsyFQWnGh_p2GD8_nEjBxFiDfcfNuufls8iAIZ490SrzcgnM/s1600/Romania+GDP+q-o-q.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSxNTv9ftAeqZ3ZmOA5ed7_li1gGHv2Pf9Rj6LwjpWRSwYZzYzI8QRcHepnzXxtuDLdtaJ4St2jvg0zTGiZIDET5rdBAupsyFQWnGh_p2GD8_nEjBxFiDfcfNuufls8iAIZ490SrzcgnM/s400/Romania+GDP+q-o-q.png" /></a>
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<br />Even though there is some discrepancy between the data published by the national statistics office and by Eurostat, it is clear that Romanian GDP is barely up from one year ago.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfnF5OmDGhfpNAHJwesXsGqY_oT13X9v8mY2fewbrmwxF72Y9DXyQfWDHMcoNSWeBAQQfRw9hoKewhiS0rpJCJsAFuTIVv0qi6as3RA0Nx9QuDJCjjbZKH4hC-qNT4GKeJyBkm1hoa9A8/s1600/romania+GDP+y-o-y.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjfnF5OmDGhfpNAHJwesXsGqY_oT13X9v8mY2fewbrmwxF72Y9DXyQfWDHMcoNSWeBAQQfRw9hoKewhiS0rpJCJsAFuTIVv0qi6as3RA0Nx9QuDJCjjbZKH4hC-qNT4GKeJyBkm1hoa9A8/s400/romania+GDP+y-o-y.png" /></a>
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<br />And indeed is still something like 8.5% below its pre-crisis peak.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-az0Wkd1AaeKaL8266d-Grl2cxksE-27IEz6pCg-6P_gmwnunNSYbTkk8col_CDq5hB9WrdXeaY4xMWjJq2xrozjwLPxFQ7hHG7jzJIgjPwLoczUlGoUnh0PVHYi3sOEUnb6HFhZvf_Y/s1600/Romania+Constant+Price+GDP.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-az0Wkd1AaeKaL8266d-Grl2cxksE-27IEz6pCg-6P_gmwnunNSYbTkk8col_CDq5hB9WrdXeaY4xMWjJq2xrozjwLPxFQ7hHG7jzJIgjPwLoczUlGoUnh0PVHYi3sOEUnb6HFhZvf_Y/s400/Romania+Constant+Price+GDP.png" /></a>
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<br />This despite the fact that exports have been booming, and are now above the pre-crisis level.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNzMBs3etEOGTfZMkkCjh_kDsuNHCV3YOjQOqAyKT6W72ajyEvSHJ8nj5-3og8UHQrUmAFSrJP5hVGlY_SXJ6ZuE-ngmx-ppfJvlt1t5-YJ6HGy4g1NAW2Hqu8z8VIaSdYDz2p7CTPzUs/s1600/Romania+Exports.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNzMBs3etEOGTfZMkkCjh_kDsuNHCV3YOjQOqAyKT6W72ajyEvSHJ8nj5-3og8UHQrUmAFSrJP5hVGlY_SXJ6ZuE-ngmx-ppfJvlt1t5-YJ6HGy4g1NAW2Hqu8z8VIaSdYDz2p7CTPzUs/s400/Romania+Exports.png" /></a>
<br />As per the regional pattern, domestic demand has not recovered and retail sales are falling.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjoUAHEf9QfizDFzdtphetFeWGq2cFnpOETLT44gtRzFt8ZLcV8GpSHvCI4FGgnS8IpxDWg5xo0PVVJerNAVftUMC0xkVFJCBYiCElcKJ2gqNYShtdC2rkIgFGcnNhdD5BS7jaJ-7O1FQ/s1600/retail+sales+index.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjjoUAHEf9QfizDFzdtphetFeWGq2cFnpOETLT44gtRzFt8ZLcV8GpSHvCI4FGgnS8IpxDWg5xo0PVVJerNAVftUMC0xkVFJCBYiCElcKJ2gqNYShtdC2rkIgFGcnNhdD5BS7jaJ-7O1FQ/s400/retail+sales+index.png" /></a>
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkRk1pPScV-RBRexAAHKIA0YsCeeW_vxgCgI_WWlsIxxr0EWUDAQJh20fAyBxb7GPhzLyXefv4M5x2WlRVwOuPymg4kRKSmsDNR-kZtIbu2Ssz2uXtkhU5iprF_ufeXniKME6LCJTdFmI/s1600/Romania+Constant+Price+Household+Consumption.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkRk1pPScV-RBRexAAHKIA0YsCeeW_vxgCgI_WWlsIxxr0EWUDAQJh20fAyBxb7GPhzLyXefv4M5x2WlRVwOuPymg4kRKSmsDNR-kZtIbu2Ssz2uXtkhU5iprF_ufeXniKME6LCJTdFmI/s400/Romania+Constant+Price+Household+Consumption.png" /></a> </p>
<br />
<br />
<br />Construction is well down, and is unlikely to return to pre-crisis levels. </p>
<br />
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijmZHvkqh-08GBIg0F48P6lQ4CkRqik-NEFfEudN_Kfvp-YP2jTNmbAVbOCj4huhcaSEgCY9Qufkmq0ORE0sjWHdc2OokkwmpRWSi8vF1KHh_cbqGuBDxmPoQQh1qA57lHxCulx0St-oI/s1600/construction+index.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEijmZHvkqh-08GBIg0F48P6lQ4CkRqik-NEFfEudN_Kfvp-YP2jTNmbAVbOCj4huhcaSEgCY9Qufkmq0ORE0sjWHdc2OokkwmpRWSi8vF1KHh_cbqGuBDxmPoQQh1qA57lHxCulx0St-oI/s400/construction+index.png" /></a> </p>
<br />
<br />
<br />But Romania and the other countries we are about to look at suffer from an additional problem - the have significant external debt levels, and despite the activation of <a href="http://www.ebrdblog.com/wordpress/2011/04/the-vienna-initiative-moves-into-a-new-phase-out-of-crisis-coordination-towards-crisis-prevention/">the so called Vienna initiative </a>they continue to suffer from very tight credit conditions.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKTTQqqL8nzER9VUPtJSMg8sXIywil5vXfvnkHrX_RUOTAjXxwEOo5rthdw6Vf6bPVYON4sDXx0QynWk9VR0uRhDAKUixuS4QpU-3XvTzLvLZjh7bjTvKLDGyPyj81NIq0QJqh-OdusE0/s1600/Romania+Total+Non+Government+Credit.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhKTTQqqL8nzER9VUPtJSMg8sXIywil5vXfvnkHrX_RUOTAjXxwEOo5rthdw6Vf6bPVYON4sDXx0QynWk9VR0uRhDAKUixuS4QpU-3XvTzLvLZjh7bjTvKLDGyPyj81NIq0QJqh-OdusE0/s400/Romania+Total+Non+Government+Credit.png" /></a>
<br />
<br />Total Romanian government debt is not high (only just over 35% of GDP), but the country does suffer from deficit problems (6.5% of GDP in 2010), while external debt is over 70% of GDP (a lot of this in forex loans to the private sector). The country continues to run a significant current account deficit (4.2% of GDP in 2010):
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjT7y7a4hx1COOrPUKsIFyO7sdki878ijlbmW6LAXIeovXkTBe1YsgxvOrl6k3igovZaWs1kUwqqi240CXFLXfEGe_q_I7osaLSNrt1AvaGECXABdbGvOCgpAkiVyjuuJxVPQtW7BADpjM/s1600/Romania+Current+Account+Deficit.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjT7y7a4hx1COOrPUKsIFyO7sdki878ijlbmW6LAXIeovXkTBe1YsgxvOrl6k3igovZaWs1kUwqqi240CXFLXfEGe_q_I7osaLSNrt1AvaGECXABdbGvOCgpAkiVyjuuJxVPQtW7BADpjM/s400/Romania+Current+Account+Deficit.png" /></a>
<br />
<br />and inflation has been far higher than is desireable, given that the country cannot easily devalue to restore competitiveness given the external debt exposure.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjscpKtO_42sFwP-f385kfSXlbq7tqczHkEX1LV5IJ7DIrjXufB7nM_04fLqFrGAlRJvv22WgIRhvl_idFZQIh-NvhVfosfy9vmdw7qtsubmGVRVxg7Mpb2jL_hwVJ3zUkbaHzEj094JhY/s1600/CPI+YoY.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjscpKtO_42sFwP-f385kfSXlbq7tqczHkEX1LV5IJ7DIrjXufB7nM_04fLqFrGAlRJvv22WgIRhvl_idFZQIh-NvhVfosfy9vmdw7qtsubmGVRVxg7Mpb2jL_hwVJ3zUkbaHzEj094JhY/s400/CPI+YoY.png" /></a>
<br />
<br />True, the inflation rate was exacerbated by a 5% VAT rise in July 2010 and the annual rate has now fallen back from 8% in June to 4.9% in July, but I really would question the wisdom of the widespread recourse to VAT rises made by the IMF, since while they do offer a fairly quick short term fix to deficit issues, they only compound growth and external competitiveness problems, in particular in cases where devaluation is not a quick'n easy option.
<br />
<br /><strong>Bulgaria's Limp-along Economy</strong>
<br />
<br />The Bulgarian case is not dissimilar to the Romanian one, even though the economy did return to growth in the second quarter of last year. Growth screeched to a virtual halt in the most recent quarter (0.1% q-o-q):
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZLpp1W1qx1XyUJ2wOWl1CrpTBCUfeLd29FhU-Eh4BFxIBsOYxFzcCy8Nth3tcHFFE662MSuPq1umANbu3kaho_VfIUNEtAKDoMsyfXckfkLAR4dUdbnER6UsHXFjuYjDfBBnGj9RDucs/s1600/bulgaria+GDP+q-o-q.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZLpp1W1qx1XyUJ2wOWl1CrpTBCUfeLd29FhU-Eh4BFxIBsOYxFzcCy8Nth3tcHFFE662MSuPq1umANbu3kaho_VfIUNEtAKDoMsyfXckfkLAR4dUdbnER6UsHXFjuYjDfBBnGj9RDucs/s400/bulgaria+GDP+q-o-q.png" /></a>
<br />
<br />while interannual growth slowed to 1.9% from 3.4% in the first quarter. </p>
<br />
<br />
<br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEirgTg63Q_iktaDSuAIFHNitqBx5N87vlhvhniQqlQD7z9wa-NtQQ1f9O9Mosprihs87FYg7CKbaLH3TM-Vbrq0H7E1wNpZe6s2U5oe1DrxbkKbghqy46vn1n_VgIxiuxMlbYa1bUpvPos/s1600/bulgaria+GDP+y-o-y.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEirgTg63Q_iktaDSuAIFHNitqBx5N87vlhvhniQqlQD7z9wa-NtQQ1f9O9Mosprihs87FYg7CKbaLH3TM-Vbrq0H7E1wNpZe6s2U5oe1DrxbkKbghqy46vn1n_VgIxiuxMlbYa1bUpvPos/s400/bulgaria+GDP+y-o-y.png" /></a>
<br />
<br />Bulgarian GDP has recovered rather more than it has in Romania, but at the end of June it was still more than 7% down from the pre crisis peak level.
<br />
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhUs5QYhQVnfPApRjUNjGcobWP0O_cnGKS0AvY_HAGvhPGWL2u0xHXK0ntLYSvy_lP_GFAoBrl1VEhOVLkihwJfKNnNOfqzqKBJg_NEV8M5hGcpkqJphIUXBKmLwMhMJP_QHD1vB1GBpiE/s1600/Bulgaria+Constant+Price+GDP.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhUs5QYhQVnfPApRjUNjGcobWP0O_cnGKS0AvY_HAGvhPGWL2u0xHXK0ntLYSvy_lP_GFAoBrl1VEhOVLkihwJfKNnNOfqzqKBJg_NEV8M5hGcpkqJphIUXBKmLwMhMJP_QHD1vB1GBpiE/s400/Bulgaria+Constant+Price+GDP.png" /></a>
<br />
<br />The explanation for the weak recovery is the same as elsewhere, with domestic consumption stagnant, and retail sales in tendential decline.
<br />
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl8d1bS6Kc3Q6MmbNI2mXLSw1U03RcRFhrJ_b-hfi0g29JsUpm84GwIF1sVri143Ak2I0vtoi4bpaEJo7VVQxA4Qfugyk9QJsBoXfS7_7vXNMwRx1NWBZAQqlssL7UCL0o81SwiPTnGRM/s1600/Bulgaria+Constant+Price+Household+Consumption.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgl8d1bS6Kc3Q6MmbNI2mXLSw1U03RcRFhrJ_b-hfi0g29JsUpm84GwIF1sVri143Ak2I0vtoi4bpaEJo7VVQxA4Qfugyk9QJsBoXfS7_7vXNMwRx1NWBZAQqlssL7UCL0o81SwiPTnGRM/s400/Bulgaria+Constant+Price+Household+Consumption.png" /></a>
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgKMHxhfygNKgsKjSbJ_6FqDyO4rZ1loXzfvEpPiIDPlWybzaBXdAs_QQXhh9371_H1WFlnYu17_MLFBrycKMRy2P9k45xDEuCQiBDE4qEr3zcCBI_WHGiIXWiSwS1tLSfbNNbeNqqgwZ4/s1600/bulgaria+retail+two.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgKMHxhfygNKgsKjSbJ_6FqDyO4rZ1loXzfvEpPiIDPlWybzaBXdAs_QQXhh9371_H1WFlnYu17_MLFBrycKMRy2P9k45xDEuCQiBDE4qEr3zcCBI_WHGiIXWiSwS1tLSfbNNbeNqqgwZ4/s400/bulgaria+retail+two.png" /></a>
<br />
<br />Construction has also slumped significantly.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRCNvVid0GRleArpdd7ZPSvZHs6phdA62YV35Kik0K86hODjNoqPy01qcLpoTSP-lPwG2G1RoMCMKJbcBHmMt50MFWuVcrHOFEj0Ue2oJjkpSAOizifXr2KfJ5hhMxMG2Qa6PUl129pbU/s1600/bulgaria+construction.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRCNvVid0GRleArpdd7ZPSvZHs6phdA62YV35Kik0K86hODjNoqPy01qcLpoTSP-lPwG2G1RoMCMKJbcBHmMt50MFWuVcrHOFEj0Ue2oJjkpSAOizifXr2KfJ5hhMxMG2Qa6PUl129pbU/s400/bulgaria+construction.png" /></a>
<br />
<br />In addition to the credit crunch which is to be found elsewhere, Bulgaria faces the added difficulty that many banks are Greek owned, and are themselves facing a liquidity stretch at home.
<br />
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwuvDEMTVdgCJ3NPjvDnwRtGAaOOuwK92VoHxKoWGdD0yinmXkEjw9BdaRPUJ6KS6p9DpPVBb7V4M0063QwvfIm0stqhKjkdtDDJziM1LJQampBqeLZQiQfZkrdXUVGQbpYQ5IklTF1zE/s1600/Bulgaria+Total+Loans.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwuvDEMTVdgCJ3NPjvDnwRtGAaOOuwK92VoHxKoWGdD0yinmXkEjw9BdaRPUJ6KS6p9DpPVBb7V4M0063QwvfIm0stqhKjkdtDDJziM1LJQampBqeLZQiQfZkrdXUVGQbpYQ5IklTF1zE/s400/Bulgaria+Total+Loans.png" /></a>
<br />
<br />Yet despite the Euro peg the country continues to run a sizeable inflation rate, and competitiveness - as measured by the REER - continues to deteriorate. Thus an export sector which in value added terms is already too small for the job it has to do is facing headwinds which don't exactly encourage expansion.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEga6aPQp4A_c7QsK3Kk3XXxiop-IOZ5ptoKPOUiREynIxCPqmDUIEeKu14E9QG8wZbSd1wbobPzb9p_DIvrX0GQ5G6p6HYOLBuOH94vIe7PUC1IdEq_t5AYuj9rHkGMT8oOp4pdhonaN94/s1600/bulgaria+CPI.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEga6aPQp4A_c7QsK3Kk3XXxiop-IOZ5ptoKPOUiREynIxCPqmDUIEeKu14E9QG8wZbSd1wbobPzb9p_DIvrX0GQ5G6p6HYOLBuOH94vIe7PUC1IdEq_t5AYuj9rHkGMT8oOp4pdhonaN94/s400/bulgaria+CPI.png" /></a>
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSd8Khv3IfiHaqm8IqftVXC-CKDCAPkcRFg_SnwcX8TfHx2Tf5Iq7Wfn6nHEJYDEGINdCftJMTrud9SiX-94swBDhd-NKfgAokSPdwUN2UdOCNiBUT7YSm8MT253DXLsmw2nGCqRTO7qQ/s1600/Bulgaria+REER+monthly.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSd8Khv3IfiHaqm8IqftVXC-CKDCAPkcRFg_SnwcX8TfHx2Tf5Iq7Wfn6nHEJYDEGINdCftJMTrud9SiX-94swBDhd-NKfgAokSPdwUN2UdOCNiBUT7YSm8MT253DXLsmw2nGCqRTO7qQ/s400/Bulgaria+REER+monthly.png" /></a>
<br />
<br />
<br /><strong>Hungary Had No Boom, But The "Bust" Continues</strong></p>
<br />
<br />Hungary's GDP growth basically stalled in the second quarter (0.0% q-o-q), taking the year-on-year rate down from 2.4% to 1.5% in the first quarter. This is well below consensus expectations (2.5%) and also worse than the central bank forecast of around 2.2%. The pull from net trade evidentally weakened substantially, and in an economy that only has one cylinder to fire on (exports) this makes itself noticed quickly.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdulLH7DvI12vYcK-w0hmw1sq0OFKKeC8x_o5jjwMNVASZ86A4mMoEjYJGOH9TpEPGFV32XH71mR-7mMucnsnPIQbDsUMhakMLOEYNDDyc62rw5JRw5KvldnaaPNEJ0pfheCafnkMry_M/s1600/Hungary+GDP+q-o-q.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdulLH7DvI12vYcK-w0hmw1sq0OFKKeC8x_o5jjwMNVASZ86A4mMoEjYJGOH9TpEPGFV32XH71mR-7mMucnsnPIQbDsUMhakMLOEYNDDyc62rw5JRw5KvldnaaPNEJ0pfheCafnkMry_M/s400/Hungary+GDP+q-o-q.png" /></a>
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmgHy4wl5YvbqeT98yoKknaO7UbhW0kJTjNz6pgPBhzZ7ZIwtruAyGytWgJFWfNTHKHXF7lbyHznmd2gRhWwsm2TqzyU5SmI72FBjuhMfUE65bHefoiNEXb3kE3wzFyYP1c7sHz2bnxXM/s1600/Hungary+GDP+Y-o-Y.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmgHy4wl5YvbqeT98yoKknaO7UbhW0kJTjNz6pgPBhzZ7ZIwtruAyGytWgJFWfNTHKHXF7lbyHznmd2gRhWwsm2TqzyU5SmI72FBjuhMfUE65bHefoiNEXb3kE3wzFyYP1c7sHz2bnxXM/s400/Hungary+GDP+Y-o-Y.png" /></a>
<br />
<br />
<br />Hungarian exports have risen well since early 2009, but in recent months growth in both these and industrial output has tapered off.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQxK8bSnxBGi-736i2on6_vSpEbfJ2Vh_qP1fPHHyyCjvEJTsdyzLphrKkJYqw3r6k0N6XOTzcXiRwQckCKJdbUib0GEFUergRh48bbG3hMs0OVSqMO6hMVgClato3xnQ5rpWaZyzvT3c/s1600/hungary+exports+two.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhQxK8bSnxBGi-736i2on6_vSpEbfJ2Vh_qP1fPHHyyCjvEJTsdyzLphrKkJYqw3r6k0N6XOTzcXiRwQckCKJdbUib0GEFUergRh48bbG3hMs0OVSqMO6hMVgClato3xnQ5rpWaZyzvT3c/s400/hungary+exports+two.png" /></a>
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjE2_KzjbuhDYAHQNwO74b_4PKb1cFgoDCCBCnATWdHbMH2jb45b3ZyF0t2pEFrcyJDsWHOSyuBT7d_Cs5CF_3h33I_r3uz3zINknUnB5dBCFh5BLhQzyi-HXcXdXNvNt-vIwr76dXoICM/s1600/hungary+IP.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjE2_KzjbuhDYAHQNwO74b_4PKb1cFgoDCCBCnATWdHbMH2jb45b3ZyF0t2pEFrcyJDsWHOSyuBT7d_Cs5CF_3h33I_r3uz3zINknUnB5dBCFh5BLhQzyi-HXcXdXNvNt-vIwr76dXoICM/s400/hungary+IP.png" /></a>
<br />
<br />Hungarian GDP is still over 8% down from the pre-crisis peak.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLXm7xMbWiQL-Dr5YKoHfwJn4MabQDdoPXIlqlOZXV5bi2FXWgy8UdZKHrHc45_g86aE5Iq5B3HB3JgsuuZRPiVitCp7ADekNpLIfwhi_bFjjQdCu_3YgFkd_20HLko-nSNGyFN1Gl0zQ/s1600/Hungary+Constant+Price+GDP.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLXm7xMbWiQL-Dr5YKoHfwJn4MabQDdoPXIlqlOZXV5bi2FXWgy8UdZKHrHc45_g86aE5Iq5B3HB3JgsuuZRPiVitCp7ADekNpLIfwhi_bFjjQdCu_3YgFkd_20HLko-nSNGyFN1Gl0zQ/s400/Hungary+Constant+Price+GDP.png" /></a>
<br />
<br />Household consumption has not recovered at all, and retail sales continue to fall.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwx7FnrfyuVXiohedKSpa63zIujGv8CgcXnPFGPYxJMbPa3KA7CXkAoGdDB_mzaHDqY4cfQy9wKI26onZO2Wy1_weYb-CDenKGyAw7skOS96422bmtobISeonR5_CP6jN055QoKRZ13Uc/s1600/Hungary+Constant+Price+Household+Consumption.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiwx7FnrfyuVXiohedKSpa63zIujGv8CgcXnPFGPYxJMbPa3KA7CXkAoGdDB_mzaHDqY4cfQy9wKI26onZO2Wy1_weYb-CDenKGyAw7skOS96422bmtobISeonR5_CP6jN055QoKRZ13Uc/s400/Hungary+Constant+Price+Household+Consumption.png" /></a>
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjkz2N6BZnPwbeJjXjWY438m-8hjHITsH5h8Xwqe4wgc4WKwr38g8b7UG-ruZVB1zH27RB4U0UKesCokyGo5JX4cNGnipVnDWZhpRVVfhGm8hOHuByCoOp5MBh8k-Q-ZVO0H5t8tysRaV4/s1600/hungary+retail+two.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjkz2N6BZnPwbeJjXjWY438m-8hjHITsH5h8Xwqe4wgc4WKwr38g8b7UG-ruZVB1zH27RB4U0UKesCokyGo5JX4cNGnipVnDWZhpRVVfhGm8hOHuByCoOp5MBh8k-Q-ZVO0H5t8tysRaV4/s400/hungary+retail+two.png" /></a>
<br />
<br />Again, construction activity is trending down.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRGzaxgk_0pE2DOrpFX1L5yti65uaU9pZVS9zMqlDsSG1h-nWcRuW3QXUssGxGLThSNLWAlrE4RxEVGlArH09GcDYgozoyzKvEBotWl1HlKLVAj71cHpFNUoYT1BlYhEOBKiC7hlxqVgw/s1600/hungary+construction+index.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiRGzaxgk_0pE2DOrpFX1L5yti65uaU9pZVS9zMqlDsSG1h-nWcRuW3QXUssGxGLThSNLWAlrE4RxEVGlArH09GcDYgozoyzKvEBotWl1HlKLVAj71cHpFNUoYT1BlYhEOBKiC7hlxqVgw/s400/hungary+construction+index.png" /></a>
<br />
<br />The Hungarian current account has recovered considerably, and the country now runs a surplus, unfortunately not a large enough one to underpin stable growth.
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBCv6YpaNqSG0LY9CG2QcliVW2CeHTMbP_BA5FboYxDtaNdE_ZAES6LLSRMPc3UFHxzjbszxL6ENPYU1d4cZ0BdBClHGXffjEhnXG1mOJxsmMOyoIwEX6VV2ZJlkyjWUiYsy-9J588Prs/s1600/Hungary+Current+Account+balance+%2528quarterly%2529.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBCv6YpaNqSG0LY9CG2QcliVW2CeHTMbP_BA5FboYxDtaNdE_ZAES6LLSRMPc3UFHxzjbszxL6ENPYU1d4cZ0BdBClHGXffjEhnXG1mOJxsmMOyoIwEX6VV2ZJlkyjWUiYsy-9J588Prs/s400/Hungary+Current+Account+balance+%2528quarterly%2529.png" /></a>
<br />
<br />
<br />The stock of CHF private sector loans is equivalent to approximately 20% of GDP, most of it made up of household loans (18% of GDP). Roughly half of these loans are mortgages, and the other half consists of home equity loans. As shown in the chart below (housing loans only, but representative of the whole), most of these loans were contracted in 2005- 08, when the consensus view was that the forint was in a secular appreciation trend versus EUR as well as CHF and Hungarians felt safe about borrowing at much cheaper foreign interest rates. People were focused on the repayment size, and not the capital value movements, rather like people have recently been focusing on public deficit issues, without thinking too much about debt dynamics (until Italy came barging along, that is).
<br />
<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmxghwy7Wd8jn3mgzDtOKgTTaQWY1FolpGlOWGsSEul1Y-RXoFNe7oT7S7njsHkY1-JysleurxFblfmDwRyLwDiIQgPKEYRUYvjcQQFJznr7_nxv5IC9WYbDCJrsG23_SZUO3eYUMFffo/s1600/Hungary+forex+mortgages.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmxghwy7Wd8jn3mgzDtOKgTTaQWY1FolpGlOWGsSEul1Y-RXoFNe7oT7S7njsHkY1-JysleurxFblfmDwRyLwDiIQgPKEYRUYvjcQQFJznr7_nxv5IC9WYbDCJrsG23_SZUO3eYUMFffo/s400/Hungary+forex+mortgages.png" /></a>
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<br />In 2005, the average rate for a home equity loan in CHF was 4.8%, compared to 6.2% in EUR and 17.6% in local currency.The upward surge in the CHF together with increases in interest rates on CHF loans since these were intitially taken out means that the repayments on these mortgages have risen significantly. Morgan Stanley estimate that the average repayment on a CHF mortgage taken out over 2005-07 is up over 50%.
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<br />Carrying out some simple back-of-the-envelope calculations they also arrived at the conclusion that servicing this debt at an 8% interest rate costs Hungarians around 2% of GDP every year. Absent the adverse FX shock, servicing costs would have been around 1.4% of GDP. The 0.6% difference can be seen as a kind of growth penalty, hamstringing what would already have been pretty weak domestic consumtion. According to Morgan Stanley calculations, the rise in CHF since 2008 has had the equivalent impact on Hungarian FX borrowers of a 6% rate increase.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhucD3Fytk8bnWYNCGo84dClDXIsfcnQegnhSoFSnKlyK-gQXazC0oNYU5EuVQtiFW87OF7lx-b-hYACcjKRquZ1FT33YKOB8NuqAuHBh5vTsyQyl84OoaJkyx_S0jnxuuLU1Jf2VoLgY8/s1600/Hungary+Total+mortgage+lending+y-o-y.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhucD3Fytk8bnWYNCGo84dClDXIsfcnQegnhSoFSnKlyK-gQXazC0oNYU5EuVQtiFW87OF7lx-b-hYACcjKRquZ1FT33YKOB8NuqAuHBh5vTsyQyl84OoaJkyx_S0jnxuuLU1Jf2VoLgY8/s400/Hungary+Total+mortgage+lending+y-o-y.png" /></a>
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<br />And it isn't only householders who are suffering from Forex risk. Hungary's gross external debt is around 135% of GDP. The country has the largest public debt in the region (around 80% of GDP), and although one off measures with the pension system mean that this will fall this year, the upward path may then resume unless the country has a growth revolution. Worse, 45% of public debt is not in Forints (and some of it is even in Swiss Francs), meaning that currency depreciation risk exists. All in all, it is very had to see the country being able to find its way onto a sustainable debt path.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNPYP832gfLRbsPSdgxBpBmfqiZvmREbZ7xkOhgvjm5Bm17uz0rlccZAMTJlgi_u2OButSXdqW9CMa5vY4KHrSDzF8Hcbs8uyLdY5kG6MkXTRxIrUmZiG43W0RtUoHNzOd7aXnuMfQOyA/s1600/Hungary+Gross+External+Debt.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNPYP832gfLRbsPSdgxBpBmfqiZvmREbZ7xkOhgvjm5Bm17uz0rlccZAMTJlgi_u2OButSXdqW9CMa5vY4KHrSDzF8Hcbs8uyLdY5kG6MkXTRxIrUmZiG43W0RtUoHNzOd7aXnuMfQOyA/s400/Hungary+Gross+External+Debt.png" /></a>
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<br /><strong>Drifting Towards Export Dependence Too Slowly For Comfort?</strong>
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif8RlT0xOBwaz-M4tUMffSywr31CVHcRTDEvplFxJ4hmXh9Y9z-VMkoCGAY_AayPnP8bUHk903U94I9qKq8wYh5Q4UNEOahDJvp9EApgddBTr6RgwmZaMY4z-gbPQy-fqyPWWkBUGlqV0/s1600/Romania+Population.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif8RlT0xOBwaz-M4tUMffSywr31CVHcRTDEvplFxJ4hmXh9Y9z-VMkoCGAY_AayPnP8bUHk903U94I9qKq8wYh5Q4UNEOahDJvp9EApgddBTr6RgwmZaMY4z-gbPQy-fqyPWWkBUGlqV0/s400/Romania+Population.png" /></a>
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<br />
<br />The recent enthusiasm we have seen for the East European model has a nasty and worrying precedent, since in the years leading up to the financial crisis those who lauded the merits of the European Union’s newest members were not few in number. They were seen as the high-growth members of the Union who had learnt the costly lessson that big government was to be strenously avoided. Such was the enthusiasm that even the very evident and very substantial current account deficits were considered almost benign. But then, as even, after pride came the fall, as one country after another had financing difficulties and became forced to call in the IMF.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGLn2jqULTx4H-SkOy9aI9WBbOsiV8bVrOAW05ZAuJeWFG-amfhREAfwB15SkVK_W1NDjJDZULM9upqu5RPHJjHox3OifXc7pg2o-VAlcETSlYieMuU7cliZZvAlv5dFRnzfSx1nBsOow/s1600/bulgaria+population.png"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 259px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGLn2jqULTx4H-SkOy9aI9WBbOsiV8bVrOAW05ZAuJeWFG-amfhREAfwB15SkVK_W1NDjJDZULM9upqu5RPHJjHox3OifXc7pg2o-VAlcETSlYieMuU7cliZZvAlv5dFRnzfSx1nBsOow/s400/bulgaria+population.png" border="0" /></a>
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<br />
<br />Now countries in the East are cited for their low debt, and capacity to accept sacrifices in avoiding excessive deficits. Two issues stand out as important: the prevalence of unhedged forex debt and the regions unique demographics. Just like in the Euro Area's Southern Periphery the presence of forex borrowing severely limits devaluation as a potential competitiveness restorer, while ageing and declining populations mean that the economies are increasingly export dependent. This means they often have both increased exposure to global slowdowns (or recessions), combined with an external financing dependency when sources of funding may rapidly dry up.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDfO8aEJKdgt3-iMit-GOFNW05_oSPl9J4tfE71CGVrRGqt6y0KX3BpTyhPpxlT943AEmMVLwD8UoA0b3GGXcKnEB-GFAa5ZbSQYbWemjsIWyU-yROSIJVYAwzYIeBcVIfNp_dKTJXn5g/s1600/hungary+population.png"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 219px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhDfO8aEJKdgt3-iMit-GOFNW05_oSPl9J4tfE71CGVrRGqt6y0KX3BpTyhPpxlT943AEmMVLwD8UoA0b3GGXcKnEB-GFAa5ZbSQYbWemjsIWyU-yROSIJVYAwzYIeBcVIfNp_dKTJXn5g/s400/hungary+population.png" border="0" /></a>
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<br />
<br />Evidently, societies with young, growing populations can hope that the sheer pace of economic growth will eventually burn down their debt, but societies with shrinking populations, and rapidly rising elderly dependency ratios cannot adopt such a complacent attitude. Older societies are normally lower growth societies, and in addition, with the number of people of working age falling and falling, an ever greater burden falls on an ever smaller labour force. All four countries in our sample are pioneeers in this regard, sounding out the frontiers of a world in constant decline, a world which is ever older.
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<br />This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-49056577714683964772011-07-07T11:45:00.033+02:002011-08-22T17:44:22.760+02:00Smoke On The East European Horizon?<blockquote>"The market is pricing these sovereigns at much wider levels than where their agency ratings would imply," said Diana Allmendinger, a director at Fitch Solutions.CDS on Italy imply a rating of BBB, five notches below its agency rating of AA-minus. And Spain's implied rating is BB-plus, nine notches below its agency rating of AA-plus.</blockquote>
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<br />With so much emphasis being placed on what has been happening farther to the South, economic realities on Europe's Eastern periphery have largely been escaping the close scrutiny of media and analyst attention. In the wake of the belated recognition of the region's vulnerability which followed the bout of acute stress experienced during the post-Lehman crisis, a new consensus has now emerged (<a href="http://www.economonitor.com/edwardhugh/2011/06/02/bells-in-hell-that-dont-go-ting-a-ling-a-ling/">for an in-depth study of the Latvian example see this piece</a>) that the IMF-guided programmes put in place at the time have essentially set things, if not entirely straight then at least on the right track. In particular, as a result of the extensive fiscal discipline and willingness to sacrifice shown a much brighter future now awaits these countries well to the sidelines of all those horrible Greek debt concerns.
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<br />Certainly this is the picture you get from looking at the way the ratings agencies have been treating many of the countries in the region. Only last week Fitch upgraded Estonia to A+, citing the country's solid economic growth performance, exceptionally strong public finances, declining external debt ratios and increasing stabilization in the banking sector. But since many reservations have been being expressed in Europe of late about the validity of rating assessments, I thought it might be interesting to seek out an alternative opinion, and take a look at what the financial markets have been saying, <a href="http://www.bloomberg.com/news/2011-06-19/euro-drives-estonia-credit-risk-lower-as-neighbors-dodge-greek-contagion.html">at least as far as the recent evolution of Credit Default Swap prices go</a>.
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<br />The recently upgraded Estonia, for example, was being valued as recently as just two years agao as having the third-riskiest sovereign debt in the European Union. But the country is now trading in quite another league, and finds itself included among the European "top ten" sovereigns in terms of price. <a href="http://www.bloomberg.com/news/2011-06-19/euro-drives-estonia-credit-risk-lower-as-neighbors-dodge-greek-contagion.html">As reported by Bloomberg on 20 June</a>, Estonian credit-default swaps were trading at 87 basis points, while France was being quoted at 83.7, the Czech Republic at 83, Austria at 68.7 and the U.K. at 66, according to data provided by CMA. By way of comparison Polish CDS stood at 159.6. Effectively, Poland was being considered as almost twice as risky as Estonia. The big question, of course, is whether this kind of realignment in valuations make any kind of economic sense? Is contagion risk being reasonably priced in, and if it isn't, do we face the risk of a sudden (and destabilising) adjustment in the not too distant future?
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjK5Oqtmnm6W0ppwLmOxb1nO0FlCiijV2RCF8Z_DkW38rZ7f-Bb9F-QqNOhtrFcPMeMr4TY9Dm2_flg0j6DzIRwp_kOtFrZ5pn39L7ap7Um_atH156SuC9EpukpMq78rHA9tNEg1GEAqFc/s1600/Estonia+CDS.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjK5Oqtmnm6W0ppwLmOxb1nO0FlCiijV2RCF8Z_DkW38rZ7f-Bb9F-QqNOhtrFcPMeMr4TY9Dm2_flg0j6DzIRwp_kOtFrZ5pn39L7ap7Um_atH156SuC9EpukpMq78rHA9tNEg1GEAqFc/s400/Estonia+CDS.png" /></a>
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<br />Obviously, it is clear that the Estonian Sovereign was never, even during the worst moments of the financial crisis, and under the most severe of worst case scenarios, the third riskiest that was to be found within the frontiers of the EU (Estonia was the only EU country to have a budget surplus last year - worth 0.1 percent of GDP - while public debt totaled a mere 6.6 percent). On the other hand it is the case that Estonia faced an extremely challenging crisis in 2008/09, and had the Euro peg collapsed in one of the four East European countries who had one at the time then the pressure of private debt could certainly have confronted the country with some very complex and difficult choices. So, if we all stop being emotional about CDS for a moment, and start to consider that they might be a traded instrument which can tell us not who is about to default but rather something about the perceived levels of country risk at a given moment in time then they might offer us some sort of yardstick for following how market sentiment is moving, and even (the case in point for my argument here) whether market pricing of relative risks is in line with economic fundamentals.
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<br />So, following the argument along a bit, it is far from clear that the current level of Estonian CDS prices risk in in any more satisfactory way than they did at the height of the crisis, since as we will see there are rather curious anomalies in the way in which some of the countries in the region are being priced, while an excessive short term emphasis on fiscal deficits has perhaps mislead observers about real risks in Europe whether these lie to the South (Italy) or to the East.</p>
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<br />It is not my intention here to single out Estonia for special - negative - treatment (that would not be warranted) but the value being placed on the CDS really is incredibly low for a country that just entered a Euro Area whose outlook could, at the very least, be considered as reasonably uncertain. It is being priced as part of core Europe, when in reality it forms part of Europe's periphery. Arguably, were the Euro to break in two, Estonia would incline towards riding with the German lead group, but given the fact that the country now has a totally export dependent economy (this is the part that I feel is least understood) , and a currency which was arguably over valued at the time of Euro entry (and the country now has ongoing above-Eurozone-average inflation) it is not clear how prepared the country would be to handle the challenges of being attached to the new, and ultra-high value, currency which would be created. Of course, some are going to argue that the risk of this happening is slim, but is this risk, small as it may be, currently being priced in? That is the question. I suggest it isn't, and this creates the possibility of a dangerous surprise in the markets in the event of a disorderly Greek default.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoWn4JNVSOZRYPLaoMcaBeZbzZCKHBVCNqZrwmA51Uc5dvPUWNLI2qeiCyIJR06DB7gvJ240Hg6lNFlJFsbcItBIWRaLwSz91kdCsbQKFDw1oLg3JS95jzBCMvd27jIZbKL4AAsXLvGZk/s1600/Estonia+%2526+EA16+inflation+compared.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoWn4JNVSOZRYPLaoMcaBeZbzZCKHBVCNqZrwmA51Uc5dvPUWNLI2qeiCyIJR06DB7gvJ240Hg6lNFlJFsbcItBIWRaLwSz91kdCsbQKFDw1oLg3JS95jzBCMvd27jIZbKL4AAsXLvGZk/s400/Estonia+%2526+EA16+inflation+compared.png" /></a>
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<br />Strangely, as a country which has recently entered the common currency, country risk seems to have followed a path which is rather nearer to that of its Baltic peers that equivalent Euro Area countries.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiI0H5yqnHupyrb1qp7V2yJWp8PpvLwZFfszmnw5GdD6dW36K15RKKeIJ0V9ZSkmxGhTvCarEFSNveQJ3Uu3ft9t-Fp-SiLfT2XQf3n_PDDvxyeyIVOnBcQe2i_jji2vsJ3zSY51FqGFnY/s1600/Latvia+CDS.png"><img border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiI0H5yqnHupyrb1qp7V2yJWp8PpvLwZFfszmnw5GdD6dW36K15RKKeIJ0V9ZSkmxGhTvCarEFSNveQJ3Uu3ft9t-Fp-SiLfT2XQf3n_PDDvxyeyIVOnBcQe2i_jji2vsJ3zSY51FqGFnY/s400/Latvia+CDS.png" /></a>
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<br />This disparity becomes even more striking if we look at the evolution of Baltic CDS with those of the two countries in Eastern Europe who entered the Eurozone before Estonia. The spread on Slovenian and Slovakian CDS has surged in recent months, not because short term risk of sovereign default in either of these two countries has increased notably, but simply because these two countries as members of a Eurozone with known problems, and real contagion dangers, are now seen as being more risky. So why isn't this the case with Estonia?
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg67KZ_7Dvcy4Anw_dHQrUimIPRmvWuN-0mvGcntSY52o0n8GujbeGwFOJiCKMHtnD6R5_XELk3SjSFMFvwcF47CTr2K3DiHBmhRRONqQ7krW0Q8GYPRodxiIA4NgYrj4sGH3HycQihgpU/s1600/Latvia+and+Lithuania+CDS.png"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 285px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg67KZ_7Dvcy4Anw_dHQrUimIPRmvWuN-0mvGcntSY52o0n8GujbeGwFOJiCKMHtnD6R5_XELk3SjSFMFvwcF47CTr2K3DiHBmhRRONqQ7krW0Q8GYPRodxiIA4NgYrj4sGH3HycQihgpU/s400/Latvia+and+Lithuania+CDS.png" border="0" alt="" /></a>
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<br />True Slovenian and Slovakian CDS are still comparatively low risk priced (Slovenia at 109 and Slovakia at 102) but it is the direction and velocity of the movement which is striking, and especially in comparison with Euro Area peer Estonia. Why are these two countries considered to be more at risk than Estonia, especially given the size of the latter's recent historic legacy?
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<br />Moving beyond the Baltics, risk in a number of other East European countries seems quite mispriced, unless we think that only being pegged to the Euro (rather than actually being a member of it) is a less risky mode to live in. Bulgarian CDS (currently around 225) have been steadily moving down all this year, and in sharp contrast to what happened in June last year, have so far not responded to the Greek crisis, despite the fact that Bulgaria's banks are quite dependent on their Greek parents for funding.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0GI1qlHit5X-JSS1ShmjLJqR5fgQVTh8TFSm25w7-vdDnZ2tfjRdB5xvVeGv8JDG0MqwpxXOziUWgcx29G6kBkCeR9PqxIiUJPnmCMTgEfDeGJPiqfi6lrZm7_McrXEwiXNsem0Sj54A/s1600/Bulgaria+vs+Romania+CDS.JPG"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 195px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0GI1qlHit5X-JSS1ShmjLJqR5fgQVTh8TFSm25w7-vdDnZ2tfjRdB5xvVeGv8JDG0MqwpxXOziUWgcx29G6kBkCeR9PqxIiUJPnmCMTgEfDeGJPiqfi6lrZm7_McrXEwiXNsem0Sj54A/s400/Bulgaria+vs+Romania+CDS.JPG" border="0" alt="" /></a>
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<br />The picture in Romania is rather similar, with the current price of 250 being well off last years highs of around 415, which means that markets are currently perceiving risk in Spain and Italy as more pronounced than those in Bulgaria and Romania. Certainly I would not want to argue that risk in both the aforementioned countries is high, but I am not at all convinced that contagion risk in the latter two is anything like as low as is being suggested, which is presumably why <a href="http://ftalphaville.ft.com/blog/2011/06/14/593531/old-greek-bank-risk-in-new-europe-again/">Nomura was recently advising clients in a research note</a> to sell South African CDS and buy the wrongly priced Bulgarian and Romanian ones (<a href="http://ftalphaville.ft.com/blog/2011/06/30/609776/that-greek-bank-risk-in-new-europe-continued/">also see here</a>). Looking at the macro economic fundamentals of the respective cases, I can't help feeling that in this case the analysts are right.
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<br />And if we move over to Hungary, then we find that as of last Friday CDS stood at around 285, well below the highs of over 400 seen as recently as last November in the wake of the Irish crisis.
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<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPPh_kfto1-loYp2LdDpmf9FBEcf-Q1JqwikZfU9F37PUL_4uuY3NlQz0mpnwT7piYIkcQfcgSR3bryXLu_7j2PVpzjbncd768bPLy5Qg7PDSD5hcnM-7WExqdYE-GwBqyX97MeTcCxQ0/s1600/Hungary+CDS.JPG"><img style="margin:0px auto 10px;text-align:center;cursor:pointer;cursor:hand;width: 400px;height: 222px" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPPh_kfto1-loYp2LdDpmf9FBEcf-Q1JqwikZfU9F37PUL_4uuY3NlQz0mpnwT7piYIkcQfcgSR3bryXLu_7j2PVpzjbncd768bPLy5Qg7PDSD5hcnM-7WExqdYE-GwBqyX97MeTcCxQ0/s400/Hungary+CDS.JPG" border="0" alt="" /></a>
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<br />Arguably the Hungarian case is the most glaring one, since it is the East European country with the highest debt to GDP levels (around 80%) it has very high gross foreign debt (around 135% of GDP, of which 45% is forex denominated), and it is a country where institutional quality is a constant cause for concern. In many ways Hungary is the Italy of the East. Apart from the presence of a strong trade surplus there is not that much to commend in Hungary's recent economic performance, yet its CDS has fallen into line with a regional pattern, and there is little in the way of what is happening in Spain and Italy to be seen in the spread, let alone what is going on in Slovenia and Slovakia.
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<br />Both Hungary and Romania were the object of IMF/EU rescues during the height of the financial crisis, and as a result their financing problems subsided. Both countries have made substantial progress in reducing their fiscal deficits, and have carried out a number of structural reforms. But both countries still have high levels of external indebtedness coupled with economies which are now extraordinarily export dependent for growth. In addition the demographic outlook for many of these countries is absolutely dire, and you will continually have smaller and older workforces trying to pay down increasing quantities of debt.
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<br />This underlying reality constitutes an unstable combination which make the countries concerned highly vulnerable to both a renewed deterioration in sentiment and an external economic slowdown of the sort we could see following a disorderly Greek default, and yet markets in general seems to be shrugging off the risk as almost non existent. "Smoke on the horizon" the admiral said as he lowered the telescope from his blind eye, "I see no smoke on the horizon".
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<br />This post first appeared on my Roubini Global Economonitor Blog "<a href="http://www.economonitor.com/blog/author/ehugh3/">Don't Shoot The Messenger</a>".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-29795590339494446982011-01-13T14:11:00.000+01:002011-01-13T14:19:01.116+01:00And Then There Were Seventeen...."If you know your Thucydides and the Melian dialogue you know that small countries rely most on everyone following the rules. That's why we follow the rules. If there are no rules, then the big will do what they want,"<br /><br />Estonian President Toomas Ilves in an interview with the EUobserver<br /><br /> <br /><br />In a blog post which has gathered a certain notoriety, <a href="http://krugman.blogs.nytimes.com/2010/12/31/congratulations-to-estonia-or-maybe-condolences/">Paul Krugman recently sent the Estonians his condolences</a>. I will send them, not my condolences, but my congratulations, and these not for the somewhat dubious honour of being allowed to join the Eurozone, or even for having carried out a highly successful "internal devaluation" (this outcome is still in doubt), but rather for their stubborness, courage and tenacity. These are indeed hard (and enduring) men and women. And in honour of their courage I offer them a homage, in the form of two charts. The first of these is the latest Estonian industrial production one.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBdu95ec85mHIVWAUKKjPEuEOjUCkMv8JWuijrVsiUbD0loJoD5_Lx3ntredd2ZXcyqVraz1LtNXNghPHy_reb_oM89TD7cRfti67b-XRBTOMVN9AThA3SgssC2OP5CkBpFaHePmWXdPMR/s1600/Estonia+IP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 215px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBdu95ec85mHIVWAUKKjPEuEOjUCkMv8JWuijrVsiUbD0loJoD5_Lx3ntredd2ZXcyqVraz1LtNXNghPHy_reb_oM89TD7cRfti67b-XRBTOMVN9AThA3SgssC2OP5CkBpFaHePmWXdPMR/s400/Estonia+IP.png" alt="" id="BLOGGER_PHOTO_ID_5560287021364261122" border="0" /></a><br /><br />While the second is the Spanish equivalent.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhl-42bkwgZQXP_kaOexkaMsSTso6mNf1sOjEo-j469Y2s9Po2VUMdv7x7sIpyE7XHOb__C3R-N_E19uExS9K7veyo0td0R0E0pVmaDir9Gg5MteQlqdGf2th36jBNuv7cet43o8yaqtXuj/s1600/industrial+output+-+Spanish.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 210px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhl-42bkwgZQXP_kaOexkaMsSTso6mNf1sOjEo-j469Y2s9Po2VUMdv7x7sIpyE7XHOb__C3R-N_E19uExS9K7veyo0td0R0E0pVmaDir9Gg5MteQlqdGf2th36jBNuv7cet43o8yaqtXuj/s400/industrial+output+-+Spanish.png" alt="" id="BLOGGER_PHOTO_ID_5560287283650891650" border="0" /></a><br /><br /> <br /><br />Can you spot the difference? If not squint a little closer. Estonia's economy fell by around 18% during the crisis, while Spain's has so far has fallen only by something like 7%, yet Estonia's industrial output is now almost back to where it was before the crisis started, while Spain's has fallen but so far not recovered. No sign of even the tiniest green shoot.<br /><br /> <br /><br />Curiously, Spain's political leaders constantly complain that the markets are being unfair to their country, and are underestimating their ability and determination in responding to the crisis, yet if we compare the relative performances of the industrial sectors in the two countries, it is pretty obvious why the markets entertain the doubts they do. Both are destined now to live from exports, but one country is evidently living rather better from them than the other. It is clear that companies in the Estonian industrial sector have been far more agile in diversifing and finding new markets than have their Spanish counterparts.<br /><br /> <br /><br />Both countries experienced a construction lead "boom-bust" (Spain's of rather larger proportions than the Estonian one), and consequently now face highly impaired domestic demand, yet the Estonians have succeeded where the Spaniards have failed, by shifting a part of their previously inwardlooking industrial base towards the outside world and towards growth. There is simply no other explanation for the evident discrepancy, since (as we will see below) Estonia's industry is not growing due to the pull of domestic demand, although it is on the point of returning to "back to normal" operating levels. Spain's export sector is also recovering (after all the external demand is now there), but the part of Spain's industry which is geared towards supplying domestic demand simply hasn't been able to adapt, and is still contracting along with domestic consumption. In fact it is still contracting so rapidly that that the shrinkage is totally cancelling out all the fine work being done by the companies who are doing all the exporting, which is why industrial output remains more or less stationary, and the Spanish economy fails to return to life.<br /><br /> <br /><br /><b>Many Rivers Left To Cross</b><br /><br /> <br /><br />Well that, as they say, was the good news. What follows possibly won't be anything like so palatable for Estonians to read as what went before, which doesn't mean it isn't worth reading and thinking about. You see, that old black magic (sorry, devaluation) debate, was never about whether or not the Estonian export sector could recover to its old level after the economic contraction came to a halt. As I keep stressing, it is obvious that it could, since in this case recovery depends on factors external to Estonia, and these factors have now changed, as a number of countries have seriously started to recover. No, the issue was always about the fact that the Estonian economy had become severely distorted during the boom years, and that the existing export sector was too small to do the heavy lifting that was going to be required of it after the bust in domestic demand. How many times did people say to me during those early days "but what can we export?", or "don't you realise that Estonian exports are largely re-exports of processed imported goods", as if these added disadvantages made the situation any easier, or my arguments somehow irrelevant. When a country is in trouble, but really in trouble, one of the first signs, I reckon, of the depth of the problem is that you get a long queue of official economists lining up to give you a thousand and one reasons why it is going to be impossible to export your way out of difficulty. This is like a leading indicator for "problems looming", since the situation has become so serious that effective solutions are virtually beyond the realm of the thinkable, and we need to soothe ourselves with nice sounding palliatives. In the realm of economic science, however, reality has a nasty habit of coming back and waking us from our slumbers.<br /><br /> <br /><br />What all this really suggests to me is that the thrust of the original argument about why the size of the export sector needs to increase sharply in economnies which have become so badly distorted as the Estonian and Spanish ones have was never really properly understood. So it is in honour of all those valiant Estonians who have sacrificed so much in order to gain so little that I endeavor just one more time to make things clear (my original pieces on Estonia's internal devaluation can be found <a href="http://www.bloomberg.com/news/2011-01-12/portugal-borrowing-costs-fall-at-auction-as-bailout-speculation-diminishes.html">here</a> and <a href="http://balticeconomy.blogspot.com/2009/03/devaluation-euro-membership-and-loan.html">here</a>).<br /><br /> <br /><br /><b>The Estonian Economy Is Recovering!</b><br /><br /> <br /><br />As one-commentator-after-another never tires of informing us, the Estonian economy has returned to some sort of growth recently, indeed (hat tip <a href="http://krugman.blogs.nytimes.com/2011/01/06/what-if-they-had-a-depression-and-nobody-noticed/">to Krugman</a>) the Washington Post even went so far as <a href="http://www.balticbusinessnews.com/article/2010/12/27/The-Economist-Estonia-to-become-a-Nordic-kitten-on-Jan-1">to lump it together with Germany as one of Europe's “growing economies”</a>, while the Economist Central Europe correspondent <a href="http://www.balticbusinessnews.com/article/2010/12/27/The-Economist-Estonia-to-become-a-Nordic-kitten-on-Jan-1">described it as a Nordic Kitten</a>, seemingly a designation created to distance it from its more problematic Baltic neighbours. Unfortunately, wine doesn't improve simply by changing the label on the bottle (even if it does now say “appellation Frankfurt controlé”), and Estonia is neither a growth economy (which is the Goldman Sachs term for the new Emerging Market tigers like India, Indonesia, Turkey and Brazil) nor is it a "growing one", it is simply a "steadily recovering" one, and what's more, given the severity of the challenges it still faces it is far from having entirely managed to distance itself from the set of economic problems characteristic of what has come to be known as the “Baltic syndrome”.<br /><br /> <br /><br />Yes, Estonia’s economy has now started to grow again, indeed it was up by an annual 5% in the third quarter. But, to put this number in context, it was still down by around 16% from the Q4 2007 high, and just below the level of Q3 2005. So there is still rather a long way to go to get back to meaningful growth, indeed so long, as Krugman again points out, that IMF forecasts don't contemplate the country's economy reaching its 2007 level again before 2015 (Germany just more-or-less hit its 2007 level in 2010).<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAy6JW_W1CU9Wdr1olDC4uZlnJ3pxNwqqJFHIjC0Nt9_-SrAATTyYebl47wOVaWVmV56HHNStDq61SQkKETtKMU7wZoHRDCBIfh472DWKG7Y0R7UXxQ2FiNvsMyB16XuXSF4_S8r5k0RrC/s1600/Estonia+Constant+Price+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAy6JW_W1CU9Wdr1olDC4uZlnJ3pxNwqqJFHIjC0Nt9_-SrAATTyYebl47wOVaWVmV56HHNStDq61SQkKETtKMU7wZoHRDCBIfh472DWKG7Y0R7UXxQ2FiNvsMyB16XuXSF4_S8r5k0RrC/s400/Estonia+Constant+Price+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5561345738106723250" border="0" /></a><br /><br /> <br /><br />So, what is slowing the recovery down? Well, as I indicated at the start of this post, it certainly isn't the industries in the country's export sector, which are now more or less back to where they were before the crisis started.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEikDLkVDeI2Bsu16hveAsMwbUOGgRLYUkCccyzDgX9n_UqcTG9PCKLBjMSwktRFzvfgXIOucqO3qIBgIxWDfY0KfKlI5iftopXfYb0ZL3mb2AFfkTjFie5P1y-zaX2P460Csquq6T8eUq24/s1600/Estonia+Constant+Price+Exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEikDLkVDeI2Bsu16hveAsMwbUOGgRLYUkCccyzDgX9n_UqcTG9PCKLBjMSwktRFzvfgXIOucqO3qIBgIxWDfY0KfKlI5iftopXfYb0ZL3mb2AFfkTjFie5P1y-zaX2P460Csquq6T8eUq24/s400/Estonia+Constant+Price+Exports.png" alt="" id="BLOGGER_PHOTO_ID_5561351180051622146" border="0" /></a><br /><br /> <br /><br />But rather the problem lies in the state of private domestic demand, which obviously isn’t recovering.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiX5yszU8eBRUnHI_GKCr-QJ7ySKenhrMmKrnSfcENqKaiPfAv-aCKLlW3hUqwtp3MgsespqGwZiTS-ePqqV-J-PX3D1qehIGzHVszalYCxTr0QfqiUJozwqNjnCAadawgF-j2LJJwCUGz/s1600/Estonia+Constant+Price+Private+Household+Consumption.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiiX5yszU8eBRUnHI_GKCr-QJ7ySKenhrMmKrnSfcENqKaiPfAv-aCKLlW3hUqwtp3MgsespqGwZiTS-ePqqV-J-PX3D1qehIGzHVszalYCxTr0QfqiUJozwqNjnCAadawgF-j2LJJwCUGz/s400/Estonia+Constant+Price+Private+Household+Consumption.png" alt="" id="BLOGGER_PHOTO_ID_5561352056942776290" border="0" /></a><br /><br /> <br /><br /> <br /><br />As the Estonian Central Bank put it <a href="http://www.eestipank.info/pub/en/press/Press/kommentaarid/_258.html?ok=1">in their economicpolicy statements</a> (and <a href="http://www.eestipank.info/pub/en/press/Press/pressiteated/pt2010/_12/pt1209">here</a>, and <a href="http://www.eestipank.info/pub/en/press/Press/pressiteated/pt2010/_11/pt1111">here</a>) on the latest GDP numbers:<br /><br /><blockquote>“Estonia's recovery has been mostly driven by exports, which, measured in current prices, reached close to the all-time high in September”, and “Export growth indicates that the economic activity of our main export partners is expanding quickly and Estonia's companies are making good use of it.... The export volume of industrial production reached a historical high in the third quarter. Irrespective of the continuously weak domestic demand, the sale of industrial production started to pick up in the domestic market as well, but it is still some 25% below the pre-crisis level.... since unemployment continues to be high, the level of consumers' income and purchasing power will remain weak in the next years”. </blockquote>And as the central bank also point out, export growth will now be harder (that is we <span style="font-weight: bold;">have now picked most of the low lying fruit</span>).<br /><br /><blockquote>“Though most of industrial enterprises still have under-utilised production capacity, the existing capacity stock is running out along with rapidly expanding sales volumes. This refers to the need for additional investment”.</blockquote>Yet, unfortunately, the sad truth is that investment activity has still not picked up.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiN_XD7YNR5LTXjEPA2GGllhtjvOms9VSKSNzHQ_Da4V55L7pDmlp8SC4IvGw3bqy9KRSBTref_5897fOj_f7upJcWixdo6oiO_5-0uaA7-akyzrfl4oTdhyphenhyphennZeS8Bbykd-wBDhhcGpKI8t/s1600/Estonia+Constant+Price+GFCF.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 244px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiN_XD7YNR5LTXjEPA2GGllhtjvOms9VSKSNzHQ_Da4V55L7pDmlp8SC4IvGw3bqy9KRSBTref_5897fOj_f7upJcWixdo6oiO_5-0uaA7-akyzrfl4oTdhyphenhyphennZeS8Bbykd-wBDhhcGpKI8t/s400/Estonia+Constant+Price+GFCF.png" alt="" id="BLOGGER_PHOTO_ID_5561351592485596754" border="0" /></a><br /><br /> <br /><br />This lack of series investment in fixed capital contrasts sharply with recent movements on the equities side, since, according to Bloomberg data, Estonian stocks are valued at an average of 16 times estimated earnings, compared with 11.3 times for Polish and Czech shares, and 12.6 times for Slovenia (the chart sort of resembles the export one, doesn't it?).<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicR11N4t7DUZ_LdctklMy__-lS2tjmUVT1bAHP_Y5qcdjBNXGXpc-WbPeRIqv4Fr-fJWYUByIb5ldvWkLX2T2tK7FMNJyAgu1EkmItVGUX5Hv0V6Sb0ajk4UGkNkiN9AFQ6uU_BwsuDD_D/s1600/Estonia+OMX+Tallinin+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 293px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicR11N4t7DUZ_LdctklMy__-lS2tjmUVT1bAHP_Y5qcdjBNXGXpc-WbPeRIqv4Fr-fJWYUByIb5ldvWkLX2T2tK7FMNJyAgu1EkmItVGUX5Hv0V6Sb0ajk4UGkNkiN9AFQ6uU_BwsuDD_D/s400/Estonia+OMX+Tallinin+Index.png" alt="" id="BLOGGER_PHOTO_ID_5561355321788062450" border="0" /></a><br /><br /> <br /><br />But the issue is this: following a pattern seen in many emerging markets over the last 12 months, short-term fund inflows pushed values on the Tallinn exchange up by some 73% in 2010, making it the third-best performance worldwide, according to Bloomberg data. They also quote Tallinn-based SEB researcher Peeter Koppel as saying: “Euro adoption has somehow triggered more widespread thinking about saving and investing in general,”...... Foreign retail investors “now have the hard fact of euro and the certain caution, especially from the Scandinavian side, is gone.” Which sounds to me more like “previously wary investors have now thrown caution to the wind,” on the back of all the pro-Euro Nordic-kitten hype. What Estonia needs, and is not getting (as the central bank itself recognises) is serious, long term, FDI for greenfield projects generating jobs and output in the export sector.<br /><br /> <br /><br /><b>Boosting Domestic Demand Means Increasing The Size of the Export Sector & Creating Employment</b><br /><br /> <br /><br />As I say, in contrast to what is happening in the external sector domestic demand is far from recovering. Retail sales were up 5% (at constant prices) in November over November 2009, and 1% in October. But the annual rise is more a by-product of the very low level of sales hit in November last year, and in fact between January and November 2010, retail sales were down 4% compared to the same period in 2009.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOGBGk0V2tUTSKiN4jt1lhL_3vHM6BcWAQkoITLd2eiD12fnFyU6kjH1uRnB-pYLvrcpSTzB4IwP3JaHm-B4h0ub54uLrSgG8FKibLRUzihwKjfcx-faki6rDI6CBB7vU8UxuqNQM_UGF5/s1600/Estonia+retail+sales.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOGBGk0V2tUTSKiN4jt1lhL_3vHM6BcWAQkoITLd2eiD12fnFyU6kjH1uRnB-pYLvrcpSTzB4IwP3JaHm-B4h0ub54uLrSgG8FKibLRUzihwKjfcx-faki6rDI6CBB7vU8UxuqNQM_UGF5/s400/Estonia+retail+sales.png" alt="" id="BLOGGER_PHOTO_ID_5561355771731279314" border="0" /></a><br /><br /> <br /><br />The domestic construction sector isn’t recovering either. According to Statistics Estonia, the total production of Estonian construction enterprises increased 1.2% in Q3 2010 compared with a year earlier. But when you read the fine print, the increase was entirely produced by construction companies operating abroad (whose activity was up by 25%) – ie once more it is a question of exports.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1umo6VxQ3p1_7YHPbSaUuvio-5rqLwwP2hjsSJK7-R-EWOSvrVDPOQAZeacQ1gbccC0KDFJm29ntIr6aOZH7iUj-BwcA4QVi3wj7LHBcWp0IUk-8LYxOXVEFSEEOGm0fMDzLO-CPtsZo8/s1600/Estonia+Constant+Price+Construction.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1umo6VxQ3p1_7YHPbSaUuvio-5rqLwwP2hjsSJK7-R-EWOSvrVDPOQAZeacQ1gbccC0KDFJm29ntIr6aOZH7iUj-BwcA4QVi3wj7LHBcWp0IUk-8LYxOXVEFSEEOGm0fMDzLO-CPtsZo8/s400/Estonia+Constant+Price+Construction.png" alt="" id="BLOGGER_PHOTO_ID_5561355976586624258" border="0" /></a><br /><br /> <br /><br />And in fact construction output inside Estonia fell by around 1% compared to the 3rd quarter of 2009, and even this drop only wasn’t larger due to the availability of EU infrastructure funding, since the volume of building construction decreased 9% while the volume of civil engineering increased 15% at constant prices. According to data from the Estonian Register of Construction Works, in the 3rd quarter of 2010 there were only 481 housing units completed - 50% down on the same period of 2009. 65% of these were flats, the majority majority of them in Tallinn.<br /><br /> <br /><br />As the Central Bank point out, domestic demand can only improve in a sustained way if there is a major improvement in the labour market, but as they also stress, this is only recovering slowly, with the unemployment rate declining to 15.5% in the third quarter, and with the need to improve productivity and only low growth expected in the quarters to come, unemployment is likely to remain high for several years.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6qcnemzJcp2EM7qS2FkvpW24rquv0PBRRakLko67PK_fQSpjT63LJdrAtMe9udnUvNTWU_me0dYNoYopKZkmBeB3x6sHK8fMg966cK8ApkcEtskoLE7zHro1qodjlCEZuxuUrwPDm3Gzj/s1600/Estonia+Eurostat+Unemployment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6qcnemzJcp2EM7qS2FkvpW24rquv0PBRRakLko67PK_fQSpjT63LJdrAtMe9udnUvNTWU_me0dYNoYopKZkmBeB3x6sHK8fMg966cK8ApkcEtskoLE7zHro1qodjlCEZuxuUrwPDm3Gzj/s400/Estonia+Eurostat+Unemployment.png" alt="" id="BLOGGER_PHOTO_ID_5561356284187329538" border="0" /></a><br /><br />So despite the recovery in external demand, as was to be expected the demand for domestic credit far from recovering continues to contract, whether we are talking about corporates:<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQh2Tt4F20URAOi9YVKuficGW6U9UWsbEEIXzs3AdiXGJ3GZyRan7EKkeRLxALSmHpZu_ze78wP_kzxjJTETQ299t9gx4PHaE2xu8uqxPQIllrqHPIywS2V80cPTxDw639A2E2Ti2sy89-/s1600/Estonia+Corporate+Borrowing+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQh2Tt4F20URAOi9YVKuficGW6U9UWsbEEIXzs3AdiXGJ3GZyRan7EKkeRLxALSmHpZu_ze78wP_kzxjJTETQ299t9gx4PHaE2xu8uqxPQIllrqHPIywS2V80cPTxDw639A2E2Ti2sy89-/s400/Estonia+Corporate+Borrowing+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5561356536236457442" border="0" /></a><br /><br /> <br /><br />or about households:<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7zqhcveEyGyR6heXSNyZ0db-COsVM9q1GJnIpLGJYYINRGLDu3Mbs_Y61JmBPrqM8dhUnPjWaOkaTO2nQtTeZwL-1LZOE44dToH7JAEHJPIi7DzXBVUJt_wnHKgVt4u5LKJb_Kpv1NmKg/s1600/Estonia+Household+Borrowing+y-o-y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7zqhcveEyGyR6heXSNyZ0db-COsVM9q1GJnIpLGJYYINRGLDu3Mbs_Y61JmBPrqM8dhUnPjWaOkaTO2nQtTeZwL-1LZOE44dToH7JAEHJPIi7DzXBVUJt_wnHKgVt4u5LKJb_Kpv1NmKg/s400/Estonia+Household+Borrowing+y-o-y.png" alt="" id="BLOGGER_PHOTO_ID_5561356816035947234" border="0" /></a><br /><br /> <br /><br />or about housing mortgages:<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiUFn9hmdbdjfnaI1NnwnhON8QVtdHRz9j8QZWeApKmCk6sk15_AxiMWCrtJNgSEBrjs2wP_tMHUkxpsD1W60Cm6r2k2wpYAcBqU-mi6Ub-M3g6DNHwLj-DOi_KAkYOunjzvnTJnZxeguMa/s1600/Estonia+Mortgage+Lending.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiUFn9hmdbdjfnaI1NnwnhON8QVtdHRz9j8QZWeApKmCk6sk15_AxiMWCrtJNgSEBrjs2wP_tMHUkxpsD1W60Cm6r2k2wpYAcBqU-mi6Ub-M3g6DNHwLj-DOi_KAkYOunjzvnTJnZxeguMa/s400/Estonia+Mortgage+Lending.png" alt="" id="BLOGGER_PHOTO_ID_5561357052126141698" border="0" /></a><br /><br />Added to this, the way that fiscal austerity was implemented (raising VAT, and fuel costs) has meant that the Estonian price level, far from continuing to deflate (which is what is needed to increase competitiveness quickly enough) is now rising again, and at around 5.5% (my estimated HICP, <a href="http://www.balticbusinessnews.com/article/2011/01/07/Estonian-consumer-prices-up-5-7-in-December-yoy">the Estonian CPI was up 5.7% but the weightings are different</a>) is well above the 2.2% estimate for the Euro Area, or the 1.9% December inflation estimated for Germany by the Federal Statistics Office. Perhaps one of the clearest indications of the malfunctioning of the Eurozone as currently structured is that the Germany economy (which is recovering rapidly) is experiencing far higher levels of inflation than the Eurozone periphery, which in theory should be deflating to recover competitiveness.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvy3GezF90KwaRrvlTqQXKirZ2jWs88Hm03UAWu4smnbdbivOmoZ88CVUpcEbCdotOdXPthVmUD39CFB0Um5UmhUnMFM_hK_yG1Slju95GO75GiCw-rAj16bSXTSAfrY8s_H5dT6xFkLln/s1600/Estonia+%2526+EA16+inflation+compared.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvy3GezF90KwaRrvlTqQXKirZ2jWs88Hm03UAWu4smnbdbivOmoZ88CVUpcEbCdotOdXPthVmUD39CFB0Um5UmhUnMFM_hK_yG1Slju95GO75GiCw-rAj16bSXTSAfrY8s_H5dT6xFkLln/s400/Estonia+%2526+EA16+inflation+compared.png" alt="" id="BLOGGER_PHOTO_ID_5561357269069019970" border="0" /></a><br /><br /> <br /><br />True Estonia did begin to recover some part of the lost competitiveness, and unit labour costs as compared with some key competitors did start to improve, but this process slowed considerably in the first two quarters of 2010, marked time in the third one, and may actually have started to deteriorate again in the final quarter as inflation accelerates (OECD data - please click on image for better viewing).<br /><br /> <br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhY8XzESmIFFzoLh7tvTLyZrcKnsxMM6wtS1lIL6F_eQSzHAVU9HQP6xaGZx5HBzoKefEGmTBnBeWLHnnLbkugzRiGlVcoj8EskgO1sSPgZFA_j-UbzxYOsQNGz0VYAgJ4vmqdiUq5Ld5CE/s1600/Estonia+Unit+Labour+Costs.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhY8XzESmIFFzoLh7tvTLyZrcKnsxMM6wtS1lIL6F_eQSzHAVU9HQP6xaGZx5HBzoKefEGmTBnBeWLHnnLbkugzRiGlVcoj8EskgO1sSPgZFA_j-UbzxYOsQNGz0VYAgJ4vmqdiUq5Ld5CE/s400/Estonia+Unit+Labour+Costs.png" alt="" id="BLOGGER_PHOTO_ID_5561641691010523842" border="0" /></a><br /><br /> <br /><br />Hourly wages (on a moving average basis) seem to have stopped falling, and the next move will almost certainly be up as inflation bites in.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEisnbJIWSaWtkCKL40jg6FIGt3_aGcpuIPZRKA9dG5wOQh6v5KOJ1cWABshBAm_7fHc9kEVLqiTw5jx6xqwP_74xYUp7LRwD9NPrdgqp-yV2pJlCCKXS1CYZJAuhbqPXSNGWQUt1-tcvCEn/s1600/Estonia+Hourly+Wages.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 259px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEisnbJIWSaWtkCKL40jg6FIGt3_aGcpuIPZRKA9dG5wOQh6v5KOJ1cWABshBAm_7fHc9kEVLqiTw5jx6xqwP_74xYUp7LRwD9NPrdgqp-yV2pJlCCKXS1CYZJAuhbqPXSNGWQUt1-tcvCEn/s400/Estonia+Hourly+Wages.png" alt="" id="BLOGGER_PHOTO_ID_5561646496031827714" border="0" /></a><br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4sQ4yzcJedFu_n6sD3aK4o3XJVT7PTwmSrpwhwXBTW0wbnS0w4tYgYTwLB-JSPKVOsvRYmHTYNUrQTPZUuG8k6tN8bpxxjIU3hgHyq_RRaT3YfGMNM7DAhUalVPdVpKhR6ZHb7DbAlRqH/s1600/Estonia+Hourly+wages+y-o-y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 261px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4sQ4yzcJedFu_n6sD3aK4o3XJVT7PTwmSrpwhwXBTW0wbnS0w4tYgYTwLB-JSPKVOsvRYmHTYNUrQTPZUuG8k6tN8bpxxjIU3hgHyq_RRaT3YfGMNM7DAhUalVPdVpKhR6ZHb7DbAlRqH/s400/Estonia+Hourly+wages+y-o-y.png" alt="" id="BLOGGER_PHOTO_ID_5561644946397164418" border="0" /></a><br /><br /> <br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjHMRCcbMsEK_KqPhjt4IFZM6by-MatdOHZCgVzHmCev4Y28koll9oZYO_6Q4urGpVjNTOMAemeuAIlhirt5e_Q87IDJzzL8wVMBBb5jk85GbmyQTA7uQrJqB-fF1BZ0p3cSB7QOAu-uc3C/s1600/Estonia+PPI.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjHMRCcbMsEK_KqPhjt4IFZM6by-MatdOHZCgVzHmCev4Y28koll9oZYO_6Q4urGpVjNTOMAemeuAIlhirt5e_Q87IDJzzL8wVMBBb5jk85GbmyQTA7uQrJqB-fF1BZ0p3cSB7QOAu-uc3C/s400/Estonia+PPI.png" alt="" id="BLOGGER_PHOTO_ID_5561647062992033138" border="0" /></a><br /><br /> <br /><br />True, the Central Bank would undoubtedly argue that much of the inflation was due to food and energy, and that core inflation was running much lower (1.2% in November), but it is hard to see the impact of movements in the leading CPI not feeding through into wages, and producer prices (another important measure of industrial costs) were up an annual 4.5% in November.<br /><br /> <br /><br /> <br /><br /><b>And Its A Hard Road To Travel!</b><br /><br /> <br /><br />In his most recent assessment of the Estonian situation (<a href="http://blog-imfdirect.imf.org/2011/01/07/toughing-it-out-how-the-baltics-defied-predictions/">Toughing It Out: How the Baltics Defied Predictions</a>) <a href="http://blog-imfdirect.imf.org/bloggers/christoph-rosenberg/">Christof Rosenberg</a> (former coordinator of the IMF baltic intervention, and current head of the Fund's Hungary mission - this man also likes hard challenges!) also pays hommage to the grit and flexibility of the Baltic populations (a characteristic I also wholeheartedly applaud), but he draws a conclusion which I feel is as yet at best premature.<br /><br /> <br /><br /><blockquote>"The Baltic experience demonstrates that large economic adjustment, including nominal wage and benefit cuts, is indeed possible under a currency peg (or, for that matter, in a currency union)".</blockquote><br /><br /> <br /><br />Certainly, as Christoff points out, a large correction has taken place in Estonia. The current account, for example, is now in surplus.<br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIOgNdyVNlXWN6pO1XHFfWjhUBg6Bqve-dgryNSp2tPrwJOXL967Su3G555F71YKscPpOB64AawXq0dEN_OX6FGEojN7mPktJuFC-DyX3tV-3cUooYkLRqbRCLxqzv2sPYKe_ky5c8Ml3L/s1600/Estonia+Current+Account+%2528monthlyl%2529.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 212px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiIOgNdyVNlXWN6pO1XHFfWjhUBg6Bqve-dgryNSp2tPrwJOXL967Su3G555F71YKscPpOB64AawXq0dEN_OX6FGEojN7mPktJuFC-DyX3tV-3cUooYkLRqbRCLxqzv2sPYKe_ky5c8Ml3L/s400/Estonia+Current+Account+%2528monthlyl%2529.png" alt="" id="BLOGGER_PHOTO_ID_5561652201140060690" border="0" /></a><br /><br /> <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiR3W_KuUb_TlAeHg2ZE9XtToOyF4wRccWvTdOky-HhRuFk-6sT0V2-Wv7C5dbWIkHROHxU8ranJRKcXXXU9NMHkAQnAfyeMzV49coe9_-TIK11VVawLDm8hx1uTY6I55kkAc4xKaFGfwnb/s1600/Estonia+Current+Account+%2528annual%2529.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 253px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiR3W_KuUb_TlAeHg2ZE9XtToOyF4wRccWvTdOky-HhRuFk-6sT0V2-Wv7C5dbWIkHROHxU8ranJRKcXXXU9NMHkAQnAfyeMzV49coe9_-TIK11VVawLDm8hx1uTY6I55kkAc4xKaFGfwnb/s400/Estonia+Current+Account+%2528annual%2529.png" alt="" id="BLOGGER_PHOTO_ID_5561651445249692962" border="0" /></a><br /><br /> <br /><br />The issues I am raising is whether this correction is enough, or whether it is sustainable. As <a href="http://www.eestipank.info/pub/en/press/Press/pressiteated/pt2010/_12/_259.html">the Bank of Estonia note</a>, the Non-performing loans situation has been stabilised, and the value of loans overdue for more than 60 days contracted by over 250 million kroons in November to stand at 6.8 per cent of the total loan portfolio. But most of the old loans are still there, they have not been cleaned from the books, and have been sustained and refinanced by what Christoff calls the "deep pockets" of the Scandinavian lenders. These loans would be once more put into question by any renewal of the internal devaluation and serious price deflation. So hard decisions are going to need to be taken.<br /><br />Inflation is already excessive, and net-exports are nowhere near large enough as a proportion of GDP to carry the economy forward with a strong growth dynamic. Indeed the IMF itself is forecasting a return of growing current account deficits after 2013, which should alert us to the fact that all is not yet as it should be, by a long way. Thus, in conclusion, I think it is very true to say, as Christof does, that it still far too early to pass any kind of definitive judgement on the success or otherwise of what he calls "the Baltic strategy". There is still a very long hard road out there in front, and the hardest and steepest part may well be yet to come.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-72206265962636854742011-01-08T19:03:00.000+01:002011-01-08T19:20:44.955+01:00Turkey's Audacious Experiment In "Post Modern" Monetary PolicyThe recent decision of the Turkish Central Bank to lower rather than to raise interest rates in an risky attempt to quench the inflation flames that many feel are threatening to engulf what <a href="http://www.google.com/url?sa=t&source=news&cd=2&ved=0CCkQqQIwAQ&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052748704034804576025082119095912.html&ei=T7IZTdePAcidOrT0weMI&usg=AFQjCNEnH0t9ywh38fYy9LCnbwfCVj5RUg">some call an "overheating" economy</a> (or <a href="http://www.google.com/url?sa=t&source=news&cd=4&ved=0CEoQqQIwAw&url=http%3A%2F%2Fblogs.ft.com%2Fbeyond-brics%2F2010%2F12%2F10%2Fturkey-high-growth-fuels-rate-dilemma%2F&ei=T7IZTdePAcidOrT0weMI&usg=AFQjCNEelrItvoNwlFDd1SaIHk127hQl9A">here</a>) has lead to a good deal of heart-searching and consternation in the economic and financial press of late. After all, at the end of the day aren't they doing exactly the opposite of what the text book says they should? Well, as is usual in the realm of the dismal science, all is not exactly what it seems to be.<br /><br />To put the issue in some sort of context, the background to this decision is undoubtedly Ben Bernanke's move in early November to extend US monetary easing, by going one bridge further in his assault on the housing deflation and continuing high unemployment which weigh down the economy by introducing what effectively amounts to a second round of exceptional policy measures (<a href="http://fistfulofeuros.net/afoe/an-unusual-but-interesting-argument-which-may-help-to-understand-why-qe2-is-now-almost-inevitable/">known coloquially as QE2</a>). The leading objective behind this move was to increase the amount of liquidity available in the US economic and financial system, although a more covert consideration was cleary to weaken the dollar in an attempt to boost exports and use the strength of external demand to tow the US consumer back towards growth territory. Joining up the dots, we find that the key link between these two otherwise seemingly unrelated central bank decisions (after all one is concerned with an economy which is growing too slowly, while the other is working with one which may be growing too quickly) is to be found in the fact that the US economy is already saturated with as much liquidity as it can handle (in terms of the capacity for absorbtion of the domestic sector) and as a result the funding made available works its way through to more attractive, and more profitable outlets across the developing world.<br /><br />So what has happened in practice is that large quantities of liquidity have been been seeping out of the back door, some of it undoubtedly heading over to Europe in the search for the reasonably safe but still quite attractive pickings which have become available due to the Sovereign Debt Crisis, but the lions share is surely making its way towards those, seemingly "risky" rapidly growing emerging economies.<br /><br />This has lead to a certain amount of angst and confusion among developed economy political leaders, with Angela Merkel, among other European politicians, voicing the complaint that the financial markets are effectively "mispricing" risk. Personally, I don't claim to have any special insight into whether or not the markets are pricing risk well, or badly. I would have thought that that was exactly why we had markets in the first place (rather than a centrally planned pricing mechanism): to put a price on risk. But that being said, the systematic downgrading of the ageing developed world and the systematicup grading of the youthful "growth" economies in the third world has a certain logic to it.<br /><br />Obviously, in a world which is as rapidly changing as ours is, markets need time to adjust. And market participants are evidently a vulnerable as anyone else is to the human failing of getting things wrong. Markets are not superhuman entities, their outcomes are the aggregated product of a very large number of individual human decisions. But I think it is important here that all concerned recognise their own limits and limitations. It is either an extremely bold or an extremely foolish politician who feels equipped to move to a higher level to pass judgement on a process whose outcome is still remains an open question. Post hoc, as we have seen in the wake of the recent financial crisis, there is no shortage of critical voices, and all and sundry have a notable facility to point the accusing finger to tell the markets "you got it wrong"! But telling them you have it wrong before the event, well that takes gall! And if you are really so sure, then put your money where your mouth is, and buy up all that debt the markets evidently don't want.<br /><br />In fact, markets are neither omniscient, nor omnipotent, and often move as much behind the curve as they do in front of it, correcting to changing undelying realities in a herd-like fashion and even then only after a time lag. Yet, as I say, there is a certain logic behind the most recent trend, which involves repricing risk in the developed economies (due to their ageing populations, and large uncovered obligations with the future, issues whose importance was not sufficiently appreciated and accounted for in the pre-crisis world ), at one and the same time that risk in the developing world is also repriced, since emerging market "risk" may not be quite so risky as the "old normal" mindset used to think it was.<br /><br />As a result, a number of key emerging economies find themselves in the pleasant position of enjoying the benefits of a win-win dynamic, since far from struggling with ever higher elderly dependency ratios, the proportion of their population in the labour force (and also in employment) is now rising constantly, while both inflation and interest rates (including ones related to country risk) are trending downwards in the longer run. Turkey is, in fact, one of these fortunate economies, which is why I think the latest move from the Turkish central bank needs serious consideration, and should be understood not as just one more piece of "midwinter madness", but rather seen as part of a much more calculated and comprehensive strategy which comes from a modern and continually evolving tool set. New problems need new remedies, so let's leave small open (and even large open) economies where they belong: in the unreal world of the academic textbook. In today's world interest rates are not set locally, and excessive domestic inflation is often produced more by the dynamics of global capital flows than by the irresponsible spending decisions of local politicians. Which is not to say that the Turkish central bank have the balance right (or wrong), but simply to state that global problems require global solutions, and in the meantime, national leaders will have to adapt their policy mix to confront new problems, problems which but a few short years ago would have seemed almost unimaginable.<br /><span style="font-weight: bold;"><br />Complex Problem Set With A Positive Outlook</span><br /><br /><br />As Erdem Basci, deputy governor of the central bank recently argued, strong capital inflows (see chart below), fuelled by quantitative easing in developed economies, are in danger of producing the undesireable outcome of distorting economic development in emerging economies and potentially fuelling asset bubbles in the longer run. According to Basci, as argued in a posting on the central bank website, the best policy response to this thoroughly modern problem is to try to make these countries less attractive to short-term investors by cutting interest rates in a step-by-step process (a move which would also make the country more attractive to longer term investors - think FDI), while making extensive use other tools to attack the excess liquidity problem and restrain domestic credit growth.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiz4UDbUDnptp5EPUbOX438yF_G8CbN5T5GeNCHcXsBygycWnCqlFY2HUeyp6RowvPSMUkS0jdXKD3NoL5FFq3zGLg58qkAVK5eIsm0jbw00hwjJH3ouj5Ujus0TUPUWr80GARwlKAUBE8/s1600/Turkey+Central+Bank+Reserves.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiz4UDbUDnptp5EPUbOX438yF_G8CbN5T5GeNCHcXsBygycWnCqlFY2HUeyp6RowvPSMUkS0jdXKD3NoL5FFq3zGLg58qkAVK5eIsm0jbw00hwjJH3ouj5Ujus0TUPUWr80GARwlKAUBE8/s400/Turkey+Central+Bank+Reserves.png" alt="" id="BLOGGER_PHOTO_ID_5553423348877688642" border="0" /></a><br /><br />And so it was to be, since the central bank's monetary policy committee voted at its most recent meeting to cut the reference lending rate by 0.5% (to 6.5%). This move was rapidly followed by the second of the steps advocated by Basci, since the bank then announced that the required reserve ratios (RRRs) for Turkish banks would be lifted to 8%, a move was expected to drain an estimated 7.6 billion Turkish lira (or $4.9 billion) from the economy in one foul swoop, with the objective of reducing the amount available for Turkish banks to lend to their clients.<br /><br />Now in order to make sense of this decision, the key point to grasp is that Turkey's economy <span style="font-weight: bold;">is not, in fact, currently overheating</span>. At the present time, the very opposite is happening, since the economy has been slowing, with the quarter-on-quarter growth rate falling in the third quarter to a "mere" 1.1%, down from the sweltering "China like" pace of 3.7% clocked up between April and June. Now a 1.1% quarterly GDP growth rate (or a 4.4% one annualised) is not exactly small beer by present developed economy standards, but it certainly is <span style="font-weight: bold;">not</span> overheating territory for an economy in the process of making the shift from underdeveloped to developed status in the way that Turkey's is.<br /><br />Nor is inflation showing signs of getting out of hand. True, at around 7% it is still stubbornly high, but it has been stabilised, and shows no sign of getting out of hand, while the core inflation rate has been falling steady, and is now around 3%. So while the situation signals caution, it hardly cries out for drastic monetary tightening.<br /><br />So what the recent decision was really about was not an attempt to conform with the objectives of conventional monetary policy, rather the move was intended to dissuade and deter speculative investments looking for higher yields from continuing to pour into Turkey and magnifying the economy’s key weakness: <span style="font-weight: bold;">the mushrooming current-account deficit</span>. The idea was to reduce the yield differential with lending rates in the quagmired developed economies.<br /><br />So the problem facing Turkey's policy makers is not the economy isn't growing, or that it is growing too quickly (there is plenty of spare capacity left out there), rather the problem is that <span style="font-weight: bold;">it is growing in an unbalanced way</span>. The high yield differtial, and the funds inflow which it is producing, means that the currency is appreciating even while inflation remains excessively high (now stuff that in yourtext book and smoke it), and this combination is a sure fire way <span style="font-weight: bold;">for the export sector to lose competitiveness</span>. And this is in fact what is happening, as imports (driven by the consumer credit boom) surge, while exports fail to keep pace, with the result that the trade balance deteriorates, and along with it the current account one.<br /><br />But as Erdem Basci among others, including some IMF economists, argue, hiking interest rates could be totally counterproductive in the current climate since it might well serve to make the country even more attractive (by <span style="font-weight: bold;">increasing that key yield differential</span>) to precisely the kind of funds they want to deter. Turkey, as many analysts constantly point out, has become <span style="font-weight: bold;">over-dependent</span> on the wrong kind of funding to finance its current account deficit. What Turkey needs is to attract longer term investment finance, and while reducing the volume of short term speculative finance which is currently distorting prices in the country's equity markets. This argues for lower, not higher, interest rates, since bringing the longer run cost of borrowing down should make the country more attractive to the kind of investor it needs.<br /><br />So the bank have decided to adopt a monetary experiment based on a resort to other measures, and the first of these is an attempt to withdraw some liquidity from the banking system. One of the principal worries is that the rapid expansion in the volume of domestic credit has triggered a rise in imports and thus aggravated the deterioration in the current account deficit. But the problem is not only a current account deficit one. The following chart (prepared by staff at the Turkish economicresearch institute TEPAV) shows that the credit expansion is also associated with a rise in the systematic risks of the banking sector, since much of the lending is evidently being financed by short term fund flows.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmQXt3vDx9JY6xSbiJBXh6aFh2itj2kxTOoA7AUoyb7-2j2nDc4ZltFbNekVLd8L-9AuirV3I8AquQEtBKysVYqDoYEriMzrndGrR54QXpCZ1aAQugeKmE7pw9_5SI6wXaB-3RcOokbKw/s1600/Foreign+Fund+Flows.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 188px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmQXt3vDx9JY6xSbiJBXh6aFh2itj2kxTOoA7AUoyb7-2j2nDc4ZltFbNekVLd8L-9AuirV3I8AquQEtBKysVYqDoYEriMzrndGrR54QXpCZ1aAQugeKmE7pw9_5SI6wXaB-3RcOokbKw/s400/Foreign+Fund+Flows.png" alt="" id="BLOGGER_PHOTO_ID_5559833935586402146" border="0" /></a><br /><br />[Please Click on Image to View More Clearly]<br /><br />Net foreign financing of Turkey's banking sector hit US$17 billion in the last quarter of 2008. Subsequently the level fell rapidly, but with the economic recovery foreign funding has once more been on the increase, an as of October 2010 it was in the region of US$22.5 billion. One important characteristic of the foreign funding the Turkish banks have been accessing since the advent of the recovery is that something like 98 percent of the funds are short term. This sharp rise in short term funding is not only unprecedented, it is also highly dangerous, since were there to be a sudden change in risk sentiment (due to factors which had nothing directly to do with Turkey itself), such funding might not be renewed, leading to a maturity mismatch between the banks' borrowing and lending which could severely strain the Turkish financial system.<br /><br />The central bank is therefore pretty concerned to slow the rate of credit expansion, and with this in mind it has also introduced a second bloc of measures involving steps to contain the rate of expansion in consumer credit - credit card restrictions, increased loan to value ratios in house purchase, etc. Due to the endless ability of those who are smart enough to find ways to get round such rules, none of these are perfect, but they are a lot better than nothing, and nothing, some will remember, was those responsible for managing the Spanish and Irish economies did when their credit and indebtedness ratios were obviously on the verge of getting out of control, and when the relevant central bank seemed to see no inconvenience at all in applying negative interest rates to their already credit-bloated economies. So by all means criticise the Turkish central bank, but let's be clear what (and who) we are comparing them with.<br /><br />Obviously additional measures could and should now come from the Turkish government. Measures which involve the judicious (and even aggressive) use of fiscal policy to drain in the most direct fashion excess demand from the system. In this context it is pleasing to be able to note (see below) that this year's strong rise in tax revenues is not being matched by an equivalent increase in spending. Indeed the country is now running a quite strong primary budget surplus. More of the same, and then some, is what we need to see, but with elections looming it is doubtful decisive steps will be taken until the new government is formed.<br /><br />And it isn't only rapidly growing credit that is a concern, a lot of the money has gone into Turkish stocks which are now not far off their 2008 pre-crisis highs. In fact foreign purchases of Turkish financial assets rose to around $15.5 billion in the first 10 months, from $730 million a year earlier, according to central bank data. In October alone, international investors bought $969 million in shares and $1.5 billion in government bonds.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgc4vnvv8kOOBHNW8AWQmvjWVmiiSJp1W5q8Ocd1N3esQu14GRYdxPnnLDD8UNaHjTFkiw5S_8HuoMSSV23ENk7mkytUOi1oG1KHGQE4jwiIB2_yBBHUCtxfXLgdqiXJgVDGn2QXZnkR_Y/s1600/Turkey+MSCI+Core+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgc4vnvv8kOOBHNW8AWQmvjWVmiiSJp1W5q8Ocd1N3esQu14GRYdxPnnLDD8UNaHjTFkiw5S_8HuoMSSV23ENk7mkytUOi1oG1KHGQE4jwiIB2_yBBHUCtxfXLgdqiXJgVDGn2QXZnkR_Y/s400/Turkey+MSCI+Core+Index.png" alt="" id="BLOGGER_PHOTO_ID_5559871621152415250" border="0" /></a><br /><br />Summing up, it is hard to say at this point whether the Turkish central banks attempt to operate what some have called a "post modern" monetary policy will work exactly as intended, especially since the outcome is not directly in the hands of the central bank, and very much depends on the determination of the government to take the necessary measures on the fiscal side. But whatever the outcome, of one thing we can be sure: <span style="font-weight: bold;">doing something always has to better than doing nothing</span>. After all, who else would knowingly and willingly wish to end up in the kind of unfortunate situation Spain and Ireland now find themselves in?<br /><span style="font-weight: bold;"><br /><br />The Economy Has Surpassed Pre-Crisis Levels, And Is Now In Full Recovery Mode</span><br /><br /><br />Turkey's economy slowed in the third quarter, and the pace of GDP growth slipped back to a calendar adjusted 6.4% year on year in the third quarter, down from the China like 10.2% pace registered in the second one. The key to the slowdown was the deterioration in external trade: exports dropped by 2% year on year, the sharpest contraction since the third quarter of 2009, while import growth remained in double-digits for a fourth consecutive quarter (albeit slowing marginally to an annual increase of 16.9% from 18.8% in the second quarter).<br /><br />Final domestic demand growth, on the other hand, strengthened to 11.2%, its fastest pace of advance in more than four years. Private consumption growth was strong, and surged by 7.6%, but the heavy lifting seems to have been done by investment (much of it in construction), with an increase in gross fixed capital formation of 31.3%. Even if the underlying housing boom offers the explanation for much of this growth, capital goods investment was also strong, as shown by the fact that the import of capital goods rose by an annual 31.3%.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMmLrb3ux3KFFG8KcmwN4wMW7xUHAPNF9KfYxaKfntbaAMlaMw1mZ88o1opSBFsN_om_5_VIxkexiDFZR7pHxxxmOT9fq-rwWVJQkOZUfJk_nWlpqLbiiXGtvyJ0MAOxMmEphnUntjL0Q/s1600/Turkey+GDP+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMmLrb3ux3KFFG8KcmwN4wMW7xUHAPNF9KfYxaKfntbaAMlaMw1mZ88o1opSBFsN_om_5_VIxkexiDFZR7pHxxxmOT9fq-rwWVJQkOZUfJk_nWlpqLbiiXGtvyJ0MAOxMmEphnUntjL0Q/s400/Turkey+GDP+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5553435788007248562" border="0" /></a><br /><br />In fact, the most worrying part of the Q3 performance was not the fall in exports, it was the surge in imports, and the impact this is having on the trade and current account balances. Correcting this disturbing trend must now be one of the most important policy priorities for Turkish decision makers. Consensus forecasts now suggest Turkey could well grow by an annual 7% this year (up from an earlier expectation of 6%) and this does not seem to be at all unreasonable,<br /><br />Whatever the weaknesses, the big picture story is that Turkey’s economy is once more growing dynamically and reaching new highs. Real economic gains are being made and we now are seeing increasing evidence of a true recovery which goes well beyond the confines of a simple statistical rebound.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiI-hIhvdoqK69EhbVBf52uQCPdFc6jBpReoVeRs56AFUWYOHKMqnGRLFMWeRUqYzrq9vIu-Vkhbetxei9sF69Doe-UQdMviIjetX11dcuv_R_JU8bhsbOIqpvaq4rTu3-oKn1CH1jP8vY/s1600/Turkey+Constant+Price+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiI-hIhvdoqK69EhbVBf52uQCPdFc6jBpReoVeRs56AFUWYOHKMqnGRLFMWeRUqYzrq9vIu-Vkhbetxei9sF69Doe-UQdMviIjetX11dcuv_R_JU8bhsbOIqpvaq4rTu3-oKn1CH1jP8vY/s400/Turkey+Constant+Price+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5553444486064131650" border="0" /></a><br /><br />But a dose of realism is called for. Despite the fact that the economy will in all probability now grow by at least 7% in 2010, in 2011 Turkish growth rates will undoubtedly continue to drop back from the very high level seen in the first half of this year, but if this weakening in headline GDP numbers is simply the result of a deteriorating net trade position then we will have the worst of both worlds, as debt driven consumption growth will be faster than desireable, while the export sector will continue to weaken, even as import substitution undermines the domestic industrial sector. Unchecked this could lead to the same sort of manfuacturing industry job loss we have seen across Southern Europe over the last two decades.<br /><br />On the other hand, the Turkish economy is likely to continue turning in an impressive performance, one which will stand out among regional peers since sustainable trend growth in Turkey remains high. If adequate steps aretaken to rein-in the current account deficit, and to attract more in the way of job-creating FDI, 6% growth could well remain a realistic target for 2011, even if there is a deterioration in the external environment and a weakening in the level of external demand.<br /><br />One factor which makes Turkey stand out from many of its regional peers is that it is not overly export-dependent and has a dynamic domestic economy which complements the export sector. This means that the Turkish economy basically stands upright, and on both feet, and that, despite the recent loss of export competitiveness the impetus behind GDP growth is much more broadly-based than in the other, heavily-indebted countries which can be found in the surrounding region. In addition, the underlying strength of domestic demand means the Turkish government has a far broader, and ever-growing, potential tax base. This makes it much easier to attain longer term fiscal stability, and means that the country does not have to continually stagger forward on the basis of a series of “one off” measures to keep the deficit undercontrol.<br /><br />To some extent the slackening in Turkey's growth performance is only to be expected, since, in terms of external demand (and as in many other economies) all the "low lying" fruit has now been picked as exports have steadily attained their previous level. Reaching out for the rest will now become more and more difficult, especially with so much "deleveraging" going on in the neighbourhood, and so many export dependent economies in the region, which is why the export competitiveness issue needs to be so strongly stressed.<br /><br />Thus, while Turkey turned in an 11.7% annual growth rate in the first three months of the year, and then followed up with an impressive 10.3% in the second three – a rate only equalled by China among the major economies – the calendar adjusted 6.4% rate registered between July and March is better read as a return to normality rather than the commencement of a serious slowdown. Quarter on quarter the economy grew by a seasonally adjusted 1.1%, and output was still up by 8.2% in the first nine months of the year over the equivalent period in 2009.<br /><br />On top of this, the economy is now reaping the long run fruits of major macro economic restructuring in the early years of this century, while in addition the country faces a very favourable demographic evolution. The result of this very fortunate combination is that the dollar denominated value of Turkish GDP is now very substantially above where it was ten years ago, and now that the recession is behind us it should continue to rise rapidly.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdAAn4Yl7JHFzskKtXsseg92UhuRqPFcbsUeDpNw8iuLtClAzcpiUb7HBdAwFhiHip5aQLOFSB6QnzHjvsCWkZv9-EVX3nR0Pfw1_dAHfgNQWLQLmJWw3s4dXqts_QUsSbAxJiZqIwNto/s1600/Turkey+Dollar+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdAAn4Yl7JHFzskKtXsseg92UhuRqPFcbsUeDpNw8iuLtClAzcpiUb7HBdAwFhiHip5aQLOFSB6QnzHjvsCWkZv9-EVX3nR0Pfw1_dAHfgNQWLQLmJWw3s4dXqts_QUsSbAxJiZqIwNto/s400/Turkey+Dollar+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5553453575415052498" border="0" /></a><br /><span style="font-weight: bold;">Current Account Woes</span><br /><br /><br />Throughout this year the negative balance on Turkey’s current account has steadily worsened, and the trailing 12 month deficit total in October was around $40 billion, or 5% of GDP. This underlying deterioration in parts reflects the country’s energy dependence and the impact of rising fuel costs, but it also gives a measure of the strength of the domestic consumer rebound coupled with the impact of the inflation-driven real exchange rate appreciation.<br /><br /><br />Turkey has had a long history of persistent current account deficits, and as might have been expected while the problem eased during the recession, the arrival of the recovery slammed issue straight back onto the table. During last year’s sharp contraction, Turkey’s current account deficit fell back to 2.3% of GDP, and the topic moved quietly off everyone's radar. But last year's reduction was due to very exceptional circumstances (the sharp contraction in domestic demand during the global financial crisis), so this years widening of the deficit to a level which could eventually be as high as 6% of GDP (or even slightly over) is essentially a reversion back to type. Which does not make it any the less problematic.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaFp9CYXrlLVDHqM8bo1AKtsDleP8rrOk7_YympM5WIj2fnqEJJH7Vd9GPtcnViSrrsD3CIgXq64DDLQhCgJmDMcJEFm8yNPPz_6N4X2UAoeGfe3o-fxwANresOXdoYNkQz3ujMMsOWdU/s1600/Turkey+Current+Account+Monthly.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaFp9CYXrlLVDHqM8bo1AKtsDleP8rrOk7_YympM5WIj2fnqEJJH7Vd9GPtcnViSrrsD3CIgXq64DDLQhCgJmDMcJEFm8yNPPz_6N4X2UAoeGfe3o-fxwANresOXdoYNkQz3ujMMsOWdU/s400/Turkey+Current+Account+Monthly.png" alt="" id="BLOGGER_PHOTO_ID_5553455551831806162" border="0" /></a><br /><br />When thinking about competitiveness, as well as simple exchange rate movements it is also important to take inflation differential's into account. Indeed the Turkish currency has been weakening recently on the back of the European Sovereign Debt Crisis, and the lira fell to a five-month low against the dollar following the central bank announcement of the latest measures. But even prior to the rate reduction the lira had been falling, and is now down around 7.5% against the US dollar since November 4 as concern has grown about potential economic spillovers to Europe's trading partners from the growing problems in countries like Ireland, Spain and Portugal. Weakening European demand is not good news for Turkey, since Europe is Turkey's main trading partner.<br /><br />Thus while the lira rose by something like 9% against the euro last year the net 2010 gain against the dollar (before the post-November 4 slide) was only about 4 percent. However, given the much closer trade ties that Turkey has with the EU, it was the Euro rate which mattered for the export performance.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivXaLr6qSgg0e5h9j37MZjxYIH8lKhenuhWIkUhKpC3ZXeZ7yJSnxUviyefq1gS-pxH97OJXW90nuL3TsahyphenhyphenpmxiAC3MWg_tXIcprBaO3anvhFtE8g48qG05U7eZiBl6_5uwMxHiE6JKI/s1600/Turkey+Lira.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivXaLr6qSgg0e5h9j37MZjxYIH8lKhenuhWIkUhKpC3ZXeZ7yJSnxUviyefq1gS-pxH97OJXW90nuL3TsahyphenhyphenpmxiAC3MWg_tXIcprBaO3anvhFtE8g48qG05U7eZiBl6_5uwMxHiE6JKI/s400/Turkey+Lira.png" alt="" id="BLOGGER_PHOTO_ID_5553456700459649154" border="0" /></a><br /><br />Although Turkey's exports were up sharply in October (to $11 million), after several months stuck around the $9 million mark, the improved performance was not sustained, and in November they fell back again to around $9.4 billion.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjxz_CDrcAUSdQhPGSctnnZYjQdJebWLhhEM7_MhndGaqHjkfK42zzplVbDUYijA9l_WBqtNEIF9EJjVtSTTHn1MJfi6PqF9ItjJd89zBFM5zMbAzG_RlbPfBZYkiQIzEsleZ16A-vRuow/s1600/Turkey+Exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjxz_CDrcAUSdQhPGSctnnZYjQdJebWLhhEM7_MhndGaqHjkfK42zzplVbDUYijA9l_WBqtNEIF9EJjVtSTTHn1MJfi6PqF9ItjJd89zBFM5zMbAzG_RlbPfBZYkiQIzEsleZ16A-vRuow/s400/Turkey+Exports.png" alt="" id="BLOGGER_PHOTO_ID_5555729769735469762" border="0" /></a><br /><br />But of course, in the complete picture we would have to note that imports (and with them the trade deficit) have also continued to rise steadily, although at $17.1 billion in November, they were still some considerable way below the July 2008 high of $20.5 billion.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmDE-UdqFF9GLRUBfWgzjwWHy6ZV_VgGAtXQ2M3M5nLNwOcUMb8CplhBvO1P2GVdTlF4BRC2nVurIpVxPtnfX3ZBnFc0jiwW9v5mhhN_cN02T7KUH_c-op-pmSSoZjnuMQMrh8jCC59OE/s1600/Turkey+Imports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmDE-UdqFF9GLRUBfWgzjwWHy6ZV_VgGAtXQ2M3M5nLNwOcUMb8CplhBvO1P2GVdTlF4BRC2nVurIpVxPtnfX3ZBnFc0jiwW9v5mhhN_cN02T7KUH_c-op-pmSSoZjnuMQMrh8jCC59OE/s400/Turkey+Imports.png" alt="" id="BLOGGER_PHOTO_ID_5553586911151128610" border="0" /></a><br /><br />The seasonally adjusted trade deficit has continued to deteriorate steadily since the recovery started in late 2009.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5e4Fh4o5YGzdKy39ZmxwxWGXMOpIPgHE-YkuUpvUd5C3d0VX8xgDt4jbxcCwqJpyZqdLw3YMNCnk9s3coacjLzm2NFOzBxhHHRgiZpc2tqQl-ebA81bOpfoPQ89DjKuLRBVQbRHDoCHA/s1600/Turkey+Goods+Trade+Balance.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5e4Fh4o5YGzdKy39ZmxwxWGXMOpIPgHE-YkuUpvUd5C3d0VX8xgDt4jbxcCwqJpyZqdLw3YMNCnk9s3coacjLzm2NFOzBxhHHRgiZpc2tqQl-ebA81bOpfoPQ89DjKuLRBVQbRHDoCHA/s400/Turkey+Goods+Trade+Balance.png" alt="" id="BLOGGER_PHOTO_ID_5559809055192954226" border="0" /></a><br /><br /><br /><span style="font-weight: bold;">Domestic Activity Also Rises</span><br /><br />The recent recovery in manufacturing activity continued at full pace in October, with industrial output posting an annual increase of 9.8%, well above the 6.1% market consensus expectation. Following a tame performance in September, where seasonally adjusted output stayed flat at the August level, production surged again in October, and by an eye-catching 3.1% on the month. It is worth noting that industrial production has now returned to pre-crisis levels, implying that (even though <span style="font-weight: bold;">overheating is not an issue</span> at this point) the output gap may be narrowing faster than central bank projections anticipate.<br /><br />The better-than-expected increase is largely due to a strong performance in both capital and consumer-durable goods. Capital goods were up by an annual 25.6%, and consumer durables by 21.7%. While the numbers for consumer durables reflect the expansion in consumer credit, the ongoing strong performance in capital goods suggests that the investment activity also continues apace.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaQF9lErxWOh579eJVgKQKFvJ9sCMk5CsiHDbKDNVrrT2f409FWEo81GgDNtKiyK52wN-e7mHlM4hEf_a1J7pVzxMA38bxX8lAnRBEu5MdMBQpXJA2jLUH0sh_JyxMlQbF0BEP73f-R8M/s1600/Turkey+Industrial+Output+Index.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaQF9lErxWOh579eJVgKQKFvJ9sCMk5CsiHDbKDNVrrT2f409FWEo81GgDNtKiyK52wN-e7mHlM4hEf_a1J7pVzxMA38bxX8lAnRBEu5MdMBQpXJA2jLUH0sh_JyxMlQbF0BEP73f-R8M/s400/Turkey+Industrial+Output+Index.png" alt="" id="BLOGGER_PHOTO_ID_5553587817771559730" border="0" /></a><br /><br />And the continuing strong performance registered in December's manufacturing PMI suggests the short term outlook for the Turkish industrial sector remains positive.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw7E1chVuKfjYdNcjhhhY0kJxbt47YcD-HA58u6tvAumsy5jZNRENqtTYMN0cZDWOc1QlFv5UG2zFtMf2tmKdADqZcodoYpSYn8piiRAq6jmyBeUJkp75KlfE7GkoWzrR1mr8ZWyObKwU/s1600/Turkey.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhw7E1chVuKfjYdNcjhhhY0kJxbt47YcD-HA58u6tvAumsy5jZNRENqtTYMN0cZDWOc1QlFv5UG2zFtMf2tmKdADqZcodoYpSYn8piiRAq6jmyBeUJkp75KlfE7GkoWzrR1mr8ZWyObKwU/s400/Turkey.png" alt="" id="BLOGGER_PHOTO_ID_5559810783576721378" border="0" /></a><br /><br /><blockquote>Commenting on the Turkey Manufacturing PMI survey, Dr. Murat Ulgen, Chief Economist for Turkey at HSBC said:<br /><br />““The Turkish manufacturing sector maintained November’s impressive performance in December, expanding at its fastest rate since May. The pace of output and new order growth moderated slightly from the previous month, though still remained impressive. New export orders, on the other hand, showed the fastest improvement since October 2009. More encouragingly, this bright picture supported employment creation with conditions reaching their best level ever in the survey history. Backlogs of work increased marginally in December, while manufacturers continued to slash their finished goods inventories to meet order demand. In the meantime, this stellar performance also led to some price and margin pressures. Input prices soared at a very high rate, reminiscent of 2008 Q1 with rampant global commodity prices, whilst suppliers’ delivery times lengthened at a close to record rate. As such, manufacturers continued to reflect this in output prices that rose at the fastest pace in eight months.””</blockquote><br /><br />Surprisingly, while retail sales continue to grow steadily, up to now they have not been one of the leading drivers of the current expansion, as indicated by the fact that the third quarter increase was only 7.5% over a year earlier. Not bad by developed economy standards, but well short of the level of construction investment increase, for example.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgily4Tvkfpm8YZdnT-TEtz_anMC4q5XEuC7hvE9Tcb8J_RQC4bCLtl4vFUDUNLd8rK83oJvlopUWVRU9_grBE_mQuyYjpzAk3UFgIcP4j8EqcRYFKG7cegikiv457rLJnH0Mi0KsRup7Q/s1600/Turkey+Retail+Sales.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgily4Tvkfpm8YZdnT-TEtz_anMC4q5XEuC7hvE9Tcb8J_RQC4bCLtl4vFUDUNLd8rK83oJvlopUWVRU9_grBE_mQuyYjpzAk3UFgIcP4j8EqcRYFKG7cegikiv457rLJnH0Mi0KsRup7Q/s400/Turkey+Retail+Sales.png" alt="" id="BLOGGER_PHOTO_ID_5553594745308390898" border="0" /></a> <span style="font-weight: bold;">Unemployment Falls Even As The Labour Force Grows and Grows</span><br /><br />Still, the outlook on domestic sales continues to improve, and one of the principal reasons for this is the continuing fall in the seasonally adjusted unemployment rate, which was down to 11.8% in September. In fact unemployment peaked (on a seasonally adjusted basis) at 14.8% in April 2009, and has since been falling steadily, while the seasonally adjusted level of <span style="font-weight: bold;">employment</span> continues to rise. Such strongly positive co-movements in employment and unemployment evidently lead households to have an increased sense of job security and purchasing capacity.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgY8Wf_GT_CfzSSDzeYwpzai9C0AW9CTDmyW9jk9yNX65Q6C6w58OqqC8Za_xwmbee2QCykn63R2nb2rVVQBelfn5Gw2qE5ickPzcMPGWfIw-K6OQM9kV9557dShsbAZc6YiWiWQZyPpyo/s1600/Turkey+Unemployment+Rate+-+Eurostat.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgY8Wf_GT_CfzSSDzeYwpzai9C0AW9CTDmyW9jk9yNX65Q6C6w58OqqC8Za_xwmbee2QCykn63R2nb2rVVQBelfn5Gw2qE5ickPzcMPGWfIw-K6OQM9kV9557dShsbAZc6YiWiWQZyPpyo/s400/Turkey+Unemployment+Rate+-+Eurostat.png" alt="" id="BLOGGER_PHOTO_ID_5553601040359944386" border="0" /></a><br /><br /><br />The country has been creating and continues to create jobs in large numbers. When compared with September 2009 the number of those employed rose by nearly a million (to around 23 million), with the share of those occupied in the industrial sector (around 20%) rising significantly.<br /><br />Under the impact of the global financial crisis, Turkey’s unemployment hit a record high of 16.1% in February 2009. A year and a half later, and in sharp contrast with most of its regional peers, the country has achieved an impressive drop in its jobless rate. Even more significantly, Turkey has achieved this improvement at a time when the size of the labour force has been rising sharply, from 51.3 million to 52.7 million. This is yet another example of how Turkey is in a very different position to its regional peers, most of whom face ageing and declining labour forces due to their negative demographic trends.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlgKJmTgaXE_g9HQFVdiRJR5lt5Jrz2Xz2fI5H4-enRt4CPfBuAXBmjNCWUmFHKJ8Ttx5skDjSUeTcgsGqoQQEOvmNy1Q_qInIut7QSWV9YNk7OpCCsIIHAb38GiCWhxdVUYPP6srG-7E/s1600/Turkey+Employment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhlgKJmTgaXE_g9HQFVdiRJR5lt5Jrz2Xz2fI5H4-enRt4CPfBuAXBmjNCWUmFHKJ8Ttx5skDjSUeTcgsGqoQQEOvmNy1Q_qInIut7QSWV9YNk7OpCCsIIHAb38GiCWhxdVUYPP6srG-7E/s400/Turkey+Employment.png" alt="" id="BLOGGER_PHOTO_ID_5553602453211257746" border="0" /></a><br /><br />In its bid to achieve ultra-fast "catch-up" economic and employment growth without generating excessively high inflation Turkey is able to benefit from the phenomenon known as the “demographic dividend.” Cutting aside the rigmarole, what this idea basically implies is that as fertility falls ever higher proportions of the population are to be found in the working age category, initially boosting employment and output, and then, in a second wave, fuelling productivity, credit and consumption growth. This is what sets the Turkish case apart, for example, from the recent experiences in places like the Baltics and Bulgaria.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwTOdAo2jOzyZuY1nLfraCejp8d8jDysTm3wNPBOB_QnfJis3RRqpUyjbc2vGVXFHIjowGLycSJF87om4TyjsAKrawVz1Uh9TwT9nPDUOUN2_0xkNW56MhBpctxHl8WyLYyohaY8HzpY8/s1600/Turkey+Labour+Force.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 234px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwTOdAo2jOzyZuY1nLfraCejp8d8jDysTm3wNPBOB_QnfJis3RRqpUyjbc2vGVXFHIjowGLycSJF87om4TyjsAKrawVz1Uh9TwT9nPDUOUN2_0xkNW56MhBpctxHl8WyLYyohaY8HzpY8/s400/Turkey+Labour+Force.png" alt="" id="BLOGGER_PHOTO_ID_5553602794859452066" border="0" /></a><br /><br /><br />As the country's median age rises, Turkey is rapidly approaching that demographic “sweet spot” where sustainable rapid catch-up growth is totally realistic and achievable. However, it is important to bear in mind that this process is far from automatic, and depends for its effectiveness on continuing and deep structural reforms. The Turkish economy still fails to make satisfactory use of its existing labour resources, and the country’s employment rate, at just above 40%, remains the lowest in the OECD area. Deep-rooted socio-cultural factors, combined with the steady drift from rural to urban areas, mean that many Turkish women continue to withdraw from the labour force on marriage, which leaves the employment rate for women stuck around the 20% level, 40 percentage points lower than the equivalent rate for men.<br /><br />Turkey's population has been growing rapidly, and will continue to grow quite rapidly for at least the next two decades. This will mean there will be an internal market with a strong growth dynamic, and that the country faces a more stable population pyramid in terms of pension and health care systems, and sovereign debt sustainability. This outlook also implies improving credit ratings and lower risk evaluation on the part of investors, with consequently lower interest rates for investment projects.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhAfpTuWcYHyfshfFZaU-iX0K6CWzBOCIshIPD58KmvsxcQeMl3XLa-D-VMk1PJqVLX7vvzO0x7l2ZKttU1IWRdXZW7zK5rarYVED9997E8F-kvU4erC2x-_ieZHFkic0iIRo52oew6cLg/s1600/Turkey+Population.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 202px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhAfpTuWcYHyfshfFZaU-iX0K6CWzBOCIshIPD58KmvsxcQeMl3XLa-D-VMk1PJqVLX7vvzO0x7l2ZKttU1IWRdXZW7zK5rarYVED9997E8F-kvU4erC2x-_ieZHFkic0iIRo52oew6cLg/s400/Turkey+Population.png" alt="" id="BLOGGER_PHOTO_ID_5553603162809140578" border="0" /></a><br /><br />As I say, Turkey's median age is also rising, although the country is still very young, with a median age of just 28.5 and 30 per cent of the 74 million population under 18. The demographic "sweet spot" of median ages between 30 and 40 is thus set to last for some considerable period of time.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGyH0mTyIUBFMsUl6gU95uLdoSSJbZAg7Mu7v7zrqj6JCJhp-XZLQ62ppti8VTzUDjzJE9vH_clu9JMaGmEKfKmGdFC8Pg63P39uZ1CnWlYb1h-pbKLvxyh8OXrBWCR-MwK5WoOfFVP3c/s1600/Turkey+Median+Age.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGyH0mTyIUBFMsUl6gU95uLdoSSJbZAg7Mu7v7zrqj6JCJhp-XZLQ62ppti8VTzUDjzJE9vH_clu9JMaGmEKfKmGdFC8Pg63P39uZ1CnWlYb1h-pbKLvxyh8OXrBWCR-MwK5WoOfFVP3c/s400/Turkey+Median+Age.png" alt="" id="BLOGGER_PHOTO_ID_5553604196689656146" border="0" /></a><br /><br />Rising median ages, and growing proportions of the population in the working age group are a product of two distinct forces, declining fertility and rising life expectancy. Turkey's fertility has been falling steadily for the last thirty years, and is now around the critical 2.1 replacement level. The key driving force behind the change is female emancipation and rising education levels. The difficult thing for the country now will be to arrest the fertility decline and maintain the birth rate around the replacement level. Unfortunately, absent a serious and sustained change in the policy approach it is far more likely that Turkey will follow the pattern already seen in Southern and Eastern Europe, and head towards very low (and therefore unsustainable in the long run) fertility levels.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2FqVU-P3bKoX0S7q0rm_jfhFV9mWlkZTcm_ac33hcl3vdZFYgjD5G6o_F7h9n7_upleca5L1vmWuRfm-ICScAW_iwI47tGr4chCNY2Ldtr9XHi53uxbqXPPsv3z12yeJtQi8zHKSxT9c/s1600/Turkey+TFR.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 200px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2FqVU-P3bKoX0S7q0rm_jfhFV9mWlkZTcm_ac33hcl3vdZFYgjD5G6o_F7h9n7_upleca5L1vmWuRfm-ICScAW_iwI47tGr4chCNY2Ldtr9XHi53uxbqXPPsv3z12yeJtQi8zHKSxT9c/s400/Turkey+TFR.png" alt="" id="BLOGGER_PHOTO_ID_5553608611099642818" border="0" /></a><br /><span style="font-weight: bold;">Rapid Growth With Low Inflation?</span><br /><br />Given the controversial nature of the new monetary policy experiment, it is highly the country's inflation rate will come under increasing scrutiny. After keeping its benchmark interest rate unchanged at 7% since November 2009, the central bank has now lowered the rate to 6.5%, even as the economy continues to show signs of strong growth in credit driven consumer demand.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiX4kkMTQs8pBAZjPpWfIF6C8QCyxzfrWo708cT6IZRyNJ18gAr5naiS24rlWHUAe8EelHoOBBIXaADcobcaURY_XrKf0-PJRq8pEyQAz1yuHbBurgCjykiPqQBoWys9R_mYORmuxOGUN4/s1600/Turkey+Interest+Rates.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiX4kkMTQs8pBAZjPpWfIF6C8QCyxzfrWo708cT6IZRyNJ18gAr5naiS24rlWHUAe8EelHoOBBIXaADcobcaURY_XrKf0-PJRq8pEyQAz1yuHbBurgCjykiPqQBoWys9R_mYORmuxOGUN4/s400/Turkey+Interest+Rates.png" alt="" id="BLOGGER_PHOTO_ID_5553610502431531730" border="0" /></a><br /><br />The bank have justified their decision by highlighting the fact that core inflation rate is falling, and in fact came in under their year-end target for the first time since the central bank introduced an inflation targeting regime. They also strongly draw attention to the potential negative consequences of raising rates in an environment where this may only accelerate the inflow of short-term, speculative funding. Given that one of the key objectives of the central bank has to be reducing the level of interest rates in order to make it easier and more attractive to invest, the bank is likely to show great reluctance in moving towards monetary tightening and will most probably continue to rely on other tools to keep inflation in check, such as increasing reserve requirements to control credit growth.<br /><br />Since the start of the crisis the central bank have lowered rates 14 times from their October 2008 high of 16.75%. The Bank’s stated objective is to bring the level of interest rates permanently down to well below their long term historic levels. Their ability to do this, however, is conditional on their success in reducing the endemically high levels of inflation which have continually plagued the economy.<br /><br />Certainly Turkey’s inflation rate is now extremely low compared with levels considered typical only a decade ago, but it is still an upside outlier in comparison with regional peers, and in recent months it has been showing renewed signs of an uptick.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj8QyozE3vi_zmi446HNa5mO90M0f_XFKJd8DJiKlUAY0e5mTLthwcdBRvP8k-0yYT9zHQkC-VpNoHAeQ10j3RCZFTNS_kmjMl6H1JHAlEC-evk9-aHFab9Gc1TVgCThU5geilDT6wpBHw/s1600/Turkey+Inflation+Annual.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj8QyozE3vi_zmi446HNa5mO90M0f_XFKJd8DJiKlUAY0e5mTLthwcdBRvP8k-0yYT9zHQkC-VpNoHAeQ10j3RCZFTNS_kmjMl6H1JHAlEC-evk9-aHFab9Gc1TVgCThU5geilDT6wpBHw/s400/Turkey+Inflation+Annual.png" alt="" id="BLOGGER_PHOTO_ID_5556930569123702194" border="0" /></a><br /><br />Despite the country’s secular disinflationary tend, inflation has remained stubbornly high in recent months, although it did fall for the third consecutive month in December, registering a 12 month low of 6.4%, and down from the 9.3% seen in September. Nevertheles this level is still way too high for comfort, and especially in the context of an appreciating currency. The December inflation drop was largely due to a fall in volatile food prices, which were down 2.7% from November. The ex-fresh-food-and-energy core reading has been falling all year, and stood at 3.18% in December.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhW_CW7Fg-r8CShN2XgKLcFdcGs649FW572c8dm0ckp0RdL5jiE3o4BnB2Q7N6YUbfI8rJsfUO7P4jhFKfombuTDpdHP7KdF3kkayKfqWweCj-huYUhiDxV_VTpes-jGfTifRNIM2pTFFk/s1600/Turkey+HICP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhW_CW7Fg-r8CShN2XgKLcFdcGs649FW572c8dm0ckp0RdL5jiE3o4BnB2Q7N6YUbfI8rJsfUO7P4jhFKfombuTDpdHP7KdF3kkayKfqWweCj-huYUhiDxV_VTpes-jGfTifRNIM2pTFFk/s400/Turkey+HICP.png" alt="" id="BLOGGER_PHOTO_ID_5559806988128373538" border="0" /></a><br /><br />This core inflation is one of the central bank’s preferred measures of underlying inflation, so they will have drawn some comfort from downward rend, but they will also have noted that producer prices rose by an annual 7.73% in December (as compared with 4.16% in December 2009), a detail which may not alarm them at this point, but which will certainly give them food for thought if the rate remains high as 2011 advances.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheXw3KqqH_pIdRtCDxKitiig-EVhbRpkf-Qtqb9d8wP3mAk-Oq7PQeBlyOfEbiC1Y51wF0QT0gJN_4uEbut0AKQj0PED2FagjqpRz9c9kxFtgM00Bm3EA2NjPDueJD9cS_VJdH5UOFW88/s1600/Turkey+Core.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheXw3KqqH_pIdRtCDxKitiig-EVhbRpkf-Qtqb9d8wP3mAk-Oq7PQeBlyOfEbiC1Y51wF0QT0gJN_4uEbut0AKQj0PED2FagjqpRz9c9kxFtgM00Bm3EA2NjPDueJD9cS_VJdH5UOFW88/s400/Turkey+Core.png" alt="" id="BLOGGER_PHOTO_ID_5559806900036355970" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiT1MTZq-Df-SEuJ-N_IEH-bMCT7O4dljpSaqVH-TE7ta6mDQwuFKXCrYksorTw9Y-fnccqyum0VIK1LXtYI92A0oCP9-6zfXHsvXgPlQxIeTawkI_W5HbPae5ZOTMFNRA_Hrf58yWoMyA/s1600/Turkey+PPI+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 203px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiT1MTZq-Df-SEuJ-N_IEH-bMCT7O4dljpSaqVH-TE7ta6mDQwuFKXCrYksorTw9Y-fnccqyum0VIK1LXtYI92A0oCP9-6zfXHsvXgPlQxIeTawkI_W5HbPae5ZOTMFNRA_Hrf58yWoMyA/s400/Turkey+PPI+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5559807070266608786" border="0" /></a><br /><br /><span style="font-weight: bold;"><br />Public Indebtedness Is Not A Serious Problem</span><br /><br />After many years of extremely high government deficit, Turkey has been remarkably prudent since the turn of the century . The country’s fiscal deficit has remained low since the implementation of the IMF programme, and this despite the recent crisis-generated increase. As a result, with low deficits, strong growth and high inflation debt to GDP has fallen steadily (don't start letting your mouth water Greece, this combination is impossible in a currency union). Driven up by the recession, the deficit hit 5.6% of GDP in 2009, and according to IMF projections it is expected to fall back again to 3.4% in 2011. Gross debt peaked at 45.5% of GDP in 2009, and is in the process of falling back steadily, although we shoudn't get too excited about this, since it is what you should expect to see in a country with such a comparatively young population: real pressure on the sovereign will only start as and when the population median age rises to current EU levels .<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEib1rS40HnijDoFHzucmO3j6L9symk7q4uZJYlkW-Ab3DIM4oUsToaN6L96bciTC5D7WX_9fczH3QvkUtbGRtYb9yVQTJagDd-8pr_YOj4PeqMPQKtwr4qKlWqb-IZmGTS0pkEP35ujHuI/s1600/Turkey+Gross+Government+Debt.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 230px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEib1rS40HnijDoFHzucmO3j6L9symk7q4uZJYlkW-Ab3DIM4oUsToaN6L96bciTC5D7WX_9fczH3QvkUtbGRtYb9yVQTJagDd-8pr_YOj4PeqMPQKtwr4qKlWqb-IZmGTS0pkEP35ujHuI/s400/Turkey+Gross+Government+Debt.png" alt="" id="BLOGGER_PHOTO_ID_5556932860154795218" border="0" /></a><br /><br /><br />So there is little room for complacency. The recent decision by the Turkish government to shelve the proposed Fiscal Rule legislation (a measure which would have permenently committed the government to target a 1% fiscal deficit) has come in for a lot of criticism, most notably from the IMF. But caution is called for here, since the decision most likely reflects the government’s concern not to prematurely tie its hands in the face of what might be a quite closely contested election in 2011. So a wait and see attitude might be more appropriate before passing any kind of definitive judgement.<br /><br />Certainly the data we have to date show quite a strong fiscal performance throughout 2010, with the government posted a primary budget surplus of TRY4.6 billion in November compared with a TRY1.2 billion deficit in the same period of 2009. Central government revenues rose by an impressive 42.4% YoY in November, while expenditures rose by 22.9%. In fact November’s results bring the year-to-date general budget deficit to TRY23.5bn – almost half of the budget deficit in January-November 2009 – and the primary surplus to TRY 23bn (Jan-Nov 2009: TRY 5.8bn), which means last years budget deficit may well come in at under the EU limit of 3%, and will in any event be significantly below the government target of 4% So despite credibility slippage, in the short term the strong economic expansion may well assuage concerns about longer term sustainability. What really matters is what happens this year, and in the years which follow. The government has budgeted for a 2.8% fiscal deficit in 2011, and given the credibility issues involved I wouldn't be surprised to see them keep to this, despite the coming election.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-bwBIQsp8pXPvbp48rSNSAqWhydhBYZbWMj0be3f9gc888Y2ckBxx9mxJC-VvjXCxqZiU7hjvlfQ2wTHQYvTb4ea4c7YvQM49l6YGiP9bZ-HqyS2pAw-bgrwlyuuTTAmlsGaGkyrxA6E/s1600/Turkey+Fiscal+Deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 251px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-bwBIQsp8pXPvbp48rSNSAqWhydhBYZbWMj0be3f9gc888Y2ckBxx9mxJC-VvjXCxqZiU7hjvlfQ2wTHQYvTb4ea4c7YvQM49l6YGiP9bZ-HqyS2pAw-bgrwlyuuTTAmlsGaGkyrxA6E/s400/Turkey+Fiscal+Deficit.png" alt="" id="BLOGGER_PHOTO_ID_5556934906923518642" border="0" /></a><br /><br />However, in taking what seems to be the easier path now and postponing the watertight commitment to fiscal stability for some moment in the future, the government may be storing up trouble for itself or its successor. Spending excess tax revenues is only stimulating an economy which is not in need of stimulation, whereas saving them would not only be building a cushion for the future, it would also help reduce pressure on the current account deficit by draining some demand from the economy.<br /><br /><span style="font-weight: bold;">Private Sector Debt Not A Problem At This Point Either</span><br /><br /><br />Nor is the level of private sector debt a problem, since even though it has been rising rapidly of late, the level (at around 35% of GDP) is still quite low, and relatively sustainable for a rapidly developing country.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhswM_eWZaZlPSmrXCY4Vg3YzygIDkRfAmnVwaYgTfiVemTnrZx3YGluVKNb29S-6OOumbwp2Csb7ddP-w5aQgxMEGsRYbx1_ExN_V7Fz6H7ZlcLtQecTABU27XEht9Gs5bKIuIdxwBexg/s1600/Turkey+Total+Private+Sector+Credit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 236px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhswM_eWZaZlPSmrXCY4Vg3YzygIDkRfAmnVwaYgTfiVemTnrZx3YGluVKNb29S-6OOumbwp2Csb7ddP-w5aQgxMEGsRYbx1_ExN_V7Fz6H7ZlcLtQecTABU27XEht9Gs5bKIuIdxwBexg/s400/Turkey+Total+Private+Sector+Credit.png" alt="" id="BLOGGER_PHOTO_ID_5556938807854655074" border="0" /></a><br /><br />Household debt which has been rising at rates close to 40% this year should be brought under greater control, since while current levels are not worrysome, letting these growth rates continue is not desireable.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0H2O2xT_E0EAcE_yXL44vI8LuEIz40fhfkIr9T03GLwK3j9s5BoPh8jWcust1-SjiZ4xREmpAyqL1Z2I-aYpzn9ysBQNAUxsR4fr685rWreMIjQtLH0F5XCulKtdv4lnJjGB052yi-7w/s1600/Turkey+Total+Credit+To+Households+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 218px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0H2O2xT_E0EAcE_yXL44vI8LuEIz40fhfkIr9T03GLwK3j9s5BoPh8jWcust1-SjiZ4xREmpAyqL1Z2I-aYpzn9ysBQNAUxsR4fr685rWreMIjQtLH0F5XCulKtdv4lnJjGB052yi-7w/s400/Turkey+Total+Credit+To+Households+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5556938696513894770" border="0" /></a><br /><br />The same goes for housing loans. The current boom in construction activity and household mortgage lending is fine, but it does need to be kept in check.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQzvd5EWcQphPxx9oSrP_CK14zpf8yY7lISdAJrMbmc3cT6vF9-VhMu7reJsPDOF1Ybt4byKVRZzeL2b7_pQWm-C9aPs5L1UDbmEmO1ZjIIt-__6nLcm1O_W5jxZgWPE6x426El6Tbgl8/s1600/Turkey+Total+Housing+Loans+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQzvd5EWcQphPxx9oSrP_CK14zpf8yY7lISdAJrMbmc3cT6vF9-VhMu7reJsPDOF1Ybt4byKVRZzeL2b7_pQWm-C9aPs5L1UDbmEmO1ZjIIt-__6nLcm1O_W5jxZgWPE6x426El6Tbgl8/s400/Turkey+Total+Housing+Loans+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5556938575733124194" border="0" /></a><br /><br /><br /><span style="font-weight: bold;">Outlook: Steady Growth, Falling Long Term Interest Rates and A Round Of Credit Rating Upgrades</span><br /><br />So 2011 looks like it will be a pretty good year for Turkey. Of course, not everyone is convinced by the new monetary policy initiative, and <a href="http://www.imf.org/external/np/ms/2010/121710.htm">the IMF have been quick to warn of the dangers</a>. In particular they warn about the continuing practice of unsterilsed purchasing of foreign currencies. The answer here is not too difficult: sterilise, that is withdraw liquidity to compensate, which is what the bank seems intent on doing via the increase reuqired reserves.<br /><br />However the IMF also warned of the danger that, even if sterilised, large purchases by the central bank could become unsustainable, given the aggressive nature of the liquidity withdrawals which would be required to maintain the stance. Undeterred by the davice, on 21st December 21st Bank Governor Durmus Yilmaz announced that the Bank was not only set on continuing its policy of carrying out forex purchases, it was actually going to increase them, taking the amount of its daily foreign-exchange purchases (as of January 3rd 2011) from US$40m to US$50m. It is quite possible the IMF have a serious point here, and the bank may do well to consider more actively their proposal that the Bank apply the increased reserve requirements on both TRY and forex denominated accounts, and that they also extend coverage of the requirements to other credit providers and instruments in an attempt to rebalance the maturity profile of their borrowing, ie reduce their dependence on short term borrowing.<br /><br /><br /><br />On the other hand, while one EU sovereign after another finds itself facing ever increasing borrowing costs, the process in Turkey moving in the opposite direction. Just last week Turkish bond yields extended a record low, registering their steepest two-day decline in almost eight months on speculation inflation will continue to slow, thus allowing the central bank to cut its interest rates even further. The Turkish lira depreciated to its weakest levl in six months last week, touching 1.5683 per dollar at one point last Friday. The yield on the benchmark two-year lira bond closed the week at 6.98 percent after the two-year debt yield fell below 7 percent for the first time ever on Wednesday.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEghsYFyVSOOkcPgLnPfQsabtXa_MYl9K3VnUwi-ZLEHO5SRRhRaRKnI_pskJGZNPnH_4gv8UOqCUrgO_ZWfS6yvWM_vZjTfrfdR2fgix4AvXxn9LZTVjnyXA981vwNSO6yIPG_HS-5MMik/s1600/Turkey+2+year+yield+two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 292px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEghsYFyVSOOkcPgLnPfQsabtXa_MYl9K3VnUwi-ZLEHO5SRRhRaRKnI_pskJGZNPnH_4gv8UOqCUrgO_ZWfS6yvWM_vZjTfrfdR2fgix4AvXxn9LZTVjnyXA981vwNSO6yIPG_HS-5MMik/s400/Turkey+2+year+yield+two.png" alt="" id="BLOGGER_PHOTO_ID_5559825340663337762" border="0" /></a><br /><br />So far, then the policy is working, even if it is early days yet. Lower bond yields may also be favoured by forthcoming credit <span style="font-weight: bold;">upgrades</span>. Fitch Executive Edward Parker stated last month that while the Central Bank faced many challenges in 2011, Turkey’s sovereign credit rating would be positively affected if the new policy proves successful. Fitch currently has a local and foreign-currency bond rating for Turkey of BB+, one level below investment grade.<br /><br />He also noted that Turkey’s sovereign rating would be positively affected if Turkey’s debt to GDP ratio continued to decline and if there were no change in political stability following the general elections. In effect it is not likely that Turkey will become an investment grade country until after the June general elections since the rating agencies will want to see the results of the revised monetary policy stance, the fiscal performance ahead of the general elections and the political landscape following them before making this kind of rating upgrade. That being said, it is perfectly possible that both Moody’s and S&P's (which currently rate Turkey at Ba2 and BB, respectively, that is more than one notch below investment grade) could make an initial upgrade in Turkey’s sovereign rating (by one notch say) even before the general elections are held.<br /><br />The outlook for Turkey is thus extremely positive, even if there are concerns about the short term bias in bank funding, and longer term worries about structural distortions from the current account deficit. On the fiscal side the government is likely to have reduced the budget deficit to below 4% of gross domestic product in 2009 from 5.5% in 2009, and is quite likely to fulfil its targe of 2.8% this year, making it one of the very few countries in the EU orbit to come in with a deficit within the 3% official target level. So while there are no guarantees that the latest initiative from the Central Bank will work, there are grounds for hope and expectation that both they and the government will make changes and search for solutions even if they don't.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-76179708158669131232010-08-27T10:15:00.000+02:002010-08-27T10:19:01.107+02:00Estonia's Long Awaited Recovery May Still Be Delayed Yet AwhileIn a recent FT Op-ed, entitled "<a href="http://www.ft.com/cms/s/0/c4350686-9c01-11df-a7a4-00144feab49a.html">Estonia’s recovery defies economists and academics</a>", columnist John Dizard argued that "the “internal devaluation” policy, which means cuts in nominal costs such as wages and rents, was very hard on the population, but appears to have worked ahead of even the Estonian government’s schedule".<br /><br />But as I said to John in a very enjoyable phone conversation I had with him before he wrote the piece (where he was kind enough to descibe me as a "freelance economist", one who doesn't have to answer to a boss before expressing an opinion), perhaps we should just hold on a minute before jumping to too many conclusions, since things are still far from clear. So let's take a look.<br /><br />As John points out, many macro economists, among them me myself (<a href="http://latviaeconomy.blogspot.com/2008/12/why-imfs-decision-to-agree-lavian.html">here</a>, and <a href="http://latviaeconomy.blogspot.com/2009/01/why-latvia-needs-to-devalue-soon-reply.html">here</a>, and <a href="http://balticeconomy.blogspot.com/2009/03/why-you-need-devaluation-open-letter-to.html">here</a>) and Paul Krugman (<a href="http://balticeconomy.blogspot.com/2009/03/why-you-need-devaluation-open-letter-to.html">here</a>) have been arguing that if the Baltic countries stick to their policy of having a fixed exchange rate with the euro, they face a long period of low growth and serious internal deflation. At the start of this debate, I pointed out that the impact of price deflation on the bank loan books would be just the same with or without devaluation: not so, said Krugman (and he was right), the impact is worse, since even the Kroon or Lati denominated loans (which in truth are quite few) are affected.<br /><br />John however, does not agree, since, he tells us, the country is "stubbornly failing to comply with the predictions of what are called the 'third generation models' for currency crises" and "is already seeing a resumption of growth and a fall in its real cost of capital".<br /><br />Well, as I told John at the time, the Estonian case is a complex one, since in a country with only just over a million people a myriad of special case factors can be at work, confounding results. But still, the idea is abroad that Estonia is a kind of "black swan", a data point which tends to suggest that conventional macro economic wisdom is somehow flawed. So just how valid is this view. Let's take a look at some data.<br /><br />In the first place, John is undoubtedly right, economic activity has revived (slightly) in Estonia. In Q2 2010 the economy grew by a seasonally adjusted 2%, following an equivalent contraction in Q1 and growth of 2.6% in Q4 2010 (yes these are quarterly, not annual, numbers).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7_Q78PM6jxIoYdEcwZtWlpjHbYr8iGEG_tM86mAMvz7sNYcohP4WYbB0HdfwzW9UVf5QRSBqq5R6cdzpPV1UvYypwXaCBXEtp_ufSShItq-m7T5tkhSZMz-BmiHerSJVOrqKSZtN-yfYJ/s1600/Estonia+GDP+q-o-q.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7_Q78PM6jxIoYdEcwZtWlpjHbYr8iGEG_tM86mAMvz7sNYcohP4WYbB0HdfwzW9UVf5QRSBqq5R6cdzpPV1UvYypwXaCBXEtp_ufSShItq-m7T5tkhSZMz-BmiHerSJVOrqKSZtN-yfYJ/s400/Estonia+GDP+q-o-q.png" alt="" id="BLOGGER_PHOTO_ID_5509402361022809266" border="0" /></a><br /><br />So the first thing to say is that if these numbers are truly well adjusted seasonally (which make be hard given the boom bust background, and the amplitude of the movement in the data) what we have is a lot of volatility out there. And in the second place, we could well ask ourselves to what extent it is valid to use that so-oft maligned expression "recovery" at this point in the Estonian context. If we look at the GDP volume index (which I have put in 4 quarter moving average format), you have to look very hard indeed (go on, squint a bit more) to actually see the uptick.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2tihSf5QyA-cbtfocdzcVZrNpQKxwMbnCKpetEnLYxOGMxOt-MJOu1Tqp7LUcQoLgbcnVraJN5LuPTVr4zHChrCS7HvMzy2n-9IDTonfBYM9IDoupzjETM-PY7cBGMm9VHPWHmhvI2WCM/s1600/Estonia+Chain+linked+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2tihSf5QyA-cbtfocdzcVZrNpQKxwMbnCKpetEnLYxOGMxOt-MJOu1Tqp7LUcQoLgbcnVraJN5LuPTVr4zHChrCS7HvMzy2n-9IDTonfBYM9IDoupzjETM-PY7cBGMm9VHPWHmhvI2WCM/s400/Estonia+Chain+linked+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5509403369468443746" border="0" /></a><br />I tell you what, I'll do you all a favour, and shorten the time series and change the scale.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6foZPBEgN_vFF8HZbApxGFcN6M7OGZ52g5V6APpEs0hgwwxNoaKamGX4fEiWTDrv0nOLm41ae8ajP4ZL4T8U41VyCF_NNf65flHjvSiUbuFtuUCHqbiG9P7QOa0KXUDGpbC4WV40dql4l/s1600/Estonia+Chain+linked+GDP+Two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6foZPBEgN_vFF8HZbApxGFcN6M7OGZ52g5V6APpEs0hgwwxNoaKamGX4fEiWTDrv0nOLm41ae8ajP4ZL4T8U41VyCF_NNf65flHjvSiUbuFtuUCHqbiG9P7QOa0KXUDGpbC4WV40dql4l/s400/Estonia+Chain+linked+GDP+Two.png" alt="" id="BLOGGER_PHOTO_ID_5509404413200630274" border="0" /></a><br /><br />Well, that's a bit clearer, isn't it. I think what you can say looking at this chart is that the Estonian economy has been stabilised (no mean feat that, with an economy in freefall), but what happens next, well that, it seems to me, you can't discern from looking at the chart. To decide on that, I think, you will probably need to go back to the initial assessment you had of the problem. If, like John, you believed that what the Estonians were trying was doable, then you will probably draw the conclusion that what comes next will (eventually) be a recovery. If, like me, you had severe doubts from the outset that this was doable, then you will probably imagine the Estonians are now in for a long period of slow, "L shaped" semi-recovery, with a lot of pain still to come, further down the road. But as I say, all of these expectations probably depend on your initial theoretical assumptions (more on this later), and in that sense <span style="font-weight: bold;">nothing has fundamentally changed</span>.<br /><br /><br />That being said, there are some things that have improved in recent months. Retail sales for example.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVlvAelYOkZAps2dDbmQqCm5MvqNzjbiV0Bqt_mGeYQDWpocz6UWBK_ICsdzqzJ9LsJ0zHggSo3jzHzVESiKEyEQQl66Ba2g8smYddoQBlfRp0cTjZMikNVcZQ5QtegDzDPXQPkFIDoX08/s1600/Estonia+retail+sales.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhVlvAelYOkZAps2dDbmQqCm5MvqNzjbiV0Bqt_mGeYQDWpocz6UWBK_ICsdzqzJ9LsJ0zHggSo3jzHzVESiKEyEQQl66Ba2g8smYddoQBlfRp0cTjZMikNVcZQ5QtegDzDPXQPkFIDoX08/s400/Estonia+retail+sales.png" alt="" id="BLOGGER_PHOTO_ID_5509422748090034722" border="0" /></a><br /><br />And then there is industrial output, which is up sharply. It even almost looks like the fist leg of one of those proverbial "Vs".<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNwsSmB6-PH9ghxEwPoBukMs58LgBPdm45yokLB6vS_lJyE9Tsq1arfS7UPqAKeLAn3gy-hCArol6kVWlwOWD5f_BPSzU_nuIWfn79NuRRGmVBEdOXzkeYwnjAFU3_rP9KV_565w1XSprA/s1600/Estonia+IP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiNwsSmB6-PH9ghxEwPoBukMs58LgBPdm45yokLB6vS_lJyE9Tsq1arfS7UPqAKeLAn3gy-hCArol6kVWlwOWD5f_BPSzU_nuIWfn79NuRRGmVBEdOXzkeYwnjAFU3_rP9KV_565w1XSprA/s400/Estonia+IP.png" alt="" id="BLOGGER_PHOTO_ID_5509423050622749682" border="0" /></a><br /><br />And part of the reason for this improvement in output has been the recent improvement in demand for Estonian exports.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXXjZpEBzPjuCR_3mOlDkMOdGHKlBqp7lqfS_9LgFcTCERbeNdapw_B-1ezqmIoPUHNWHyL9IwrRiKsr6bnNuSETJp_QFUcnBzcJ0CinaKXGB0KH70ygRuT_-culr3JhQg5_C9qb0WBgiO/s1600/Estonia+exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXXjZpEBzPjuCR_3mOlDkMOdGHKlBqp7lqfS_9LgFcTCERbeNdapw_B-1ezqmIoPUHNWHyL9IwrRiKsr6bnNuSETJp_QFUcnBzcJ0CinaKXGB0KH70ygRuT_-culr3JhQg5_C9qb0WBgiO/s400/Estonia+exports.png" alt="" id="BLOGGER_PHOTO_ID_5509423582931184338" border="0" /></a><br /><br />But before we get too excited about all this, we should remember that Estonia still has a goods trade <span style="font-weight: bold;">deficit</span>. That is, on balance, the net goods trade is a drag on GDP.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhR3AOD0dtZk57766JKnTh_FdXO97-YhOQ3-R_NrKhEGzf2ia7u-gAKwJ1Vd8Z2s3jNkt-Zv70MbvqmvnEEB1howMdq_EdM62wRuwlBc-K5MAxqDmb-pklnBJGonSpLZ81W8t2VtlkGpyRs/s1600/estonia+trade+deficit.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhR3AOD0dtZk57766JKnTh_FdXO97-YhOQ3-R_NrKhEGzf2ia7u-gAKwJ1Vd8Z2s3jNkt-Zv70MbvqmvnEEB1howMdq_EdM62wRuwlBc-K5MAxqDmb-pklnBJGonSpLZ81W8t2VtlkGpyRs/s400/estonia+trade+deficit.png" alt="" id="BLOGGER_PHOTO_ID_5509425843667835634" border="0" /></a><br /><br />The problem is that the part of Estonian industry which was internationally competitive before the bust still is, but that this part is not large enough to drive the whole economy, now that the economy is export dependent. It just doesn't have a big enough share in GDP to carry the whole economy. As the Estonian statistics office put it: "GDP growth in the 2nd quarter was supported by the industrial sector exports. Due to a small domestic demand, the sales of manufacturing production on the domestic market were in downtrend. In construction, the output of which is mainly targeted at the domestic market, the generated value added showed a continuous decreasing trend".<br /><br />This is what I had always expected would be the case.<br /><br />It should be noted that Estonia runs a substantial services surplus, which at the present time easily cancels out the goods trade deficit. As a result, and this IS the good news, Estonia now runs a current account surplus. Which means that each month now, instead of getting more into debt, the country is steadily paying down its international liabilities. And this is important, since as John points out, Estonia is considerably less indebted externally than many other of Europe's peripheral economies, with net external debt according to IMF data only being some 30% of GDP.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjxlyRozd7AazhyphenhyphenLsq73r2oSSQJWHkC3Y3MA6Ca3dFJmcnwyQuXnAtxSS7QZkox-TyDW9P7GZ8vGmleG_c8FmPcDe4ua6faYcC5H1bNSKdRJxo36dc4mWUzMRG0d_AhtZCZGMpMbQPBY_n7/s1600/Estonia+Current+Account+%28monthlyl%29.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 252px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjxlyRozd7AazhyphenhyphenLsq73r2oSSQJWHkC3Y3MA6Ca3dFJmcnwyQuXnAtxSS7QZkox-TyDW9P7GZ8vGmleG_c8FmPcDe4ua6faYcC5H1bNSKdRJxo36dc4mWUzMRG0d_AhtZCZGMpMbQPBY_n7/s400/Estonia+Current+Account+%28monthlyl%29.png" alt="" id="BLOGGER_PHOTO_ID_5509428941538357714" border="0" /></a><br /><br />But nonetheless, achieving this positive situation still has a price, and that price is that the economy is being forced to operate at well below capacity level, and the clearest indication of this is the very high continuing level of unemployment. In fact, I think John got interested in his story <a href="http://www.baltic-course.com/eng/analytics/?doc=29262">when he read this report</a>, that the registered unemployment rate in Estonia fell to 12% in mid-July. Since he was aware that first quarter unemployment was somewhere around 19%, this seemed to him like a dramatic drop. But there is a confusion here, since we are dealing with two different measures of unemployment, one of them people who sign at labour exchanges to register as unemployed (and may do so because they have entitlement to unemployment benefit), and those assumed to be really unemployed when measured using ILO compatible (and EU harmonised) quarterly labour force surveys, and <a href="http://news.err.ee/economy/4ba57936-d50b-4d6d-b942-b4e7b55bd53b">as this article points out</a>, according to the latest of these surveys (April - June) there were still 128,000 unemployed, or 18.6 percent of the workforce out of work in June.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOA8zhlPrU0fdVChq60jXm9CJThJAoYkeRL76QqprM0hY75yXwoyBHxuGuBVMz0f1HKpCcqp56yLAJtOPVRl1KojLJDCB8t0prBeudIwHU6omkxxE41p2XOiaq4WU-ABsM-654GKKtMYty/s1600/Estonia+Eurostat+Unemployment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiOA8zhlPrU0fdVChq60jXm9CJThJAoYkeRL76QqprM0hY75yXwoyBHxuGuBVMz0f1HKpCcqp56yLAJtOPVRl1KojLJDCB8t0prBeudIwHU6omkxxE41p2XOiaq4WU-ABsM-654GKKtMYty/s400/Estonia+Eurostat+Unemployment.png" alt="" id="BLOGGER_PHOTO_ID_5509433216041753570" border="0" /></a><br /><br />Of course, interpreting such data presents its own problems, and the issue is a complicated one, since in the first place there seems to be a large shadow economy in Estonia. <a href="http://balticbusinessnews.com/article/2010/08/16/Estonia_ranked_2nd_by_volume_of_shadow_economy">According to Professor Friedrich Schneider of Austria's Linz University</a>, based on a study that covered 37 countries, Estonia had the second largest proportion of GDP in the informal economy, with some 40% not paying tax. Top of the list was Latvia, with shadow economy accounting for 42% of the country's GDP, then came Estonia, Bulgaria, Turkey and Greece. So of course, not all those who are not signing the registers are necessarily unemployed, or in the country even, but still people are dropping out of the statistical system, <a href="http://balticbusinessnews.com/article/2010/08/10/Paper_well_more_than_100_000_people_may_be_unemployed">according to the Estonian Health Insurance Fund</a> some 20,000 less people are registered for health cover today than there were in March 2008. At the very least we can assume these people are not working in the formal economy or registering for welfare benefits. Whether they are working in the informal one, or working abroad, we really have no idea.<br /><br />Be that as it may, <a href="http://www.stat.ee/37840">according to the Estonian Statistics Office</a>, in the 2nd quarter of 2010 the estimated number of unemployed in Estonia was 128,000 and the unemployment rate was a - seasonally not adjusted - 18.6%. So unemployment did decrease in the quarter for the first time in nearly two years, but by 1.2% (from 19.8% in Q1), and not by the rather large amount it might appear from the labour exchange registration data.<br /><br />And if you go to the details of the stats office report the situation is more complex than it seems at first sight, since while the number of new unemployed has been declining, long-term unemployment continues to grow. In the 2nd quarter, 58,000 unemployed persons had been looking for a job for one year or more (long-term unemployed), of whom 19,000 had been looking for a job for two years or more (very long-term unemployed). The share of long-term unemployed among total unemployed increased to 46%, while the share of very long-term unemployed rose to 15%. The number of persons who had stopped seeking a job or discouraged persons was also larger in the 2nd quarter than in the 1st (9,000 and 7,000 respectively).<br /><br />On the other hand the estimated number of employed persons was 559,000, which was up by 5,000 (0.9%) over the previous quarter. According to the statistics office, "employment increased due to seasonal and other temporary jobs typical of the 2nd quarter". Nonetheless there was employment growth, so we should be thankful for any mercy, however small. What remains to be seen is whether this improvement in employment is sustainable as Europe's economies slow going into the second half of the year.<br /><br />A further bone of contention between the parties evidently concerns the so-called “internal devaluation” policy being applied by the Estonian government. As John Dizzard explains such a policy "means cuts in nominal costs such as wages and rents, (and) was very hard on the population, but appears to have worked ahead of even the Estonian government’s schedule".<br /><br />When we come to scrutinise the actual data however, the fall in hourly wages has hardly been dramatic, and they have now fallen about 7% from their peak at the end of 2008. But it should be remembered in 2008 they were up by around 7%, so they are now at about the same level as they were in January 2008, following increases of 17.5% in 2006 and 20% in 2007 - rates of increase which ultimately lead to the consumption bust which followed them, and clearly not sustainable in the longer term. So, unfortunately it is just not the case that Estonia has had a very harsh policy of wage cost reduction implemented. Living standards have fallen sharply, due to the reduced hours worked, and the rapid rise in unemployment - ie due to the recession - but that is not the same thing at all as recovering lost competitiveness.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgoj9wf0jw2WBPcsRepXB-TnKr2pztbc91om7RADHUoSG_P0KlYYvUdRRw46OjOKquNi7Mkdgs4f0zC5g53J5utgMTowOiksYjhk7JNOQeMC4idIydcYXR8EP07NF5GxhFr0JAg3Sn1U2mL/s1600/Estonia+Hourly+Wages.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 260px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgoj9wf0jw2WBPcsRepXB-TnKr2pztbc91om7RADHUoSG_P0KlYYvUdRRw46OjOKquNi7Mkdgs4f0zC5g53J5utgMTowOiksYjhk7JNOQeMC4idIydcYXR8EP07NF5GxhFr0JAg3Sn1U2mL/s400/Estonia+Hourly+Wages.png" alt="" id="BLOGGER_PHOTO_ID_5509729187425903794" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifRs2bUgjre2ofAI1Cjli4Z8bKzNT5mxZUxkM55ECaYDVWqLdE5g5AJfsMxDQ1gpMBULSwmNq7AQUSpWgpgvxIk3hPXr6al9W44zTYA0nINAb69Js64acHnSGrahRsT_IQYcECnKYFkgHc/s1600/Estonia+Hourly+wages+y-o-y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 260px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifRs2bUgjre2ofAI1Cjli4Z8bKzNT5mxZUxkM55ECaYDVWqLdE5g5AJfsMxDQ1gpMBULSwmNq7AQUSpWgpgvxIk3hPXr6al9W44zTYA0nINAb69Js64acHnSGrahRsT_IQYcECnKYFkgHc/s400/Estonia+Hourly+wages+y-o-y.png" alt="" id="BLOGGER_PHOTO_ID_5509729094676505954" border="0" /></a><br /><br />The Real Effective Exchange Rate data on all this is very clear. Up to 2005 the rise in living standards was more or less in line with sustainable economic growth. From 2006 onwards things really got out of hand, and to date only a very small part of the competitiveness loss has been clawed back.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMR-ZJL7S6NugTTvxA26rgCzLbHzouNjlchEgFdLWmmW6ua72gr8HY6lkiax2XOMp3DY3Qo0s7VURfZTz4JjAxIDCAs0pk4ShwzR2c8K1pFEFexKkSoRQJqoUsB7Tj4vNzLCAgBfrQzzBU/s1600/Estonia+REER.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 250px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjMR-ZJL7S6NugTTvxA26rgCzLbHzouNjlchEgFdLWmmW6ua72gr8HY6lkiax2XOMp3DY3Qo0s7VURfZTz4JjAxIDCAs0pk4ShwzR2c8K1pFEFexKkSoRQJqoUsB7Tj4vNzLCAgBfrQzzBU/s400/Estonia+REER.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5509994123737882754" /></a><br /><br /><br />This intrepretation is confirmed by an inspection of the CPI data, which after 9 months of registering mild interannual deflation is now back in positive territory, and more or less a full percentage point above the Eurozone average, which for a country which is supposed to be in the throes of a substantial "internal devaluation" is pretty incredible, and could be seen as another example of someone or other falling asleep at the wheel, after passing the finishing line for Eurozone membership perhaps.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifz1OCwh-eP-oXyxFc-6Cxe9ccHJBwoc5hnV7HQsglYzVqS__i6BzrEBnb_oHHkblYmq-Jvg9RoWBOY9bxKgA-RKiHP0qBjj1hS9CU1nFP6NCF5nRTuFDhG6ED_DnNe3QFdPeL8iokrKDB/s1600/Estonia+CPI.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 232px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEifz1OCwh-eP-oXyxFc-6Cxe9ccHJBwoc5hnV7HQsglYzVqS__i6BzrEBnb_oHHkblYmq-Jvg9RoWBOY9bxKgA-RKiHP0qBjj1hS9CU1nFP6NCF5nRTuFDhG6ED_DnNe3QFdPeL8iokrKDB/s400/Estonia+CPI.png" alt="" id="BLOGGER_PHOTO_ID_5509734211646373666" border="0" /></a><br /><br /><br />John Dizzard argues that the Estonians are in position for a relatively rapid recovery (this part I don't see at all, anywhere in the data) because they started out with much less state and private debt than the others. This latter point is certainly true, but we should not miss the fact that while Estonia's state debt is very, very small, private sector debt (at around 100% of GDP, between households and corporates) is not so small, and indeed will continue to exert a significant downward pressure on credit growth for some time to come.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1oScUQa2TcCePelmj3nV_KvMkP4JvDVtcNQo-hr47rb4CnPBhYjWQ_-pap74NBgeO3LxEMPlTH47bz3GPV6mlBfYRsqipzkH9oxHtj5Baka_qvoop0c_n1Bu2g6Pms_TQ2q_wA6ao781d/s1600/Estonia+Household+Borrowing.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 236px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1oScUQa2TcCePelmj3nV_KvMkP4JvDVtcNQo-hr47rb4CnPBhYjWQ_-pap74NBgeO3LxEMPlTH47bz3GPV6mlBfYRsqipzkH9oxHtj5Baka_qvoop0c_n1Bu2g6Pms_TQ2q_wA6ao781d/s400/Estonia+Household+Borrowing.png" alt="" id="BLOGGER_PHOTO_ID_5509737714067054626" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNjn7g3yWAGg1LNP-xUp1vuPGSzdgA3Rz4mCJ-EqzpQxMvxjEP9Vp69C0qH87wJHA-s0RkeN_FEUHw0nOWE9uHUpVeW5PCTSPte7F7UDjyFEESbxs_fa4fH6mpoFcApo0bRaqaiaSwlagX/s1600/Estonia+Corporate+Borrowing.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNjn7g3yWAGg1LNP-xUp1vuPGSzdgA3Rz4mCJ-EqzpQxMvxjEP9Vp69C0qH87wJHA-s0RkeN_FEUHw0nOWE9uHUpVeW5PCTSPte7F7UDjyFEESbxs_fa4fH6mpoFcApo0bRaqaiaSwlagX/s400/Estonia+Corporate+Borrowing.png" alt="" id="BLOGGER_PHOTO_ID_5509737328772148786" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgC_ZCz90B74E42U9uMXu1Gn4_eil4qs5IzaDG6jUsyZn_CQd3ev-ncCiyV5HRgQWqZQh5W9qXCcO1-icfZVFKVk2zMmDEl5n9nqemF1GdYmDJG6CtQMsTK1-oLRCa5Z-4Zf86RoTvvqbR/s1600/Estonia+Government+Borrowing.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 235px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgC_ZCz90B74E42U9uMXu1Gn4_eil4qs5IzaDG6jUsyZn_CQd3ev-ncCiyV5HRgQWqZQh5W9qXCcO1-icfZVFKVk2zMmDEl5n9nqemF1GdYmDJG6CtQMsTK1-oLRCa5Z-4Zf86RoTvvqbR/s400/Estonia+Government+Borrowing.png" alt="" id="BLOGGER_PHOTO_ID_5509736214187753874" border="0" /></a><br /><br />Now one of the points raised by John which does have a certain validity is that of lower capital costs. Given the existence of significant quantities of land and warehouse and factory accommodation which are now surplus to requirement due to the "downsizing" which has been going on (creative destruction) employers do now have access to cheaper premisses, and this can offer them lower unit costs for a given level of technology and output. The key point to get here is where the demand is going to come from, and then we are still back with the same issue: exports.<br /><br />More than the internal devaluation itself, Estonia is benefitting from the decision to grant the country Euro membership. As a result the cost of servicing oustanding debt has falling, as have credit default swap spreads. John quotes one large shareholder in several Estonian companies as saying, “At the beginning of 2009, the banks were offering our companies loans at 600 to 700 basis points above six-month euribor [the euro base rate]. That’s if the money was available at all; most of the time they were cutting lines. Now the banks are offering the same companies increased lines at 100 to 300 basis points over euribor.”<br /><br />But if we come to look at the impact of this cheap credit, we will see that, as in other economies where private demand is highly leveraged (the UK, the US, Spain), the uptake on all this ultra cheap credit has not exactly been massive. In both cases the interannual rates of credit growth are still negative, which is one of the key reasons domestic demand remains so weak.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPUbOb0B56xXzcOYmPilTH6WB-8hFr8fgTb3Y1W9tg2qkhuMzkVLuBgsPwwbRP9C1Mz8Zl2Pex1arJ7DyVvPdfVNLFFN1oLuyOkiiw6uDtS8zenECruKAGfi8_vRGG690xfAa5gcGvM4I5/s1600/Estonia+Corporate+Borrowing+Y-o-Y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 235px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPUbOb0B56xXzcOYmPilTH6WB-8hFr8fgTb3Y1W9tg2qkhuMzkVLuBgsPwwbRP9C1Mz8Zl2Pex1arJ7DyVvPdfVNLFFN1oLuyOkiiw6uDtS8zenECruKAGfi8_vRGG690xfAa5gcGvM4I5/s400/Estonia+Corporate+Borrowing+Y-o-Y.png" alt="" id="BLOGGER_PHOTO_ID_5509740104172599778" border="0" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-R_28_BuApcWIkg4ttPKFMYysOH0JVbrIqSICsg_d3qmBxQcqpO-5hLwIHXNeW7mgyxicE028oNkqrLnv5j953qkWhCfbCaxOCEQCzQ2WfD_jEmcAsg94o3x_LuZLLFnA1eGCkipwN_C_/s1600/Estonia+Household+Borrowing+y-o-y.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 236px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj-R_28_BuApcWIkg4ttPKFMYysOH0JVbrIqSICsg_d3qmBxQcqpO-5hLwIHXNeW7mgyxicE028oNkqrLnv5j953qkWhCfbCaxOCEQCzQ2WfD_jEmcAsg94o3x_LuZLLFnA1eGCkipwN_C_/s400/Estonia+Household+Borrowing+y-o-y.png" alt="" id="BLOGGER_PHOTO_ID_5509739891661458306" border="0" /></a><br /><br />Although we can see the first timid signs of recovery in the housing market, both in terms of sales volume and in terms of prices, but at this point they are just this, timid signs.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQLZeoDzagZnv-NUZ2ZvAdoBfTn9LOp6io5B4-jJyyiIO8RqFRJqYGoKL_p9THsQKgfmZZqJtihGJs8vLRvlCEX4UtfafYnD6fDhinXXQrnbNnhkzFdItuAHKt89Pl0Q8iXoymkWQoBJKk/s1600/Tallinin+Appartment+Prices.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQLZeoDzagZnv-NUZ2ZvAdoBfTn9LOp6io5B4-jJyyiIO8RqFRJqYGoKL_p9THsQKgfmZZqJtihGJs8vLRvlCEX4UtfafYnD6fDhinXXQrnbNnhkzFdItuAHKt89Pl0Q8iXoymkWQoBJKk/s400/Tallinin+Appartment+Prices.png" alt="" id="BLOGGER_PHOTO_ID_5509741663399172786" border="0" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYZqef2nojpM-dvJZbsAd2cQikkDLKJujjnMg_p6XPtQix5JqWkg0joeRtVl0QPoX9motdfFBFLs24x0qQOuND8TZ7x8_d-R-2O8DXNJS1wvBRyOFrMmDlJaviq-9zh3zwC4Mi-mRYfIwN/s1600/Tallinin+Sales+Contracts.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYZqef2nojpM-dvJZbsAd2cQikkDLKJujjnMg_p6XPtQix5JqWkg0joeRtVl0QPoX9motdfFBFLs24x0qQOuND8TZ7x8_d-R-2O8DXNJS1wvBRyOFrMmDlJaviq-9zh3zwC4Mi-mRYfIwN/s400/Tallinin+Sales+Contracts.png" alt="" id="BLOGGER_PHOTO_ID_5509741309619466946" border="0" /></a><br /><br />So to go back to where we started, and John Dizzard's claim that "Estonia’s recovery defies economists and academics", I would say that rather than economists and academics (or even academic economists) who Estonia's current situation does really defy is the group of people over at the ECB governing council headed by Jürgen Stark, since, <a href="http://fistfulofeuros.net/afoe/economics-and-demography/is-estonias-euro-membership-a-done-deal/">as I reported back in April</a>, consensus thinking at the ECB was that Estonia was not coming into the common currency , due to ongoing concerns about sustainability and competitiveness issues.<br /><br />But that was April, and then came May, when the ECB was forced to do a "U turn" by the crushing pressure of the European Sovereign Debt Crisis, so all these (valid in my view) concerns where simply brushed aside. And anyway, how could anyone argue for keeping Estonia out on these grounds, when you have countries like Spain and Portugal on the inside. Either internal devaluation works, or....<br /><br />So maybe it was better for them to stay with the line that internal devaluation works, and whether they are right or not is what we are all about to get to see. As I said at that start the post, in this case as in so many others, beauty is in the eye of the beholder. If you believe in the neo classical (academic) theory of "steady state" growth - and the guy over at Swedbank that John cites who is forecasting that Estonian gross domestic product will grow at a 4.5 per cent rate next year evidently does - then naturally Estonia's economy has only been temporarily knocked off its path by this whole unfortnate incident, and will soon be back in it habitual orbit. <br /><br />If, however, like me you suspect that neo-classical steady state growth is some sort of metaphysical hocus pocus (or what they call a "necessary assumption to get the argument going") with little empirical support, then you will not be terribly convinced by all those numbers blindly and slavishly churned out by the current generation of models, and will look more to the facts on the ground. In particular, when we come to the neo classical growth theories which normally underpin the sort of optimistic analyses we see of the Estonia situation (yes John, there are academic economists on both sides), I tend to think these are flawed due to some initial erroneous assumtions Solow himself made about the impact of population dynamics on growth (<a href="http://edwardhughtoo.blogspot.com/2006/10/what-is-neoclassical-growth.html">see this extended argument here</a>), and I think it is important to remember here that Estonia, along with Hungary, Latvia and Bulgaria, is one of the countries on Europe's Eastern flank where population as well as ageing is actually falling. So I suggest you treat any analysis which talks about a steady recovery in internal demand but does not explicitly explain how this point has been taken into account....... well I suggest you treat it with more than a pinch of salt.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSjDvWu7v9e3GblqZputr3XUGLqPZPtONzovgyYWyY4v8iSLXsuRKVwNPnQ403qqSvCNLB9iJrBynUZiEBi0KMOh-6OY5vY_PQQ_SUwSuI8RpkC86dUCm4mHcYAjKjjqRmol2kfh0P3wEw/s1600/estonia+population.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjSjDvWu7v9e3GblqZputr3XUGLqPZPtONzovgyYWyY4v8iSLXsuRKVwNPnQ403qqSvCNLB9iJrBynUZiEBi0KMOh-6OY5vY_PQQ_SUwSuI8RpkC86dUCm4mHcYAjKjjqRmol2kfh0P3wEw/s400/estonia+population.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5509987786376306978" /></a><br /><br />And then, of course, there is the idea of "export dependence" and ageing, and what this all means for the future trajectory of the Estonian economy. This argument, which Claus Vistesen and I have been advancing for some years now (and is one of the reasons so many of those famous "predictions" turn out to be valid), shot to the financial headlines recently when Dominic Wilson and Swarnali Ahmed of Goldman Sachs drew the obvious to everyone's attention - namely that balance of payments current accounts are significantly driven by life cycle savings. Maybe you can argue about the validity of the age group classifiaction they use (an empirical calibration issue), but the obvious is obvious: the relative proportions of different age groups across different countries goes a long way to explaining the pattern of global savings and capital flows. And as Claus Vistesen illustrated in the chart below, this helps us understand how societies (Germany, Japan...) become increasingly export dependent as they age.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5K-uSVox8jcbQG336T7lRIU1M85-lPUtDJ-a7WaCXzSVV2odV0hKLVGDWm6TaxD8cJjHTCZ-vvg-JyxsZqzILZfxxf-mMelR179FbGw6fgAnWWSS6elQWyxsSDp30t9Il9oZD2l5DPc51/s1600/Ageing+and+the+Current+Account.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 209px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5K-uSVox8jcbQG336T7lRIU1M85-lPUtDJ-a7WaCXzSVV2odV0hKLVGDWm6TaxD8cJjHTCZ-vvg-JyxsZqzILZfxxf-mMelR179FbGw6fgAnWWSS6elQWyxsSDp30t9Il9oZD2l5DPc51/s400/Ageing+and+the+Current+Account.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5509988145641760802" /></a><br /><br />So, as I said earlier, your expectations about the future outlook for the Estonian economy will largely depend on the initial theoretical assumptions you make at the outset. If you assume that neo classical steady state growth really exists, and that all this stuff about ageing, capital flows and export dependence is exaggerated, then you will see the recovery coming in the here and now, and if you don't.........Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-8162989493942944292010-08-21T13:32:00.000+02:002010-08-21T13:38:26.007+02:00The Shape of Bulgarian Things to ComeAs the IMF say in their most recent staff report on the country, the aftermath of the recent severe economic crisis leaves us with the question as to whether potential output growth in Bulgaria in the years to come is going to be markedly lower than it was during the boom years. As the IMF point out, the current recession was preceded by an investment boom in construction, real estate and the associated financial sectors. Now that the boom (which was always unsustainable, Bulgaria's current account deficit in 2007 hit almost 27% of GDP) is well and truly over in these sectors, the strong associated decline in investment could have large negative effects on output. Moreover, it will take considerable time before the excess labor and resources that are no longer needed in these sectors can be absorbed by other sectors, which suggests that the rate of unemployment may rise yet further and remain higher for some considerable time. Not a uniquely Bulgarian story, but none the less important for that.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj8hBeyuEw8uumLkiFC-d6o5hv6hiXU09BN9xJ0tt1V7YvpOLynKjXxLp6-iQ9xz1pz_cgWi-mINkP7qehAKNVgnHrxi9jr_tASoQfR1vAK-BIYfU_o5REqrNWvLWT4R4Dr9bdVmxNcGdlS/s1600/Bulgaria+Current+Account+Annual.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj8hBeyuEw8uumLkiFC-d6o5hv6hiXU09BN9xJ0tt1V7YvpOLynKjXxLp6-iQ9xz1pz_cgWi-mINkP7qehAKNVgnHrxi9jr_tASoQfR1vAK-BIYfU_o5REqrNWvLWT4R4Dr9bdVmxNcGdlS/s400/Bulgaria+Current+Account+Annual.png" alt="" id="BLOGGER_PHOTO_ID_5507560462610246434" border="0" /></a><br /><br /><br />Following several years of strong increases (around 6% a year) Bulgarian growth declined sharply in 2009 when the economy was hit hard by credit squeeze which formed part of the global economic and financial crisis.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSwDknbnSVnZYv_9LBr40V17Ejq6508SuNT4RKX5DD8hrzaOP5McfJZ2fhcsmhzcJCMxb3bCxL-v-C0KhWTNVZPsp2ZyqVxywT_ki0AVw6erB2cRGtFGm5RYZjPWeUPOQqCcanCM-R2yEv/s1600/Bulgaria+GDP+annual.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSwDknbnSVnZYv_9LBr40V17Ejq6508SuNT4RKX5DD8hrzaOP5McfJZ2fhcsmhzcJCMxb3bCxL-v-C0KhWTNVZPsp2ZyqVxywT_ki0AVw6erB2cRGtFGm5RYZjPWeUPOQqCcanCM-R2yEv/s400/Bulgaria+GDP+annual.png" alt="" id="BLOGGER_PHOTO_ID_5507561926590377442" border="0" /></a><br /><br /><br />Capital inflows, which had been keeping the current account deficit afloat, dropped from a peak of 44 percent of GDP in 2007 to less than 10 percent of GDP in 2009. As a result, investment, which had risen by over 20 percent annually during the previous two years, fell by nearly 30%. And as the investment flows dried up, the Current Account deficit closed rapidly, as imports (and domestic consumption) dropped back sharply.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjsh9O2etnjVx83aOlxyssb5nfzazPENzPDHdopMno99LKxnsLLj5TXGmMSY0_NHUcPMSqOB7oOd0nsgygVqvq8VoCsSLrzsSjqYQ2PRYzxaVcN_jP8wuR5s5J-NGhbpIjlI0n7aUN1WW_D/s1600/Bulgaria+Fixed+Capital+Spending.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 207px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjsh9O2etnjVx83aOlxyssb5nfzazPENzPDHdopMno99LKxnsLLj5TXGmMSY0_NHUcPMSqOB7oOd0nsgygVqvq8VoCsSLrzsSjqYQ2PRYzxaVcN_jP8wuR5s5J-NGhbpIjlI0n7aUN1WW_D/s400/Bulgaria+Fixed+Capital+Spending.png" alt="" id="BLOGGER_PHOTO_ID_5507563015675592850" border="0" /></a><br /><br /><br />Employment also started to fall, while the unemployment rate rose rapidly, hitting a seasonally adjusted 9% in March and April this year, according to Eurostat seasonally adjusted data.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZkhv5lU9UhcRl5d7Fzp0udUfjmyotn_cg6Clp0wA0Oqr8anznq5Us5nmlIAaGeL6MjIgLYtskQPJO78CrWoT7Wyb6M848Q7TeOAIRDx5ZqeeBbv0Z9V5gJ8z55gy-YZcWTuzQq9MClv4a/s1600/Bulgaria+Total+Employment.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 207px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgZkhv5lU9UhcRl5d7Fzp0udUfjmyotn_cg6Clp0wA0Oqr8anznq5Us5nmlIAaGeL6MjIgLYtskQPJO78CrWoT7Wyb6M848Q7TeOAIRDx5ZqeeBbv0Z9V5gJ8z55gy-YZcWTuzQq9MClv4a/s400/Bulgaria+Total+Employment.png" alt="" id="BLOGGER_PHOTO_ID_5507563726273637810" border="0" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRpcO980SbxIURs4g36r2tvZ5sMWiuJdmPp1-zghIcqkNJX1HQ31BlxmiRlTWtCftoJ18A6NZVrseYv-6S9HaQoA8TkUJZkmr7pboxJmXN2tYzohL0iHoINAd5se_51s28G5Df408ZGLNm/s1600/bulgaria+unemployment.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRpcO980SbxIURs4g36r2tvZ5sMWiuJdmPp1-zghIcqkNJX1HQ31BlxmiRlTWtCftoJ18A6NZVrseYv-6S9HaQoA8TkUJZkmr7pboxJmXN2tYzohL0iHoINAd5se_51s28G5Df408ZGLNm/s400/bulgaria+unemployment.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5507810491556838018" /></a><br /><br /><br />The question the IMF ask, about whether Bulgaria will be able to return to the high growth rates of 2001–08 is no idle one, since with a shrinking and ageing population, and an external debt which stands at around 110% of GDP, sustainability in the medium term means finding a level of growth which can enable to country to pay down its debt and support its pension and health systems.<br /><br />And this will be no easy task, given that the early strong revenue flows from domestic consumption (VAT) have now fallen sharply and are unlikely to rebound as the country becomes increasingly export dependent for growth, and exports don't have VAT attached. Again, this isn't only a Bulgarian problem, but it is there as an issue.<br /><br /><br />Recent changes in pension system parameters and contribution rates have also put significant pressure on Bulgaria's pension finances. During the years 2003 to 2007 total revenue surged by about 51 percent and Bulgaria experienced the strongest rise in its revenue-to-GDP ratio among the new EU member states (about 4½ percent of GDP).<br /><br /><br />This sudden increase in income encouraged the Bulgarian authorities to offset part of the additional revenue by lowering social security contributions. Rates were cut by 6 percentage points from 2002 to 2007 (for the pension and unemployment funds) and there was a further 2.4 percentage points reduction in 2009.<br /><br /><br />As a result budget financing of the pension system has risen sharply during the recession. Before 2008 budget transfers to close the financing gap of the pension fund had averaged about 3 percent of GDP. This increased to about 5 percent of GDP in 2009 and for 2010 the budget anticipates a transfer of more than 6 percent of GDP. And if there is not a sharp rebound in domestic consumption (which in all probability there won't be) these shortfalls become structural, not cyclical, and solutions will need to be found.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTF-aAlrPcICIKweMenMW5ph5iSGOf-Dc9C3MMxP3c4tCEjzQPtYpiME-DI7UKYdN-e5JJDPMcFgUqQp3XTckG0Vnyv9WYKPGyQEstHhRQWOBFWpcAFuSJxCJtJv3NWQbXZDstSgkrC4mI/s1600/Bulgaria+Gross+Debt.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTF-aAlrPcICIKweMenMW5ph5iSGOf-Dc9C3MMxP3c4tCEjzQPtYpiME-DI7UKYdN-e5JJDPMcFgUqQp3XTckG0Vnyv9WYKPGyQEstHhRQWOBFWpcAFuSJxCJtJv3NWQbXZDstSgkrC4mI/s400/Bulgaria+Gross+Debt.png" alt="" id="BLOGGER_PHOTO_ID_5507565025554198850" border="0" /></a><br /><br /><br /><strong>Hoisted On Your Own Peg</strong><br /><br /><br />Apart from the obvious demographic impediments the country faces, there are other reasons to think that getting back to moderate sustainable growth may be more difficult that it initially appears. In the first place, Bulgaria operates a currency peg with the euro, yet during the boom years the country had very high inflation rates.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpMIBK2sP77iPY8iV3O2AbeOpJu_Dp_T3j1BXNTYyNhPrr-oU3IShe4pQ6VdcuU4DniQIk0bCxsIRnqVRXudcDIoWdPVacs4Eg_tRdRLWwHO1DG8T5bGAAdXXz7kWOy2D9499_Adv0Yc8Y/s1600/bulgaria+CPI.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpMIBK2sP77iPY8iV3O2AbeOpJu_Dp_T3j1BXNTYyNhPrr-oU3IShe4pQ6VdcuU4DniQIk0bCxsIRnqVRXudcDIoWdPVacs4Eg_tRdRLWwHO1DG8T5bGAAdXXz7kWOy2D9499_Adv0Yc8Y/s400/bulgaria+CPI.png" alt="" id="BLOGGER_PHOTO_ID_5507565946139067330" border="0" /></a><br /><br />As a result a sharp loss in competitiveness occured, a loss which, as the IMF point out, was not accompanied by any substantial corresponding productivity gain.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHlcxzdPE4A8qdin7u0RObJVVdvybFqgGdDDzX-ZDQCPP7gX_KTka-tgQZWqGVa66TripWnVyzC3CtErNn2NB1PHMfUV61mhsH8llLeiwGBNVLguqRTSvU9f6EfPNoOAFlmfB3HLWXWhVS/s1600/bulgaria+REER.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHlcxzdPE4A8qdin7u0RObJVVdvybFqgGdDDzX-ZDQCPP7gX_KTka-tgQZWqGVa66TripWnVyzC3CtErNn2NB1PHMfUV61mhsH8llLeiwGBNVLguqRTSvU9f6EfPNoOAFlmfB3HLWXWhVS/s400/bulgaria+REER.png" alt="" id="BLOGGER_PHOTO_ID_5507566350340773218" border="0" /></a><br /><br /><br />The other evident consequence of this loss of competitiveness was that the country developed a trade deficit, a deficit which though it has reduced following the collapse of imports still exists. In order to return to sustainable (export lead) growth, this deficit needs to become a surplus.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi82nxY483e-xmi1qhCPrij6NL6SNsXvbQSEH1Cl94z4NG1rEoSUYHNyieEjp7M6_5Gd9j3WNKpJdz5OJTmM1eoXpN2D1xAFnzsjxGTVFdto4nDhldiKZ1qFWQlXUXDs5hUNrp_2sOhzdDh/s1600/Bulgaria+Trade+Balance.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi82nxY483e-xmi1qhCPrij6NL6SNsXvbQSEH1Cl94z4NG1rEoSUYHNyieEjp7M6_5Gd9j3WNKpJdz5OJTmM1eoXpN2D1xAFnzsjxGTVFdto4nDhldiKZ1qFWQlXUXDs5hUNrp_2sOhzdDh/s400/Bulgaria+Trade+Balance.png" alt="" id="BLOGGER_PHOTO_ID_5507566895191566642" border="0" /></a><br /><br /><br />Growth during the boom years was driven by large capital inflows that fueled strong growth in the non-tradable sector. As future capital inflows are likely to remain at a level well below that of the boom years, with growth in the non-tradable sector remaining weak at best, future growth will only be rebound if the tradable sector takes over as an engine of growth. And with lower investment, the robust employment growth the country saw during the years 2001–08 will be difficult to reproduce. Much of the strong employment growth was driven by strong growth in the non-tradable sector. Total employment rose by 20 percent during this period, and three quarters of this came from the construction, real estate, wholesales and financial service sectors.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjybnwrcHmKh2f6wWUoV5nocVQQ9_xCJW7tFJaIYdkNBCCbpiEfbFHk9W0N2MveFnxC3xKmznhEJw4UM_CYWgibBaHbxx8qJnukgdgaHDhAyrznXm40aXy6JCyb75Yc47EHIXlh9n7YT8xQ/s1600/Bulgaria+total+employment+YoY.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 206px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjybnwrcHmKh2f6wWUoV5nocVQQ9_xCJW7tFJaIYdkNBCCbpiEfbFHk9W0N2MveFnxC3xKmznhEJw4UM_CYWgibBaHbxx8qJnukgdgaHDhAyrznXm40aXy6JCyb75Yc47EHIXlh9n7YT8xQ/s400/Bulgaria+total+employment+YoY.png" alt="" id="BLOGGER_PHOTO_ID_5507567586600289250" border="0" /></a><br /><br /><br />So the country (like so many others in the East and South of Europe) must now make a major shift from non-tradeables to tradeables, and this in the context of a currency peg (and a significant level of external indebtedness) is not going to be an easy task.<br /><br /><br /><b>Signs of Recovery?</b><br /><br /><br />Bulgaria does not publish seasonally adjusted quarter-on-quarter growth numbers, but given that the economy only shrank by 1.5% year-on-year (according to the flash estimate published by the statistics office on August 13), which was the lowest figure recorded since the country entered a recession in the first quarter of 2009 (and down from an annual drop of 5.9% in Q4 2009), the economy does at least seem to have stabilised.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjlix8xlzO5rjYb0_OnefMzNX3tzb87knm87Zt9pDe6hUSdsculQZx4DkelVtLqMD8H4BWC_sHeZemT_Ts5qJ89NMVGWuo45a4zuJl3RxacR021siSxaXsKDYoOhpHc8xPq6_KDWi1iRXXK/s1600/bulgaria+GDP.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjlix8xlzO5rjYb0_OnefMzNX3tzb87knm87Zt9pDe6hUSdsculQZx4DkelVtLqMD8H4BWC_sHeZemT_Ts5qJ89NMVGWuo45a4zuJl3RxacR021siSxaXsKDYoOhpHc8xPq6_KDWi1iRXXK/s400/bulgaria+GDP.png" alt="" id="BLOGGER_PHOTO_ID_5507569623391513378" border="0" /></a><br /><br /><br />As for the details agriculture contributed to the improvement, with an increase of 1.6 per cent year-on-year, while the services and industrial sectors only declined by 1.7 per cent and 0.3 per cent, respectively. Private consumption, which was one of the main drivers of economic growth in earlier years, was down an annual 7.6 per cent for the quarter, while investment was 1.4 per cent lower. So there has been no real improvement in private consumption, nor should we expect to see any in the near term.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGWnRSIMXEtkcXopgNRejCJowKwtN6TfhoI8VHe1JOgqcCWxez7f5HDzkcgIM6mgONx-4jYf4GEKxF6eN471nsp0cuBqd5vF9c0_j9olKieaKlHwhJlJp5rDpwEnHAQfyiAAV1j7xZUiXX/s1600/Bulgaria+Private+Consumption.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 206px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjGWnRSIMXEtkcXopgNRejCJowKwtN6TfhoI8VHe1JOgqcCWxez7f5HDzkcgIM6mgONx-4jYf4GEKxF6eN471nsp0cuBqd5vF9c0_j9olKieaKlHwhJlJp5rDpwEnHAQfyiAAV1j7xZUiXX/s400/Bulgaria+Private+Consumption.png" alt="" id="BLOGGER_PHOTO_ID_5507570799482815522" border="0" /></a><br /><br /><br />Retail sales seem set on a long steady downward path (similar to that seen in other countries in the region with declining populations) and again, this is unlikely to turn around in any sustained way.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqO_Z_Ctsh9tH-BVhRUlavaOfnXLP7Rf7uipDzU-OpUOei0CUR01TlSJvhGWY6kyoymw5hqAQr_gT0oTis4nEtem3pi8-6lw7r3LgfsLSHHA3Jgk0pj-JHdGokQx9xBlm7w1iSMhchesTP/s1600/bulgaria+retail+two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqO_Z_Ctsh9tH-BVhRUlavaOfnXLP7Rf7uipDzU-OpUOei0CUR01TlSJvhGWY6kyoymw5hqAQr_gT0oTis4nEtem3pi8-6lw7r3LgfsLSHHA3Jgk0pj-JHdGokQx9xBlm7w1iSMhchesTP/s400/bulgaria+retail+two.png" alt="" id="BLOGGER_PHOTO_ID_5507571152592441474" border="0" /></a><br /><br />Domestic demand is likely to remain flat to downwards for some considerable time, as the numbers for household and corporate borrowing (which are not moving upwards at all) tend to confirm.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif6xFjpHYCxAhfwzCAp2hLBAgOmGPltg4o3Eu5J3GviIXQYlvhcpOBu2go_M973FU11z-L2CVqDLGS_Who3CtrmFaHyDv3v4gqtaHhcbyYHfDg9nYFKJDbLU1i2y-i_f5ulgQXSaOkimGp/s1600/Bulgaria+Household+Borrowing.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEif6xFjpHYCxAhfwzCAp2hLBAgOmGPltg4o3Eu5J3GviIXQYlvhcpOBu2go_M973FU11z-L2CVqDLGS_Who3CtrmFaHyDv3v4gqtaHhcbyYHfDg9nYFKJDbLU1i2y-i_f5ulgQXSaOkimGp/s400/Bulgaria+Household+Borrowing.png" alt="" id="BLOGGER_PHOTO_ID_5507581360846056850" border="0" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiytXa0grpDsPUr-6mRkVPzHEL59q8G4wAyKlvsTReOb6O0TTMuv-4v9Ant9PyIZa0aqZxHaBU1v6kJZhOxnffivPTz_AB4g-qHyK5D1LoPe0Gst42B3XqQ7Ho3_73hliusE2DIty2tbI7s/s1600/Bulgaria+Corporate+Borrowing.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiytXa0grpDsPUr-6mRkVPzHEL59q8G4wAyKlvsTReOb6O0TTMuv-4v9Ant9PyIZa0aqZxHaBU1v6kJZhOxnffivPTz_AB4g-qHyK5D1LoPe0Gst42B3XqQ7Ho3_73hliusE2DIty2tbI7s/s400/Bulgaria+Corporate+Borrowing.png" alt="" id="BLOGGER_PHOTO_ID_5507581255628394226" border="0" /></a><br /><br /><br />Despite an increase in exports (up 11.4% on the year) and continued decline of imports (down 1.2%), the trade gap for the second quarter was expected to be 4.2 per cent of GDP.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaFhGszjbSEzUuKATDbUulAPspDWcz4917Hn7vXX1rmDUsF7l7B7iMJ00r47UXHGsjL9P3tjor7ajHJFS80i4qDv0CGm-Fs9Y4P4ouOVW3dLOjD8rSAblyzB1MoHi8X-1ex9NWF5isNCL-/s1600/Bulgaria+Exports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaFhGszjbSEzUuKATDbUulAPspDWcz4917Hn7vXX1rmDUsF7l7B7iMJ00r47UXHGsjL9P3tjor7ajHJFS80i4qDv0CGm-Fs9Y4P4ouOVW3dLOjD8rSAblyzB1MoHi8X-1ex9NWF5isNCL-/s400/Bulgaria+Exports.png" alt="" id="BLOGGER_PHOTO_ID_5507572837740551506" border="0" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBEPEB1ao_AuxUH5lKDXoEmoM3ad11rd-e5P7gN-xbVJ8wJRx0W1HxlCkReH0FbtCCjAIZMRebzgLuCr6PJUF-dXkqqRbjAetTye8jBPnIVP7FfjQog2qyNn6GFxTWzrvWLEkzLgNmpKSi/s1600/Bulgaria+Imports.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBEPEB1ao_AuxUH5lKDXoEmoM3ad11rd-e5P7gN-xbVJ8wJRx0W1HxlCkReH0FbtCCjAIZMRebzgLuCr6PJUF-dXkqqRbjAetTye8jBPnIVP7FfjQog2qyNn6GFxTWzrvWLEkzLgNmpKSi/s400/Bulgaria+Imports.png" alt="" id="BLOGGER_PHOTO_ID_5507573043798577362" border="0" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2uQyrrDLZaoMLxPzI8_HQoiGyK3Pe0KWq53tl8FsoAFIalIn1-pS2BHdtNRmPRBOAqiH5975WuY_K_2iry0kxCrXsfQ6M2ozkq9OvtFbImcG6pV-1A1ikw8WzPPx0QCrnFxvxg0Ca5UTk/s1600/Bulgaria+IP+two.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2uQyrrDLZaoMLxPzI8_HQoiGyK3Pe0KWq53tl8FsoAFIalIn1-pS2BHdtNRmPRBOAqiH5975WuY_K_2iry0kxCrXsfQ6M2ozkq9OvtFbImcG6pV-1A1ikw8WzPPx0QCrnFxvxg0Ca5UTk/s400/Bulgaria+IP+two.png" alt="" id="BLOGGER_PHOTO_ID_5507573196556782882" border="0" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgNl9iai1l_qH8FZW41odv1BUG3hi0guWZztCYFaFoOhRDksgC-KLNgHUXuhCHnDDnV5a7xClpuYdLdMLlfOTjXCgDwVyCD_npwLMVF34btwx2b6J-7SqVGbB-CD3IX_Qo9h7DmfduP3YFI/s1600/bulgaria+construction.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgNl9iai1l_qH8FZW41odv1BUG3hi0guWZztCYFaFoOhRDksgC-KLNgHUXuhCHnDDnV5a7xClpuYdLdMLlfOTjXCgDwVyCD_npwLMVF34btwx2b6J-7SqVGbB-CD3IX_Qo9h7DmfduP3YFI/s400/bulgaria+construction.png" alt="" id="BLOGGER_PHOTO_ID_5507573332709406706" border="0" /></a><br /><br /><br /><span style="font-weight: bold;">Long Term Growth Trend Headed Way Down</span><br /><br /><br />As the IMF stress, potential growth in Bulgaria is surely set to decline further in the longer term, since as I keep saying Bulgaria faces a serious ageing population problem. The median age is now through the critical 40 barrier, and headed on up towards the 45 range, in a country where male life expectancy is some 10 years below the West European average.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEis5mXZhemj4JNowoTWIRERqjI5SxS9-fEMps0MJ6eBGU7ZsfXBHjlDt22MHO9XNtoCz1WpNmsQXi_yHFPql682PkUvW_dJ6J4McO5lV10epZAmzeX2Y_mksJLRV03YbN5_4GnVi3nEVFFu/s1600/Bulgaria+Median+Age.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 230px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEis5mXZhemj4JNowoTWIRERqjI5SxS9-fEMps0MJ6eBGU7ZsfXBHjlDt22MHO9XNtoCz1WpNmsQXi_yHFPql682PkUvW_dJ6J4McO5lV10epZAmzeX2Y_mksJLRV03YbN5_4GnVi3nEVFFu/s400/Bulgaria+Median+Age.png" alt="" id="BLOGGER_PHOTO_ID_5507574164342092578" border="0" /></a><br /><br /><br />Bulgaria's population has been falling for a decade now, and is projected to decline by a further 28 percent between 2008 and 2060, while the old age dependency ratio would exceed 60 percent in 2060.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmKY03TLwEsy1z1GC7CVBLLL9bcWns4BLnMFORSlsBd1Mv25CJhvVRbHEYDaiNXtSBBZCi01xoMjYIz_ui-LmqBG5L-lA8lxVgg5LPdbrQggkos6SF-zylb27rBpy4i6gB7RqeVm2RDRAQ/s1600/bulgaria+population.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 259px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmKY03TLwEsy1z1GC7CVBLLL9bcWns4BLnMFORSlsBd1Mv25CJhvVRbHEYDaiNXtSBBZCi01xoMjYIz_ui-LmqBG5L-lA8lxVgg5LPdbrQggkos6SF-zylb27rBpy4i6gB7RqeVm2RDRAQ/s400/bulgaria+population.png" alt="" id="BLOGGER_PHOTO_ID_5507574594568385922" border="0" /></a><br /><br /><br />This population drop is already affecting the working age population, which is already in decline, and is forecast to fall by an additional 25 percent over the next 50 years.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi5F6_qJ7TtvO04nYmVpTuchfSWHFn8uW2BvRwwxYVBeoVDWPxOVYHHSHH8v0tMbSCW-aTsXpgCbIH1dBi2_pWTn_nTJvXHA1QyIF5XBSo_anpR6A8dyDgUdFqV2gU47ByGTU2AIw_2-ccV/s1600/Bulgaria+Working+Age+Population.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 207px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi5F6_qJ7TtvO04nYmVpTuchfSWHFn8uW2BvRwwxYVBeoVDWPxOVYHHSHH8v0tMbSCW-aTsXpgCbIH1dBi2_pWTn_nTJvXHA1QyIF5XBSo_anpR6A8dyDgUdFqV2gU47ByGTU2AIw_2-ccV/s400/Bulgaria+Working+Age+Population.png" alt="" id="BLOGGER_PHOTO_ID_5507575341051262722" border="0" /></a><br /><br /><br />As a result, the EU 2009–12 Convergence Programme is forecasting a steady decline in potential growth to an annual 0.3 percent in 2050, and this meagre growth is only obtained by assuming a - totally unrealistic (in what will then be such an old population) - labour participation rate of 70 percent. Personally, I think these numbers are way, way to optimistic, and all of this is badly in need of a current calibration based on what is already happening in ageing societies like Germany and Japan. Bulgaria's sustainable growth rate doesn't start to get affected in 2050, it is already on its way down now.<br /><br /><br />And Bulgaria has another handicap: the large number of Bulgarians who now live and work abroad. The worrying thing is that we don't know how many such workers there are, since the migration data from Bulgarian statistics hardly acknowledges they exist (same situation in Latvia, see this study), using the argument that only those who officially inform them they are emigrating count as migrants.<br /><br />So how do we know they exist? We know they exist because these migrants send home remitances, and the World Bank attempts to track them. According to World Bank data (and my calculations), migrants sent home remittances to the order of an estimated 5.3% of GDP in 2009. Not small beer this at all. And we also know from the national data of resident foreigners in other countries that large numbers of Bulgarians habitually live and work away from their homeland. According to the Spanish INE, there were some 170,000 Bulgarians registered as living in Spain on 1 January 2010, and the Italian Statistics Office (ISTAT) report 41,000 Bulgarians resident in Italy in 2008.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgN-35tefTLKuAbX9FS0rRJlrSzfqXgxLLFG17DaeV1w899vzdKbkKqonAMOwB-DIe-RCTRdrKSOLMUA-7s92zSutgJp5BHiARdegEbWqP7ubXBupH1pQPYgjC9VJ3QIMQRFZ2fp1zQQITv/s1600/Bulgaria+Remmitances.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 233px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgN-35tefTLKuAbX9FS0rRJlrSzfqXgxLLFG17DaeV1w899vzdKbkKqonAMOwB-DIe-RCTRdrKSOLMUA-7s92zSutgJp5BHiARdegEbWqP7ubXBupH1pQPYgjC9VJ3QIMQRFZ2fp1zQQITv/s400/Bulgaria+Remmitances.png" alt="" id="BLOGGER_PHOTO_ID_5507577319987170130" border="0" /></a><br /><br /><br />But what, you may ask is a country with rising external debt (the IMF is assuming the CA deficit continues to 2015, at least)and falling and ageing population doing exporting its workforce? A good question. And why is no one seemingly concerned about this issue? Another good question. And why are neither the EU Commission and the IMF raising the problem in their respective studies of the country. Oh, there are no shortage of questions here.<br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6wchmPBpBFFTYZ6wpdRwBHZDFIZ05u3_ZH0_iQa_VXSMD9Q0yoNEEmt3RjMZVWTEmKKAuX8sSG0y4aUVQsNfkIpMjiCQlTfwWKUTvM2OAnssDSMFacGokIwAdHbiPpGj1TeGO1sT9nB3i/s1600/Bulgaria+Current+Account.png"><img style="display: block; margin: 0px auto 10px; text-align: center; cursor: pointer; width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6wchmPBpBFFTYZ6wpdRwBHZDFIZ05u3_ZH0_iQa_VXSMD9Q0yoNEEmt3RjMZVWTEmKKAuX8sSG0y4aUVQsNfkIpMjiCQlTfwWKUTvM2OAnssDSMFacGokIwAdHbiPpGj1TeGO1sT9nB3i/s400/Bulgaria+Current+Account.png" alt="" id="BLOGGER_PHOTO_ID_5507579018503891954" border="0" /></a><br /><br /><br />So, Bulgaria as a country is certainly not short of problems. What with the evident demographic ones, and the limitations of the currency peg, it is hard to see how they are easily soluable. To put it bluntly, Bulgarian industry only accounts for some 18% of GDP (in value added terms). If we assume as a rule of thumb that about 50% is geared to the domestic market, then this means that Bulgarian GDP is going to have to leverage itself forward through growth in about 10% of its output, while other sections shrink. A difficult, if not impossible task.<br /><br /><br />And there are more problems. As the IMF point out, Bulgaria's fiscal situation is challenging, since the earlier revenue boom has come to an end, while expenditure pressures are considerable. The pre-crisis revenue boom, was fuelled by higher receipts on goods and services on the back of Bulgaria's rapid domestic demand growth, but returning to pre-crisis revenue levels will be a major challenge, not only because the economy is expected to recover slowly but also because the growth pattern will need to shift, with less contribution from domestic demand and more contribution from the external sector, which will result in lower tax revenues. Put simply, since Bulgaria's treasury is stongly dependent on VAT, and exports evidently don't attract VAT, the situation becomes even more difficult.<br /><br /><br />Of course, in the short term the government debt to GDP ratio is pretty low (15% only in 2009), but any faltering in the peg at some point, and that could change quickly. So the risks are there, and difficult spending decisions will have to be taken, since, as the IMF point out "Sustaining the built-up public buffers is important because private sector vulnerabilities remain considerable. Private sector external debt stood at 102.7 percent of GDP at end-2009, while gross foreign currency debt of the non-financial private sector amounts to 80 percent of GDP". Put another way, Bulgaria doesn't have a public debt problem, but it does have a private debt problem. And neither of the options which faces the country is very appetising: sustaining the peg would seem to condemn the country to years of deflation and low growth, while letting it go would expose the public balance sheet to all the problems which have been accumulated in the private sector in recent years. They are caught, as we say here in Spain, between "la espada y la pared".Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-20649707077433700282010-07-14T21:14:00.000+02:002010-07-14T21:15:33.951+02:00Biting The Fiscal Bullet In PolandThere is a <a href="http://www.bloomberg.com/news/2010-07-12/poland-s-budget-draft-may-not-make-progress-toward-eu-budget-deficit-goal.html">good deal of speculation in the press at the moment</a> over the tricky issue of whether or not Poland will be able to comply with its agreed deficit-reduction deadline on the basis of the latest budget proposals announced by the government there. Personally, I tend to agree with those analysts who feel the spending and revenue assumptions being made by the Polish government are rather unrealistic, and that they will this be unable to comply with the terms of the Excess Deficit Procedure as laid down for them by the European Commission: difficult territory this in the "post Greek crisis" world, but it would not be the end of the world were the slippage to be justified. Unfortunately, as I will argue below, I don't think it is justified, indeed I think it is just the opposite of what sound economic management principles would prescribe in the Polish case, and seems to respond more to the impact of impending political pressures than to the precepts of good policymaking. So I do agree with the consensus here in feeling that Poland needs to do a lot more to reign in the deficit (which means unfortunately spending cuts, since I think raising taxes which will crimp growth and raise inflation is most undesirable at this point), although my reasons for arguing this are actually rather rather different from those that are normally advanced.<div><br /></div><div><b>One Fiscal Size Fits All?</b><br /><br />The facts of the matter are, more or less, as follows: the European Commission has given Poland until 2012 to meet its deficit limit of 3 percent of gross domestic product, after Poland’s shortfall swelled to 7.1 percent of GDP last year as the impact of the global economic crisis depleted government revenue and increased expenditure costs. Next year’s budget assumes something like 3.5% GDP growth and 2.3% inflation, with nominal wage growth rising by 3.7% employment increase by 1.9%.<br /><br /><br />The EU Commission expect the deficit to only narrow to 7 percent of GDP next year following a 7.3 percent budget gap in 2010. But given that Poland's debt to GDP level is only around 50% of GDP, and that Poland is one of the few large EU countries to still have dynamic internal consumption, you might want to argue that stimulus should be maintained, if only to help Poland's export dependent neighbours.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6YqMIOWAb1DHoUkynWDzzvreLVlu34maeSFdpu0dET6U0qecuUkNflb5g9duJVB6CHlRtDHvFgN2GNH2MUxe_tYZ8LhtsuSxM3yLL2STr-khyphenhyphent0A8OzbnVJdoI073Yy8LwvUmxvQVIn0/s1600/Private+Consumption.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6YqMIOWAb1DHoUkynWDzzvreLVlu34maeSFdpu0dET6U0qecuUkNflb5g9duJVB6CHlRtDHvFgN2GNH2MUxe_tYZ8LhtsuSxM3yLL2STr-khyphenhyphent0A8OzbnVJdoI073Yy8LwvUmxvQVIn0/s400/Private+Consumption.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493744342029970818" /></a><br /><br />I want to argue that this view is basically wrong, and that far from needing more in the way of stimulus, what Poland needs to do is contain an overdramatic expansion of credit based domestic demand, an expansion which, if unchecked, could very easily lead to the sort of structural distortions and competitiveness loss we have just observed in the South of Europe and Ireland.</div><div><br /></div><div><br /></div><div><b>Poland Largely Escaped The Great Recession</b><br /><br />But first, lets step back a bit and see what the problem is.<br /><br />Poland, as most observers note, escaped the worst of the 2009 great recession.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBCcMjFKd7D6vZ_SqcBdbd01LRl_8r-e1ep1E_WK1v9WT0y0NhQXLbmfSGBKqs4QlXgOBEvCwjo1uMw7YpjoEqyQd6Dppidy0D28-sIgDSa_wcYtq8JvP5iOGTz2gDm76rPHXsvzvAVt0/s1600/Poland+YoY+GDP.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 204px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBCcMjFKd7D6vZ_SqcBdbd01LRl_8r-e1ep1E_WK1v9WT0y0NhQXLbmfSGBKqs4QlXgOBEvCwjo1uMw7YpjoEqyQd6Dppidy0D28-sIgDSa_wcYtq8JvP5iOGTz2gDm76rPHXsvzvAVt0/s400/Poland+YoY+GDP.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493745632237955746" /></a><br /><br />Poland was basically able to endure without too much bloodletting for three principal reasons.<br /><br />In the first place the level of household indebtedness is still not excessively high. In the second place Poland had maintained a floating exchange rate which meant that it could let the zloty rise during the heady days of 2008, and then allow the currency to devalue when the crisis hit. An thirdly, the level of Forex lending never rose as high in Poland as it did in some of its East European neighbours, which meant that when the time came to devalue there was not such a threat of increasing the Non Performing Loan rate. As can be seen in the chart, it was starting to take off when the credit crunch came along and (fortuitously) stopped it dead in its tracks.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgk8vtKbFF7zpYrUmHNSm8Egd2Nv43tpKIbVFnO2MdAz0aaXsNwMQ4vYO8xWPIQ_V8ib2LzeRt4yWw43g8OqJQrYyVJb_jbtkT5QAs1fJeOsWsKcDiSUnzcRutYQFFfaushznMcjb_fC_E/s1600/Mortgage+Lending+Total+and+Forex.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 219px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgk8vtKbFF7zpYrUmHNSm8Egd2Nv43tpKIbVFnO2MdAz0aaXsNwMQ4vYO8xWPIQ_V8ib2LzeRt4yWw43g8OqJQrYyVJb_jbtkT5QAs1fJeOsWsKcDiSUnzcRutYQFFfaushznMcjb_fC_E/s400/Mortgage+Lending+Total+and+Forex.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493774520395473330" /></a><br />Interestingly enough then, it has been the very fact of not having gone for early Euro adoption that left the Polish monetary authorities with the flexibility needed to respond to the crisis in an appropriate manner. As <a href="http://www.imf.org/external/pubs/ft/scr/2010/cr10118.pdf">the IMF put it in their latest Article IV staff report</a>:<br /><br /><blockquote>"Staff does not support early euro adoption. While this should remain an important goal, entering ERM2 any time soon would not be advisable in view of the uncertain global outlook and the rigidities in the macroeconomic policy mix discussed above. More importantly, the crisis has underscored the importance of being able to use the exchange rate to facilitate adjustment to external shocks. In staff’s view, the swift change in the real exchange rate was one of the key reasons for Poland’s not falling into recession in 2009".</blockquote><br /><br />Indeed, the very rapid way that using currency flexibility to resore competitivenes helped should be evident from the Real Effective Exchange Rate chart below:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZSHt5N45b3fIB4yKGp03GmUyeEUDpuwa3zfBb-myIpx26zwHix76GkeQAQgxGpYGzPzptRy15-I6wvURO25PegUSEkD2BrS2IxKSQnCwaZ0miPsCIacRhDFPJlLyvN3JuEzyQfmWZb8E/s1600/REER.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 214px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZSHt5N45b3fIB4yKGp03GmUyeEUDpuwa3zfBb-myIpx26zwHix76GkeQAQgxGpYGzPzptRy15-I6wvURO25PegUSEkD2BrS2IxKSQnCwaZ0miPsCIacRhDFPJlLyvN3JuEzyQfmWZb8E/s400/REER.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493747677838115458" /></a><br /><br />As can be seen in the run in to the crisis Poland had been losing competitiveness with Germany, following a well known and well trodden path. But in 2009 the country was able to recover much of the lost ground, simply at the push of a (trader's) button - and the currency is now trading at something like 18% below its pre-crisis peak in real effective terms. This remedy is, unfortunately, no longer available to the likes of Spain, Greece, Portugal and Ireland. Even more interestingly, Poland has been able to carry through the devaluation process without provoking a very strong inflation spike.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpuhqC_sIY-V0DJqvYZ3nEWJ_NncEdQdNxJEXV9C5aA8cBL3LyJARlxro01A4CHohvuRMExEfbv-tY_DAMeksb9M5zwsrTPFjAhHd8CAB0CuoLgazERNDvxokYjnZbp758gUeCrpNltxg/s1600/CPI.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 186px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhpuhqC_sIY-V0DJqvYZ3nEWJ_NncEdQdNxJEXV9C5aA8cBL3LyJARlxro01A4CHohvuRMExEfbv-tY_DAMeksb9M5zwsrTPFjAhHd8CAB0CuoLgazERNDvxokYjnZbp758gUeCrpNltxg/s400/CPI.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493749118351955010" /></a><br /><br />Of course, there was another factor in Poland's ability to not fall from grace, the fiscal stimulus package. As the IMF put it:<br /><br /><blockquote>Fiscal policy is providing significant counter-cyclical stimulus. There was a discretionary fiscal relaxation estimated at 1¾ percent of GDP in 2008 and 2½ percent of GDP in 2009, mainly due to tax cuts enacted in 2007 but coming into effect with a delay. While the government initially intended to offset revenue shortfalls to the extent needed to maintain the state budget deficit below the limit of Zloty 18 billion in 2009—through what would have been highly pro-cyclical expenditure cuts—it appropriately changed such plans at mid-year, when it raised the limit to Zloty 27 billion. As a result, the general government deficit increased from under 2 percent of GDP in 2007 to over 7 percent of GDP in 2009. The strong counter-cyclical stimulus provided by fiscal policy—through a combination of discretionary relaxation and the work of automatic stabilizers—was a major reason for Poland’s not falling into recession during the global crisis.</blockquote><br /><br />And it is, of course, the issue of just how to withdraw this fiscal stimulus that is the main topic of debate. Unlike many of its regional neighbours, the Polish economy is now in the process of returning to reasonable levels of growth. The levels will surely not be those (possibly unsustainable) ones seen before the crisis, but rates in the order of 3% for 2010 & 2011 do not seem unreasonable.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhQ3HU4kUWFpGMO54r9i3hcvpWmF8vCf0e8S95IIhBUfAAV9A99-1prXfM1IPogaJpd-njaUxf8zCaKtD1ev4rGzO2HwJd99Q9dLGlbM3VkNgwANtd_loyBD3ke5vb_RD9QLT-Wr9wD9A/s1600/GDP+annual.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhQ3HU4kUWFpGMO54r9i3hcvpWmF8vCf0e8S95IIhBUfAAV9A99-1prXfM1IPogaJpd-njaUxf8zCaKtD1ev4rGzO2HwJd99Q9dLGlbM3VkNgwANtd_loyBD3ke5vb_RD9QLT-Wr9wD9A/s400/GDP+annual.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493752810984318002" /></a><br /><b>Monetary Policy In Times Of The Great Immoderation</b></div><div><br />The problem is, as the output gap gradually closes, the central bank will increasingly have to think how to formulate a response to the inflationary presures which will inevitably follow in the wake. Evidently, in a era of globalised capital flows, conducting monetary policy is not as simple as it used to be, since simply raising interest rates may prove to be counterproductive, and investors look to get the benefit of the increased yield margin on offer. </div><div><br />In fact, the IMF draw exactly the opposite conclusion, namely that if upward pressures on the zloty persist (see chart below), and inflation remains contained, then they argue that the policy rate should be cut. That is they prioritize (correctly in my view) competitiveness issues over the conduct of orthodox monetary policy.<br /><br /><blockquote>The recovery in global risk appetite, not least in the demand for assets of countries that have weathered the crisis well, suggest that foreign demand for Polish assets could continue to build, resulting in further zloty appreciation. In that case, staff believes that the MPC should revert to an easing bias and cut the policy rate.</blockquote><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgycXwiyHJ45XgXlv1STOGSLA3i8H9RhUKM3eD-nCAqtMcZqVDBpM5fb6uwKE8R1ZjyV53yHWKtujMoeWQXuq5tT1Ox3FenaViok6RPDxI4r7MRS7Bj3RJ9tlzk5xRCHOZrYnY76jwCHCg/s1600/zloty.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 225px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgycXwiyHJ45XgXlv1STOGSLA3i8H9RhUKM3eD-nCAqtMcZqVDBpM5fb6uwKE8R1ZjyV53yHWKtujMoeWQXuq5tT1Ox3FenaViok6RPDxI4r7MRS7Bj3RJ9tlzk5xRCHOZrYnY76jwCHCg/s400/zloty.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493748366478466626" /></a><br /><br />In fact with the central banks policy rate at 3.5% there is room for some easing, and room for increased carry too, if the rate stays were it is as risk appetite grows.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0qYbgi8M6L7W7Nf22r3DJ3u-YyTRSOgo-l6xXD8quJLe12OvFjQ55AxgVdIWlvrWgHQJJZWy94OwE8c1INZCAciIbSpxZIgfM6n_n48XHJ5ely_kA_TgdYd5MxQYT_qIUH08XkCTyTs4/s1600/interest+rates.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 246px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0qYbgi8M6L7W7Nf22r3DJ3u-YyTRSOgo-l6xXD8quJLe12OvFjQ55AxgVdIWlvrWgHQJJZWy94OwE8c1INZCAciIbSpxZIgfM6n_n48XHJ5ely_kA_TgdYd5MxQYT_qIUH08XkCTyTs4/s400/interest+rates.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493763273824454322" /></a><br /><b>The Fiscal Arm Is The Only Effective One</b><br /><br /></div><div><br /></div><div>And this is where the real argument for turning the fiscal screw comes in, not in order to simply comply with the EU's 60% gross debt rule (Poland's government debt to GDP is currently around 50%), but rather because in the absence of applying monetary tightening to contain excesses and avoid (further distortions) the government really do need to drain excess demand from the economy by resorting to fiscal policy.<br /><br />As I have said, the Polish economy is now showing signs of a renewed burst of growth. Industrial output is up sharply (it is now more competitive with imports, among other things):<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgL7kn5YSvKNU-olMIUgPe8c4YWS3k_nXVxigbVauZ_57lEJWBjd2yFsVdWNuEGQyp4vwxV6D5iLYNSRU83GWwdZoh8XR2SYhprANQoBNVr2RsU3HfZ3X3MR9M76cV_eIlzOK6uKem-jZE/s1600/industrial+output.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 205px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgL7kn5YSvKNU-olMIUgPe8c4YWS3k_nXVxigbVauZ_57lEJWBjd2yFsVdWNuEGQyp4vwxV6D5iLYNSRU83GWwdZoh8XR2SYhprANQoBNVr2RsU3HfZ3X3MR9M76cV_eIlzOK6uKem-jZE/s400/industrial+output.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493762234581607762" /></a><br /><br />While retail sales are also strong<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYea7qabPX5mEQY3dHWyF4MwpQ8smurzaEtXJEnXNMSMdIdoUukg5d_AQNSvaJRUG6K5hw8pV3mJB0AZcFddykdyWQ0uUWpwnA-akIHgJg2KGlPVhT4e4g35MM15QBtFy65_byp8iJtrU/s1600/retail+sales.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYea7qabPX5mEQY3dHWyF4MwpQ8smurzaEtXJEnXNMSMdIdoUukg5d_AQNSvaJRUG6K5hw8pV3mJB0AZcFddykdyWQ0uUWpwnA-akIHgJg2KGlPVhT4e4g35MM15QBtFy65_byp8iJtrU/s400/retail+sales.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493762465322920722" /></a><br /><br />And credit growth has once more taken off again:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyrFh1eeogYnPAS1N930VvwXhapu0QlfDY61V3Fb7qrEyjHIBbiC5s4xwWdL0ri9B7NVOObTULvUCRvepOtmW5tTejZ3diOmpw2d2ph-W4qKvi_uTxgDARGEcWgX6Vo0m8HNdwhHWO28c/s1600/Total+Household+Credit.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 217px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyrFh1eeogYnPAS1N930VvwXhapu0QlfDY61V3Fb7qrEyjHIBbiC5s4xwWdL0ri9B7NVOObTULvUCRvepOtmW5tTejZ3diOmpw2d2ph-W4qKvi_uTxgDARGEcWgX6Vo0m8HNdwhHWO28c/s400/Total+Household+Credit.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493762665444333906" /></a><br /><br />If this were to remain modest, then it would be a good sign, but continued growth, and monetary loosening, would surely run the risk of seeing the acceleration go too far. And as if to warn us, construction activity has just seen a strong lurch upwards:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8w9tTQHkk3VPyEB2jhHe_as97wvptHcDbtbek8FqN4GBSSpogk8_EdagvqX2fX2lJE2lIjRIyOup3aoWff97eeGkBbW9fuwe3bV362Eiudnpu2gqLQClUvL1FpIRXVhw1gdVHFivmeNY/s1600/construction.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 203px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8w9tTQHkk3VPyEB2jhHe_as97wvptHcDbtbek8FqN4GBSSpogk8_EdagvqX2fX2lJE2lIjRIyOup3aoWff97eeGkBbW9fuwe3bV362Eiudnpu2gqLQClUvL1FpIRXVhw1gdVHFivmeNY/s400/construction.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493763148368145506" /></a><br /><br />Faced with the danger of all of this getting out of hand the authorities can basically do two things. They can tighten loan conditions for the banking sector, by making the deposits required greater (or the Loan to Value ratios lower), and the income criteria stricter, and starting to move people over from variable to fixed interest mortgage rates on the one hand, and by implementing stricter fiscal measures on the other. Some say this will be difficult for Poland in a pre-election period, but are Polish voters really that unaware of what has been happening in other EU countries in recent years that they would willingly go for a bit of extra consumption now at the price of being another Spain five years on down the road?</div><div><br /></div><div><b>Once More Those Structural Economic Distortions</b><br /><br />Despite, all that improvement in competitiveness Poland is still running a trade deficit:<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhIkgh2STs5-R1r_vXPBoSqueahezmjIhFK7XJhflxTXc9i3Q3rQkMd2T_eqDgdiGhLYbffFjdHMofm3svSvngSxJcLaZp2l2ZFxnSx8e-JTx6WrRZZLBRw8lwojNzhiBXWo1KJTkpe3kA/s1600/trade+deficit.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhIkgh2STs5-R1r_vXPBoSqueahezmjIhFK7XJhflxTXc9i3Q3rQkMd2T_eqDgdiGhLYbffFjdHMofm3svSvngSxJcLaZp2l2ZFxnSx8e-JTx6WrRZZLBRw8lwojNzhiBXWo1KJTkpe3kA/s400/trade+deficit.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493765222827561890" /></a><br /></div><div>And it has been running a current account one for more years than anyone cares to remember.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgk8t5TVSVC3Jla2hD0_JM-zfOp3GG5_nZe4XwhqBE8OeUPtBLSLWDSOKn0On9L0OZ50llFkN3obBjhlAp46M4Yb_c6ghxY4yE80cNzemCbL97qMzkqXI9WtLmOnBlp78U-uMfHTTIcJ74/s1600/CA+deficit.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgk8t5TVSVC3Jla2hD0_JM-zfOp3GG5_nZe4XwhqBE8OeUPtBLSLWDSOKn0On9L0OZ50llFkN3obBjhlAp46M4Yb_c6ghxY4yE80cNzemCbL97qMzkqXI9WtLmOnBlp78U-uMfHTTIcJ74/s400/CA+deficit.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493766109371035266" /></a><br /><br />Maybe the deficit has not been large by prior regional standards, but who really wants to go where others have gone before. And with each new deficit the level of external indebtedness simply grows, and is now reaching the 60% of GDP mark. By no means critical yet, but surely it would be more interesting to turn south before it does go critical. And in any event, the presence of the external debt makes the Polish economy unduly dependent on external financial flows, a point highlighted recently when the <a href="http://www.imf.org/external/np/sec/pr/2010/pr10276.htm">IMF announced</a> an agreement to renew the country's US$20.43 billion flexible credit line.<br /><br />Poland is one of the few large EU countries (alongside France) where domestic demand is (for the time being at least) all but dead and buried. Some of the reasons for this are historic ones, some are just quirks of fate (the crunch came before Forex lending got out of hand) and some are demographic. Curiously Poland, like France, is rather younger than many of its regional neighbours.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0Y0We6LJ-MORtXdqXipi-POBkQN3m_49ekNBDuqvaupAoyGGEsdzG1Hqf4d5JN2NK0sEIb9cAeS1b3vMkvegO2oq6Dit1n1rh0fdoPaPTX-lpyoY8K7VNc-UjsHrFL1rOFJq_a30CkUQ/s1600/Poland+and+Slovenia+Median+Ages.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh0Y0We6LJ-MORtXdqXipi-POBkQN3m_49ekNBDuqvaupAoyGGEsdzG1Hqf4d5JN2NK0sEIb9cAeS1b3vMkvegO2oq6Dit1n1rh0fdoPaPTX-lpyoY8K7VNc-UjsHrFL1rOFJq_a30CkUQ/s400/Poland+and+Slovenia+Median+Ages.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5493774101811891314" /></a><br /><br />So for all these, and as they say many other reasons, I think the Polish authorities would do well to think again, and produce a revised set of budgetary projections for the years to come. If not, someone somewhere will one day ask them: "why didn't you see it coming".</div>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-55963092772997421272010-07-08T20:49:00.000+02:002010-07-08T20:57:03.307+02:00Croatia: On The Brink of What?As <a href="http://www.eubusiness.com/news-eu/enlarge-croatia.5du/">Croatia enters the final stage of its EU membership talks</a>, it is perhaps a fitting moment to review the other half of the picture, namely where the Croatian economy finds itself, and what the outlook might be for a continuing convergence with the requirements of Euro membership. Understandably, EU officials are fairly cautious about the likely shape and progress of the forthcoming talks (the Union has, after all got rather a lot on its plate at the moment), but Croatian Prime Minister Jadranka Kosor is decidedly more optimistic, since while she recognises that this last phase is likely to be "really difficult and demanding" she still believes that negotiations could be concluded by the end of the year, which would mean that membership in 2012 would become a possibility.<br /><br />Whatever view you take on the likely progress of the talks, one topic on which it is hard to be optimistic in the short term is outlook for the Croation economy. Despite the fact that the country may not have too many difficulties complying with the original Maastricht Euro membership conditions, the newfound interest among those responsible for EuroGroup decisions for sustainability and longer term competitiveness mean that a country whose economy has as many structural distortions in it as Croatia’s does may well find a growing number of new obstacles thrown across its path.<br /><br /><b>Reeling Under The Shock</b><br /><br />Unsurprisingly, the global economic and financial crisis have taken a significant toll on the Croatian economy. Given the background of a large current account deficit, a high level of external debt, and significant balance sheet exposures to interest and exchange rate risks, the pressure from reduced capital inflows was always going to cause problems, and it did: financial asset prices collapsed, sovereign spreads shot up, and the Zagreb stock market plunged.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpaitY07hZAyOgf6LR5rLyBX5ovt9WWIkv8OAM-LSGibOPW1ORryXNTwPcC2kXzw4DRKErtnOiyu0gnMuFIjk9pVNmcZv-m5ptH_ysCIlK0zSrLnCE0eYTNxuWYQawHFC0Bm8yWWcXF8PU/s1600/GDP+annual.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgpaitY07hZAyOgf6LR5rLyBX5ovt9WWIkv8OAM-LSGibOPW1ORryXNTwPcC2kXzw4DRKErtnOiyu0gnMuFIjk9pVNmcZv-m5ptH_ysCIlK0zSrLnCE0eYTNxuWYQawHFC0Bm8yWWcXF8PU/s400/GDP+annual.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5491599361107485506" /></a><br /><br />As a result of the combined impact of the difficult external conditions which prevailed and the ending of the domestic credit boom Croatia’s GDP fell by some 5.8% in 2009, following a number of years of strong (if not sustainable) growth. Even though in the first three months of this year there were been some tentative signs of recovery the economy was still down by 2.5% on an annual basis. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7h-lyOnQq7wugtGmDJLOyoORoX2SJUTD6PE0iog-YdT-1_42i1ecykSUJyHDuaPWjhabcuHCChrjx1OUNMcY22ZxZ9SxZb6x6GefxASTe3K2a6CsG6scWwJuprjIvyGNvW2v5QdGCAsKC/s1600/GDP+Y-o-Y.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj7h-lyOnQq7wugtGmDJLOyoORoX2SJUTD6PE0iog-YdT-1_42i1ecykSUJyHDuaPWjhabcuHCChrjx1OUNMcY22ZxZ9SxZb6x6GefxASTe3K2a6CsG6scWwJuprjIvyGNvW2v5QdGCAsKC/s400/GDP+Y-o-Y.png" border="0" alt="" id="BLOGGER_PHOTO_ID_5491598937849757970" /></a><br /><br />Personal consumption fell by 4.1%, which was not surprising given that new credit has all but dried up, but more worryingly the drop in fixed capital investment accelerated to an annual 13.9% during the three month period. Government consumption fell for the third consecutive quarter and was down by 1.1%, and the only positive point was the net trade impact, since the export of goods and services rose by 3.6% (following five consecutive quarters of decline) goods and services imports fell by 4.8%.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAFxOZfnVO74tcZ-2_xf_d4ZYgHNzzWY93VJsqBLX4JWfn2gZrchG9vB6t4qFAd_eS1vfQ6qYnVbsbUqUzg-jR41FmRJnjtXnwWlRgQZ37zj2QFV3PJzc9jTBu8efwuxnCMpc0u49w5jQc/s1600/Private+Consumption+Expenditure.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 226px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAFxOZfnVO74tcZ-2_xf_d4ZYgHNzzWY93VJsqBLX4JWfn2gZrchG9vB6t4qFAd_eS1vfQ6qYnVbsbUqUzg-jR41FmRJnjtXnwWlRgQZ37zj2QFV3PJzc9jTBu8efwuxnCMpc0u49w5jQc/s400/Private+Consumption+Expenditure.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491600269600452866" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicjj8F4dG4f9Y5zw0JOCfviPH1OYbOveMbFo8RwCKnvv60Yq6G9kTdR8QzRz1TGsPCpoLvCExaUZ6YHxUMEElt1jylPeLEijJitOQLtrFjAXoMPTLHORXq-jBouY9bhX32gVb5ygvOEn1Z/s1600/Government+Consumption.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 225px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicjj8F4dG4f9Y5zw0JOCfviPH1OYbOveMbFo8RwCKnvv60Yq6G9kTdR8QzRz1TGsPCpoLvCExaUZ6YHxUMEElt1jylPeLEijJitOQLtrFjAXoMPTLHORXq-jBouY9bhX32gVb5ygvOEn1Z/s400/Government+Consumption.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491600199994298498" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiY_WIfyZl3lPL2XRpVRMSgOsyBLjBykY1uKrlrHXDn4uwK_dLon8FdM5VxCzObZv-ml8CV7GxTgpa4bSshpD9DnqH6jYII4CztqcfoWf5u6U_6XxxeAuNth6tcm2-nNMH7FfrGes-kWy51/s1600/Fixed+Capital.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiY_WIfyZl3lPL2XRpVRMSgOsyBLjBykY1uKrlrHXDn4uwK_dLon8FdM5VxCzObZv-ml8CV7GxTgpa4bSshpD9DnqH6jYII4CztqcfoWf5u6U_6XxxeAuNth6tcm2-nNMH7FfrGes-kWy51/s400/Fixed+Capital.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491600132249736354" /></a><br /><br /><br /><b>Exports The Only Realistic Way To Pay Down The Debt</b><br /><br />Given the high level of external indebtedness of the Croatian economy (net external debt is currently running at around 95% of GDP) and the sensitivity of the financial markets to fiscal deficits, there is likely to be little in the way of a revival in domestic demand, depending as it does on the availability of credit.<br /><br />Which leaves exports to pull the cart. But this is where the high level of euroisation of the economy becomes a problem since obtaining export growth after many years where the country has run a substantial trade deficit is hardly going to be easy. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjq8UOa84tCXjEnYg7pnv_G_o_hIszFoYcrRFig1O76uJbA1gBGCr6xVFBk5S2VdhiTzIcBKPyojuQLAuYMzOTRifRYKa_xD-6lchiaOQEqVTY-qgMkuBldr4eHpntAIQzRzmQ2ai6t0ZBk/s1600/Exports.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjq8UOa84tCXjEnYg7pnv_G_o_hIszFoYcrRFig1O76uJbA1gBGCr6xVFBk5S2VdhiTzIcBKPyojuQLAuYMzOTRifRYKa_xD-6lchiaOQEqVTY-qgMkuBldr4eHpntAIQzRzmQ2ai6t0ZBk/s400/Exports.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491600835761110258" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhm8GNp9BgrZWEo-XShGWd0KugdvdNJFGfvDzS3KrIVGKyXxIeyVgE2cPwTTG8OVkGhQnHI6nFoym8hIZdL7XTm-3ErYSSn4YjyOd3M8I6aeZmR7bzMvDfmbCU8eR7iGyy6cXFatXvu2GK0/s1600/Trade+Deficit.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 225px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhm8GNp9BgrZWEo-XShGWd0KugdvdNJFGfvDzS3KrIVGKyXxIeyVgE2cPwTTG8OVkGhQnHI6nFoym8hIZdL7XTm-3ErYSSn4YjyOd3M8I6aeZmR7bzMvDfmbCU8eR7iGyy6cXFatXvu2GK0/s400/Trade+Deficit.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491600672467128194" /></a><br /><br />In fact financial euroization even increased during the crisis, and at the end of 2009 about 70 percent of the total bank credit and over 65 percent of bank deposits were either denominated in or indexed to foreign currency. As the IMF note in their latest report price and cost indicators suggest that competitiveness has been deteriorating in recent years and Croatia’s real effective exchange rate is surely overvalued. Yet all those Euro denominated loans make it very difficult for the authorities to contemplate outright devaluation of the kuna, while the prospect of having to manage an internal wage and price correction is hardly an attractive one, as we can see in the Latvian and other cases.<br /><br />Croatia’s unit labor costs have risen significantly faster than those of its principal trading partners in recent years, due largely to the fact that wages in the private sector were pushed up by rapid wage growth in the public sector. As a result, the overall wage level is high relative to Croatia’s productivity following non-competitive wage setting in a public sector which employs around a quarter of the labor force, not counting public enterprises.<br /><br />As the IMF note, rigidities in the Croatian economy are substantial, with strong labor regulations constraining labor market flexibility, resulting in high employment in the gray economy, a proliferation of temporary work contracts, both of which reduced employers’ incentives to expand employment during the boom years. The impact of the grey economy is clearly reflected in the disparity between the official unemployment rate (of around 19%) and the EU harmonised one accepted by Eurostat (which shows unemployment to be nearer 10%).<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBNxJRGnRjg1_0RX7Df9_6pWRVUiPnlxOYSJYNWQJLYawDa-cZXFTP7Scpn8WOKks-w-2qpnThlRZEmwMR2gzK0F09xeQdO231cQe33Qe4qK0DlDEjnL23IC3sFp5udcsXfwYQ0_3xUGJ-/s1600/unemployment.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 214px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjBNxJRGnRjg1_0RX7Df9_6pWRVUiPnlxOYSJYNWQJLYawDa-cZXFTP7Scpn8WOKks-w-2qpnThlRZEmwMR2gzK0F09xeQdO231cQe33Qe4qK0DlDEjnL23IC3sFp5udcsXfwYQ0_3xUGJ-/s400/unemployment.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491601328500807650" /></a><br /><br /><br /><b>And Then There's Population Ageing To Worry About</b><br /><br />Another factor to be taken into account is the rapid ageing of the Croatian population, following many years of very low fertility, and a steady increase of life expectancy. Croatia’s working age (16-65) population peaked in the early 1990s, and is now in long term decline, while the old age dependency ratio is set to rise and rise. Indeed about a quarter of Croatian population are now retired, a fact which also reflects the presence of relatively generous pension and social benefits conditions, benefits which were available during the years of increasing borrowing, but which are surely now hardly sustainable as the time comes to pay back some of the accumulated debt.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9SiarrFznyRbhnVJoHdVXdlU0eTCJHufNiJBXrXHJyPTYXaYLl3GLMqXt30yKjKKDcOLqupYkA0E8W8xgpF2P7TWSTgs40FSszzt4RxqmdioYYw5P4GN0TwUxstPuPF1Ki3Xy1bj1Tl4u/s1600/working+age+population.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9SiarrFznyRbhnVJoHdVXdlU0eTCJHufNiJBXrXHJyPTYXaYLl3GLMqXt30yKjKKDcOLqupYkA0E8W8xgpF2P7TWSTgs40FSszzt4RxqmdioYYw5P4GN0TwUxstPuPF1Ki3Xy1bj1Tl4u/s400/working+age+population.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491602147434439922" /></a><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEibKIPzingaEXDchwuneg62b0hPNmxV_RlA3bId47Jh2N7nixd9F5wUoaaJI8M9FP7839euVC3XHswO18tr3btRrU_TAzmlbLBO9kNPaL9rUqRMzjTpkTDtYBxcH43coKY79XuaaeB0OjQR/s1600/Life+Expectancy.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEibKIPzingaEXDchwuneg62b0hPNmxV_RlA3bId47Jh2N7nixd9F5wUoaaJI8M9FP7839euVC3XHswO18tr3btRrU_TAzmlbLBO9kNPaL9rUqRMzjTpkTDtYBxcH43coKY79XuaaeB0OjQR/s400/Life+Expectancy.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491601857468066130" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiX8bj6TmnDi0See8mFvbhZ_5WC0WcqpDICsZ0PchGoY9wpXooNhPPTOkq7G0dfzfgyQ_PnZfxsyKtUg8mLGk7p-g4N908IUtUiYMeFzsUD_bqr0R7f3M_s5yeetYQ7yulfE6kqsa6S05wk/s1600/median+age.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiX8bj6TmnDi0See8mFvbhZ_5WC0WcqpDICsZ0PchGoY9wpXooNhPPTOkq7G0dfzfgyQ_PnZfxsyKtUg8mLGk7p-g4N908IUtUiYMeFzsUD_bqr0R7f3M_s5yeetYQ7yulfE6kqsa6S05wk/s400/median+age.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491601688765705122" /></a><br /><br /><br />Looking ahead to the remainder of 2010 the contraction will most likely continue. The IMF forecast in April a miniscule 0.1% growth, but since that time optimism for the global expansion has waned, and in particular demand from many of Croatia’s trading partners is likely to be more muted than anticipated. Investment is unlikely to recover its earlier momentum, burdened as it is by an indebted private sector and a public sector looking to make cut-backs. Private consumption will also remain under the influence of the contraction in consumer credit. While exports should remain supportive, with imports continuing to remain low given the weak domestic demand, goods trade exports may not be as strong as some expect given the weaknesses in the European recovery, while tourism may well be affected by the high levels of unemployment which still exist in many of the relevant countries. Rising fiscal concerns will only add to the slowdown of the EU recovery (given the negative demand impact of the harsher fiscal policies) so a contraction of between 1% and 1.5% in 2010 does not seem unlikely. <br /><br />In addition Croatia remains vulnerable to contagion risks from adverse market sentiment in the region. This contagion could take the form of tightening financial constraint such as a rise in borrowing costs, or a reduction in cross-border flows. On the other hand the absence of Greek banks in Croatia and the limited real sector linkages with Greece should minimize the risks of direct spillovers from that quarter. The real threat would come from a more generalised crisis across the EU’s Southern and Eastern periphery.<br /><br /><br /><b>On The Brink Of What?</b><br /><br />So, after living for many years on borrowed money and borrowed time, running a significant current account deficit and accumulating a large external debt, Croatians are now likely to be faced with the harsh reality of living in a rapidly ageing society at a time when external competiveness has been severely undermined. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYe-_dchKk008eMHQtvo0QMEMFc72bljC5TIqkWJ06C7bewcBaCZEvDPP8NoALP835Xg5Ovl6l5FoNJV8NmPrdFUtg7zghFx0xM6GGGuGKzxeSatuJtZBD7er2J6Lo3cq28R1YmFyik_7g/s1600/CA+deficit+(annual).png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhYe-_dchKk008eMHQtvo0QMEMFc72bljC5TIqkWJ06C7bewcBaCZEvDPP8NoALP835Xg5Ovl6l5FoNJV8NmPrdFUtg7zghFx0xM6GGGuGKzxeSatuJtZBD7er2J6Lo3cq28R1YmFyik_7g/s400/CA+deficit+(annual).png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491602648145948514" /></a><br /><br />In the short term the economy may have stabilised, but in the longer term the challenges are immense, and should not be underestimated. Like many economies across Eastern Europe, Croatia is going to have to straighten out the structural distortions and pay down its external debt at just the time the oncosts of societal ageing are going to start to bite deep.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgc0IFHiaE0S4yABFNb1JM7bRMardAKNPmDM2HnGVaPRQaP8TkyB09IHKBl60MW2I-lW4hjHhvpgBmds22RHzWhdIOn6sGsgEBjXx0nbI3Msp2tjGdaKm02PL2hTb1JLKDLuEVG2mUc9Ud/s1600/Industrial+Output.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 207px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgc0IFHiaE0S4yABFNb1JM7bRMardAKNPmDM2HnGVaPRQaP8TkyB09IHKBl60MW2I-lW4hjHhvpgBmds22RHzWhdIOn6sGsgEBjXx0nbI3Msp2tjGdaKm02PL2hTb1JLKDLuEVG2mUc9Ud/s400/Industrial+Output.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491603419094018498" /></a><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhD1eQUcUnIxBcEHWAbkWIyNC3Qnh4ms5YTouo1mJxK059C7zcM8xefwB8K11EUo2fJRDgzV4233vBZRFvuCtXCrU-wwlPB8MM71gz7AkI55nibyQhv5tpM8Q8YbC24TSIc_VoBSDscnLbs/s1600/Retail+Sales+Index.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhD1eQUcUnIxBcEHWAbkWIyNC3Qnh4ms5YTouo1mJxK059C7zcM8xefwB8K11EUo2fJRDgzV4233vBZRFvuCtXCrU-wwlPB8MM71gz7AkI55nibyQhv5tpM8Q8YbC24TSIc_VoBSDscnLbs/s400/Retail+Sales+Index.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491603356578505394" /></a><br /><br />In addition a rigid labour market and an overweight public sector pose serious problems for the transition to a dynamic and competitive economy. Many changes are needed, and most Croations are only all too well aware of this fact. But one factor which doesn’t seem to get the attention it deserves is the continuing threat to long term economic stability posed by having such a low (tfr 1.4 – or only two thirds of replacement) birth rate. <br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJXR_3ESAnWf5zxFgpXXXuojKiiC_siZwgdwIGG-N3i3DzK9sAwewckc3PFwjHCEcOxSDNwXFkcJ636ppHVSNRfvUQGkWwE6NR7I8CbiJgWMN1LkEm3ymnlHxBfRye9k6TEHFF-v-9NuyP/s1600/Fertility.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 237px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJXR_3ESAnWf5zxFgpXXXuojKiiC_siZwgdwIGG-N3i3DzK9sAwewckc3PFwjHCEcOxSDNwXFkcJ636ppHVSNRfvUQGkWwE6NR7I8CbiJgWMN1LkEm3ymnlHxBfRye9k6TEHFF-v-9NuyP/s400/Fertility.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491603987218679410" /></a><br /><br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_pStCrpgWvf5nKiITwQSOjLEjXSqGZSPiWGUKxMYHdDBX6bSKE2SWgUdc2J8oZA5EDEQ5XFC2_6akfAPS-pfjrVpHRcrM1x2klNnrKVC38au7k4AjJFzgwbMkmKqEbfGA4s-sAbYPbdBk/s1600/natural+population+change.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 239px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_pStCrpgWvf5nKiITwQSOjLEjXSqGZSPiWGUKxMYHdDBX6bSKE2SWgUdc2J8oZA5EDEQ5XFC2_6akfAPS-pfjrVpHRcrM1x2klNnrKVC38au7k4AjJFzgwbMkmKqEbfGA4s-sAbYPbdBk/s400/natural+population+change.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491603815096285506" /></a><br /><br />To make matters even worse, the wage differential with Croatia's West European neighbours means it is an attractive proposition for many young people to go abroad to work, and while the remittances all those migrant workers send back may be very welcome back home - especially given the difficulties Croatian industry has in selling abroad - a country with fertility well below the replacement rate should not be exporting labour to pay down a current account deficit. The way to settle the debts is to provide work in export industries so people will stay at home, and contribute to the maintenance of the health and pension systems.<br /><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxUebwWL1-Dgmzr9KeAn5d-_WxKyhtHB9JHxROz3LMnj1Im8-fmSxpo55Fc9Bfjf6tpKplLFPlOMaYozEKHWbY89yYFnGPAjMxb8XGjcCM-QlMs9IoD8qp50uF0x8jLY_JBOx-LN8xAkGw/s1600/remittances.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgxUebwWL1-Dgmzr9KeAn5d-_WxKyhtHB9JHxROz3LMnj1Im8-fmSxpo55Fc9Bfjf6tpKplLFPlOMaYozEKHWbY89yYFnGPAjMxb8XGjcCM-QlMs9IoD8qp50uF0x8jLY_JBOx-LN8xAkGw/s400/remittances.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5491604705022136802" /></a><br /><br />Like most societies in Eastern and Southern Europe the Croatia needs to address this other imbalance, and it needs to start to do so soon, since the clock is ticking, and it won’t stop doing so. At this key moment in the country’s history it is hardly difficult to recognise that Croatia is effectively on the brink of something, but whether that something is going to be long term sustainability rather than something that it is better not to think about, well, the answer to that question can only be given by the Croatians themselves.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-27835666094470828962010-02-26T15:19:00.001+01:002010-02-26T15:34:57.976+01:00Too Soon To Cry "Victory" On Latvia?"Doom-mongers" - <a href="http://www.economist.com/world/europe/displaystory.cfm?story_id=15581056">the Economist tells us</a> - "are licking their wounds". And why exactly are they licking their wounds? Well for two years now (apparently) they have been telling us that "the struggle to save the lat’s peg to the euro was bound to end in tears". As you could imagine right in the very forefront of these so called doom-mongers is to be found <a href="http://latviaeconomy.blogspot.com/2008/12/why-imfs-decision-to-agree-lavian.html">yours very truly</a> (and <a href="http://latviaeconomy.blogspot.com/2009/01/why-latvia-needs-to-devalue-soon-reply.html">here</a>), and of course <a href="http://krugman.blogs.nytimes.com/2008/12/23/latvia-is-the-new-argentina-slightly-wonkish/">Nobel Economist Paul Krugman</a> (and <a href="http://krugman.blogs.nytimes.com/2010/02/10/riga-mortis/">here</a>).<br /><br />But while I have never thought of myself as especially adverse to admitting defeat when faced with compelling reasons to do so, just why, we might ask ouselves, should we start to think about licking our wounds right now (and why <strong>our</strong> wounds, since it is poor old Latvia which has been subjected to all the blood-letting implied by this none-too-convincing "thought experiment" turned reality)?<br /><br />Well, in the first place, given the dramatic current account correction, Latvia's outlook has been revised from negative to stable by Standard and Poor's rating agency, which means - when you get down to the nitty gritty - that they don't expect any further downward revisions in Latvia's sovereign credit rating in the next six months.<br /><br /><blockquote>Standard & Poor’s, a rating agency, has raised its outlook on Latvia’s debt from negative to stable (ie, it no longer expects further downgrades). The current account, in deficit to the tune of 27% of GDP in late 2006, is in surplus. Exports are recovering. Interest rates have plunged and debt spreads over German bonds have narrowed (see chart). Fraught negotiations with the IMF and the European Union have kept a €7.5 billion ($10 billion) bail-out on track, in return for spending cuts and tax rises worth a tenth of GDP.</blockquote>And anyway, Latvia is not as bad as Greece.<br /><br /><blockquote>Even so, Latvia looks good when compared with Greece. It did not lie about its public finances or use accounting tricks. Strikes have been scanty. Protests are fought in the courts, not the streets. Both Greece and Latvia have had hard knocks, but Greeks became used to a good life that they are loth to give up. Latvians remain glad just to be on the map.</blockquote>As evidence for just how much better Latvia is doing than Greece the Economist cite the movements in the respective bond spreads, and of course, the extra interest the Greek government has to pay to raise money (with respect to equivalent German bonds) is now marginally more than the extra interest Latvia has to pay, but then Greece has yet to go to the IMF.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjRgpRgE9tz10mKSurerkOgqgozcbmG898zqp_OzZzMChGriLO3K00Ko8t5Z5E-Y_XLFtgXTKj9prJrpCLw13X86MzCJWqhR_vmPB_YXOOrC8GQTg5bBxEeMVcqL-LNhGBJJab4fUY61TbO/s1600-h/Economist+Chart.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 320px; DISPLAY: block; HEIGHT: 309px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5442538573395897442" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjRgpRgE9tz10mKSurerkOgqgozcbmG898zqp_OzZzMChGriLO3K00Ko8t5Z5E-Y_XLFtgXTKj9prJrpCLw13X86MzCJWqhR_vmPB_YXOOrC8GQTg5bBxEeMVcqL-LNhGBJJab4fUY61TbO/s400/Economist+Chart.png" /></a><br /><br />But just in case both these arguments seem rather like clutching at straws when compared to the "gravitas" of the situation, there is a "clincher".<br /><br /><blockquote>"despite a fall in GDP last year of 17.5%, Latvia seems to have achieved<br />something many thought impossible: an internal devaluation. This meant regaining competitiveness not by currency depreciation but by deep cuts in wages and public spending. In a recent discussion of Greece, Jörg Asmussen, a German minister, praised Latvia for its self-discipline".</blockquote><br /><br />Well, I'm sure that having a positive reference from a German minister in a discussion on Greece is a positive sign, but hang on a minute: just what internal devaluation is our author talking about here, and what deep cuts in wages and salaries? According to the latest available data from the Latvian Statistics Office, average wages in Latvia were down 10% in September 2009 over 2008, but since wages in September 2008 were up 6.5% over wages in September 2007, when the Latvian economy was already in deep trouble and wages and prices were already seriously out of line, then they have only actually fallen back some 4.15% over the two year period. I am sure these cuts are painful (a 20% unemployment rate, and young people emigrating is even more painful), but I would hardly call this a "deep cut" yet awhile.<br /><br />The thing to remember here is the difficult characterists imposed by the presence of a peg. Latvian real wages (when adjusted for inflation) may well have fallen more, but this is to no avail (and simply makes the internal consumption problem worse), since what matters are the Euro equivalent prices of Latvian wages and exports. This is one of the reasons why in these circumstances a peg is such a horrible thing.<br /><br />And if you're still not very convinced, let's try the Eurostat equivalent data for average hourly wage costs, which had in fact only fallen by 3.5% year on year in the third quarter of 2009.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiePDKiDAEadTet3aDk7B7vk10c83howMelIuf8w3lHS8nmq4QpQCzKBv5MK7nmlKF0DO3p7vgWzX9P6CXvOC2kGpVDjZ_RyRTTG3W9n2uN52A0BTHGRNuj-L6dU06nu0DVoSujLjQdsSw/s1600-h/Latvia+hourly+labour+costs.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5442545887271154274" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgiePDKiDAEadTet3aDk7B7vk10c83howMelIuf8w3lHS8nmq4QpQCzKBv5MK7nmlKF0DO3p7vgWzX9P6CXvOC2kGpVDjZ_RyRTTG3W9n2uN52A0BTHGRNuj-L6dU06nu0DVoSujLjQdsSw/s400/Latvia+hourly+labour+costs.png" /></a><br /><br />Why the difference between average wages and average hourly labour costs? Well, given the depth of the recession people are obviously earning less, since they are working less, but this doesn't help overall competitiveness, since what matters here is the hourly cost of each unit of labour. I'm sorry if this is all fairly turgid economic data stuff (yawn, yawn, yawn) but if you want to cry victory, you really do need to check your facts a bit first.<br /><br />In fact, as I said in my last post, additional evidence from the consumer price index suggests the "internal devaluation" is only working at a hellishly slow pace. Prices were only down by 3.3% in January 2010 over January 2009 according to the latest HICP data from Eurostat.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipwj_PgTDk3b3FMV-OtcxyDzNO_DoyJdA9T94On2t1fyakUNiIiaQ8Qvpv1W7TosWFlYnjCPBJj75TzYFPxkfRCsgMwLxdku7s7NbjG6DkUvsM7thZz4KrvjhtyYRcXx2uWPNRFxy_deM8/s1600-h/latvia+CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5436550644988916450" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipwj_PgTDk3b3FMV-OtcxyDzNO_DoyJdA9T94On2t1fyakUNiIiaQ8Qvpv1W7TosWFlYnjCPBJj75TzYFPxkfRCsgMwLxdku7s7NbjG6DkUvsM7thZz4KrvjhtyYRcXx2uWPNRFxy_deM8/s400/latvia+CPI.png" /></a><br /><br />And while producer prices have fallen a little further - by 6.6% in January over January 2009 - there is still a long long way to go.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0EEFaA49wis-JhpkfX4KUGIpwNOeLgqrZejKTl-8Ozm4sya6pMf9oNr23E3nu8yuuWvzpOyGYG4Y91mDFSrO5zq9PErSZkttQ7lnGoPh79XIQnxe6l0IxoTS6QdFy1PVHgbNA2GCWIHwl/s1600-h/latvia+PPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 226px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5442548881533237410" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0EEFaA49wis-JhpkfX4KUGIpwNOeLgqrZejKTl-8Ozm4sya6pMf9oNr23E3nu8yuuWvzpOyGYG4Y91mDFSrO5zq9PErSZkttQ7lnGoPh79XIQnxe6l0IxoTS6QdFy1PVHgbNA2GCWIHwl/s400/latvia+PPI.png" /></a><br />Basically there is no doubt that Latvia's great economic fall may be coming to an end, but <a href="http://latviaeconomy.blogspot.com/2010/02/latvias-economy-contracts-almost-18.html">as I explained in this post here</a>, that is not the same thing at all as resuming growth. To get back to growth Latvia's internal devaluation needs to be driven hard enough and deep enough to generate a sufficient export surplus to drive headline economic growth at a sufficient speed to start creating jobs again. This is not about a fiscal adjustment, it never was, and it is little consolation for Latvia to be compared with Greece and told that they are doing just that little bit better. Cry Victory we are told, and unlease the jobs of war. Would that things were as easy done as said!Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-44888653259597557842010-02-12T08:43:00.000+01:002010-02-12T08:45:45.990+01:00Estonia's Economy "Only" Contracts By 9.4% in Q4 2009Hard on the heals of yesterday's Latvian GDP numbers we now have news that Estonia’s economy shrank at the slowest annual pace in a year at the end of 2009 as a modest recovery in exports and one-time stock-building helped offset the impact of the continuing decline in consumer spending. In fact gross domestic product fell 9.4 percent, which compares with a 15.6 percent drop in the third quarter, and a 16.1 percent decline in the second one. So the recession is evidently easing.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHYeYN4qpBEZdNLdRzUkgKfcTMIc7iAfA90HwdOphzjrR1F-wreAe4fJbUYFGxnAedwCZkGiliiUz7CDuy2GPI02rFRRcRIsHvNtIaIwgRXeERXWgAbCRe09t_WpvlQv9fVcqhpSz_9JKq/s1600-h/gdp+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 212px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437050734679758658" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHYeYN4qpBEZdNLdRzUkgKfcTMIc7iAfA90HwdOphzjrR1F-wreAe4fJbUYFGxnAedwCZkGiliiUz7CDuy2GPI02rFRRcRIsHvNtIaIwgRXeERXWgAbCRe09t_WpvlQv9fVcqhpSz_9JKq/s400/gdp+one.png" /></a><br /><br />Indeed, startling as it may sound, the economy even grew during the quarter - by a seasonally adjusted 2.6 percent when compared with the third quarter. The news caused some surprise as even the Estonian Finance Ministry had been expecting worse results - an annual contraction of something in the region of 11 to 12 percent. The critical little detail is that the numbers were skewed, since they were affected by a one-off stock- building effect, according to the Finance Ministry, since companies built up their inventories in anticipation of a January tax increase on tobacco, alcohol and motor fuels. As the ministry also added, economic growth will thus see a “negative effect” in the first quarter of 2010 as inventories will inevitably be run down again.<br /><br /><blockquote>"The alcohol, tobacco and motor fuel excises were applied in the beginning of the year, so the stocks of those products were increased, and that gave a positive move to the GDP in the fourth quarter, but will give a negative influence in the beginning of this year,” according to Andrus Sääsk Head of Macroeconomy at the Ministry of Finance. </blockquote><p><br /><br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjl7P7HFD5csfFkkQ3nN-kXAGL2BTMroflYYDCvYhfnlUwWXFNHRHWgKyJ7AraONiUDePROAWXNO9I1xFQOscIeUHqgEdHL_3eoDqrUbu8X9Ir7b_0RL3twEI0i_pr5fLt6A5cTsnljr9G8/s1600-h/gdp+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 229px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437050661661989266" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjl7P7HFD5csfFkkQ3nN-kXAGL2BTMroflYYDCvYhfnlUwWXFNHRHWgKyJ7AraONiUDePROAWXNO9I1xFQOscIeUHqgEdHL_3eoDqrUbu8X9Ir7b_0RL3twEI0i_pr5fLt6A5cTsnljr9G8/s400/gdp+two.png" /></a> </p><p><strong>No Sign Of Any Real Recovery</strong><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdlk1ZNq9vG_IBwDi4xK6PXe_ms-tbBU6oprRoaRPRj8Y9IDslpsY9yFJN1POWvWh8piW_32-TWwyxORgIlh9XpO-OJb5iqP-IEff0PIFDp77w3dhjQanckoVN8FTDPJc9SDx6B6WqaUpv/s1600-h/Estonia+Chian+linked+GDP.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 216px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdlk1ZNq9vG_IBwDi4xK6PXe_ms-tbBU6oprRoaRPRj8Y9IDslpsY9yFJN1POWvWh8piW_32-TWwyxORgIlh9XpO-OJb5iqP-IEff0PIFDp77w3dhjQanckoVN8FTDPJc9SDx6B6WqaUpv/s400/Estonia+Chian+linked+GDP.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5437104211717119266" /></a><br /><br /><br />So, as we are seeing in the other Baltic States, the recession is gradually winding down, but there is no end to the agony in sight, since structural distortions in the economies produced by the earlier boom will impede any immediate recovery. If we look at retail sales the pattern is similar to what we are seeing elsewhere, and these are now down about 28% from their February 2008 peak. </p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhP_vtRE8QYbyUiFhExDqKz0M11OJJ72Ieihc_NYAh2BSpRGw-e2sDNqPrUrG3Jf2vkgXThPr-A9dNb45oCNrxwvRTSBtNhCIqdY2Fk39bjM-jv5GVZZcIkJcsO0RSuBOKpGtpjP7tnJxZ6/s1600-h/Retail+sales+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 232px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437050819280045666" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhP_vtRE8QYbyUiFhExDqKz0M11OJJ72Ieihc_NYAh2BSpRGw-e2sDNqPrUrG3Jf2vkgXThPr-A9dNb45oCNrxwvRTSBtNhCIqdY2Fk39bjM-jv5GVZZcIkJcsO0RSuBOKpGtpjP7tnJxZ6/s400/Retail+sales+index.png" /></a> A similar situation is to be observed in industrial output, which fell back again in December (by a seasonally adjusted 2.2% from November) according to statistics office data. Industrial output is now down 32.5% from the February 2008 peak.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhov5ITjz-xBYzYEfWkszjNbcHfZEhuo-5lvPSOuqTsB2Y2QZJ3WemKkfZBs8suBp7sG2xiWKyruf2fJH0ciJAAdHTNg25kzwnSTP9aXUql8wW3OvfPffGwIs5P71TFzsAHhhWkYBCBmk-k/s1600-h/Estonia+IP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 245px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437050959053749106" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhov5ITjz-xBYzYEfWkszjNbcHfZEhuo-5lvPSOuqTsB2Y2QZJ3WemKkfZBs8suBp7sG2xiWKyruf2fJH0ciJAAdHTNg25kzwnSTP9aXUql8wW3OvfPffGwIs5P71TFzsAHhhWkYBCBmk-k/s400/Estonia+IP.png" /></a> And while exports have picked up slightly from the first quarter 2009 trough, momentum has not been strong enough yet to reverse the deadweight drag of domestic consumption.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhn0YWA6T1Xi4W4xQAcGlrBe556RSPfrk0fbaFQkYOsRWMqasFQvAUAr74xfyAbgEfA2DCjLwzKGCqNMmJj-3dJEPCm0YUq2E5u6BXrFDXRYIKssLkVRNZctSD0iBYNCkt2UMpu1JzfEi7A/s1600-h/Estonia+exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 211px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437051100614591746" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhn0YWA6T1Xi4W4xQAcGlrBe556RSPfrk0fbaFQkYOsRWMqasFQvAUAr74xfyAbgEfA2DCjLwzKGCqNMmJj-3dJEPCm0YUq2E5u6BXrFDXRYIKssLkVRNZctSD0iBYNCkt2UMpu1JzfEi7A/s400/Estonia+exports.png" /></a> The goods trade deficit has improved - indeed the 2009 deficit was the smallest since 1995 - but it is still a deficit, although the country does run a healthy services balance.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh7EIrYytdXOXuGvwvJNqAX142dQF8VPCnm8pE-h0LTKOMuZ2M0q460Mf9iHGfOBNZFrel5U3FggYYW6GuV9HmDo8BFyuzugseCnUy7SLSjqKOJfvpTo8khrPOFVpMlI8NThTT8tP8StPxi/s1600-h/estonia+trade+deficit.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 214px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437051234207880706" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh7EIrYytdXOXuGvwvJNqAX142dQF8VPCnm8pE-h0LTKOMuZ2M0q460Mf9iHGfOBNZFrel5U3FggYYW6GuV9HmDo8BFyuzugseCnUy7SLSjqKOJfvpTo8khrPOFVpMlI8NThTT8tP8StPxi/s400/estonia+trade+deficit.png" /></a> And the services balance is what makes the difference in turning the current account deficit into a surplus.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEggNs70TP1tdSK2jDRkwAzSTRKxxRhXEPfjhgP6FYrAafMKWJDGm7Z9RcqwDBdnUiZDtHssvaYV5hT2sGUgvVJJp5dAYvP_HmcKgWUwwhC3VB4RNm1w9g8TtM7XrR1-Sutau_1pgKpb8Pui/s1600-h/Estonia+CA+deficit.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 215px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437054158372925138" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEggNs70TP1tdSK2jDRkwAzSTRKxxRhXEPfjhgP6FYrAafMKWJDGm7Z9RcqwDBdnUiZDtHssvaYV5hT2sGUgvVJJp5dAYvP_HmcKgWUwwhC3VB4RNm1w9g8TtM7XrR1-Sutau_1pgKpb8Pui/s400/Estonia+CA+deficit.png" /></a> On the other hand unemployment continues to rise, and is the third highest in the European Union (after Latvia and Spain), hitting 15.2% in September - which is the last month for which the Eurostat has data at this point. Indeed statistics regularity and quality is one of the issues which Estonia will need to attend to as part of its general euro ambitions, as <a href="http://balticbusinessnews.com/article/2010/01/19/ECB_demands_independent_statistics_from_Estonia">the ECB took the trouble to point out recently</a>.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiyJjUbHARpvftascLa8SV-S1YBYgUTX4ooRAVsF_-4MMf6bN03AXP5emQwgSlLoDEDZkaIpZICZrKp3AXMuEN2xLVdPuI4UaNJ-cklOcvxC8UFa0E5w1-704q5xQu2-llOH-6SSvuBLCsV/s1600-h/Unemployment+rate.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 219px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437052009795077762" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiyJjUbHARpvftascLa8SV-S1YBYgUTX4ooRAVsF_-4MMf6bN03AXP5emQwgSlLoDEDZkaIpZICZrKp3AXMuEN2xLVdPuI4UaNJ-cklOcvxC8UFa0E5w1-704q5xQu2-llOH-6SSvuBLCsV/s400/Unemployment+rate.png" /></a> <br /><br /><strong>Demographic Issues Also Need To Be Addressed</strong><br /><br />Estonia's population fell again in 2009 - by 400 - and was estimated by the statistics office to be in the region of 1,340,000 at the end of the year. A falling death rate meant the population decline slowed down over the year, but the number of live births decreased for the first time in eight years (see chart below), raising issues about the longer term impact of the crisis. Some 15,807 live births were registered in total in 2009 - 221 birth less than in 2008.<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpB3DTCLIr4Cuk_fcF7zL2xshXdSyCPW1XmIRGHzvrFAyH-PWI0ZsCENOWoILcsA6DEsK1BWjx51ijnLTyWJy-I-Hs0g7qh8xSrReijkgdV9Yc4EZYjuCoz7_QKH7sKtI68gqAa0arIgav/s1600-h/live+births.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 219px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437054644044916210" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpB3DTCLIr4Cuk_fcF7zL2xshXdSyCPW1XmIRGHzvrFAyH-PWI0ZsCENOWoILcsA6DEsK1BWjx51ijnLTyWJy-I-Hs0g7qh8xSrReijkgdV9Yc4EZYjuCoz7_QKH7sKtI68gqAa0arIgav/s400/live+births.png" /></a> While the situation is a lot less serious than the one Latvia faces, the downturn in Estonian births is a rather bitter blow for a country where fertility had rebounded substantially from earlier lows, and while the 1.6Tfr was still a long way from population replacement level, the improvement had been a welcome one.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgenKHdPKUs2jRikFix-GS0B2KQIz9UTcKeBfTqeAcPZvkvH669jgWJMgjRTQmG_r4lOksYiL6j64V6YgSRNfQq_1lUb_dlnAkoYhQi4tnF-MrmIPvcXpY-mPs3wY0g9FbQ83J8Lr0Y8HL/s1600-h/Estonia+TFR.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 228px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5437059138845645234" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjgenKHdPKUs2jRikFix-GS0B2KQIz9UTcKeBfTqeAcPZvkvH669jgWJMgjRTQmG_r4lOksYiL6j64V6YgSRNfQq_1lUb_dlnAkoYhQi4tnF-MrmIPvcXpY-mPs3wY0g9FbQ83J8Lr0Y8HL/s400/Estonia+TFR.png" /></a><br /><strong>Credit Rating Improvement</strong></p><p><br />Estonia's credit rating outlook was raised this week by Standard & Poor’s, from negative to stable. More than the improvement, what is interesting is the reason given, since the agency cited improving prospects for euro adoption next year. This has both a positive and a negative reading. The positive reading is that S&Ps think Estonia will meet the eurozone membership criteria. The negative one is that the improvement is not due to any underlying change in the country's growth prospects, which are at the end of the day the main area of immediate concern.<br /><br />Indeed S&Ps have an A- rating, the fourth-lowest investment grade, on Estonia and the move to stable from negative, means the rating is more likely to be left unchanged than raised or lowered. The rating was in fact cut from A last August, and evidently losing the A- rating would give a rather negative signal given that the ECB is about to return to at least one A- as the minimum collateral condition. </p><blockquote>“Estonia has stabilized its public finances, which significantly increases its prospects for eurozone accession in 2011,” S&P’s Frankfurt-based Kai Stukenbrock and London-based Frank Gill said in a statement. The “outlook reflects our view of Estonia’s improving economic flexibility and the prospect of near-term eurozone accession against the challenges inherent in adapting the economy to lessen its reliance on external funds.”</blockquote><br />Fitch currently has a BBB+ rating on Estonia, and the outlook on this was also raised to stable from negative on February 5. Moody’s Investors Service has an A1 rating on Estonia with a negative outlook.<br /></p><p>Euro adoption terms require countries to maintain fiscal deficits below 3 percent of GDP, limit debt to 60 percent of GDP and ensure inflation isn’t more than 1.5 percentage points above the Eurozone average, and Estonia has met all the criteria, according to Prime Minister Ansip speaking yesterday. Whether Ansip's optimism is totally justified or not the EU Commission and the European Central Bank will publish their report assessing Estonia’s readiness to join sometime in May, and (assuming this is favourable) the Ecofin council of EU finance ministers will take the critical decision on entry on June 8.<br /><br />But as Fitch pointed out when they raised their Estonia outlook, while eurozone membership looks increasingly possible it is not yet certain. Fitch warned in their report that even if Estonia meat all the formal Maastricht reference criteria for euro entry there is still a risk that the European authorities' interpretation of these same criteria could lead them to reject Estonia's application. According to Fitch, in Estonia's case uncertainty surrounded whether the idea of "sustainable price performance" was going to be consistent with the deflation which is to be expected from such a severe recession, after inflation had so recently been in the double digit range. The agency also added that one-off measures taken by the government to reduce the budget deficit in 2009 could also count against it in the EU authorities' judgment of whether the medium-term budget plans are credible.<br /><br />The first point is an important one I think. If we go back to <a href="http://greekeconomy.blogspot.com/2010/01/competitiveness-gaps-could-hurt-euro-no.html">the 172 page EU Commission document leaked to the German magazine Der Spiegel last month</a>, the EU Stability and Growth Pact is increasingly going to focus on issues surrounding competitiveness as well as on fiscal deficit ones. That is what the whole deabate over the Greek and Spanish economies which EU leaders are engaging in this week is all about. And any country which is not considered to be in completely good health under the SGP criteria is hardly likely to get the green light from the ECB and Ecofin. <br /><br />It is obvious that the Estonian economy is still suffering from earlier structural distortions which have not yet been corrected. If we come to the consumer price index, this was only down about 2% in 2009, far short of the deflationary adjustment which will be needed to restore growth and competitiveness.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuSvSsz8I-VMxu6qOl4Ul-ngD1nEE3A4GkU1ETpceBc1VvqowpeRezhlqhUwixjjjp2Rllwz2y3miYciA7gxVoxaCbVxmo02mzlGP4JiO8ucWO09Mnb90ZQ9qD0_s0qsD5WBLirqyxz-11/s1600-h/Estonia+CPI.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuSvSsz8I-VMxu6qOl4Ul-ngD1nEE3A4GkU1ETpceBc1VvqowpeRezhlqhUwixjjjp2Rllwz2y3miYciA7gxVoxaCbVxmo02mzlGP4JiO8ucWO09Mnb90ZQ9qD0_s0qsD5WBLirqyxz-11/s400/Estonia+CPI.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5437094214795684882" /></a><br /><br />The producer price index has also not moved as far and as fast as will be needed, since it was only down some 3% on the year.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9OfIMwaQyTpzFfIV0LD19CxtRLuqJf6u_ZKM7WTsZvTP-lYju0-iaVX9gn781f5Qir219BzzgtUvx0FS9jNFx8uSa-z6YL9zGPSNKicz_8golDVUmQS-j08QOWc-tDGnJQYp4g3ejJHnA/s1600-h/Estonia+PPI.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg9OfIMwaQyTpzFfIV0LD19CxtRLuqJf6u_ZKM7WTsZvTP-lYju0-iaVX9gn781f5Qir219BzzgtUvx0FS9jNFx8uSa-z6YL9zGPSNKicz_8golDVUmQS-j08QOWc-tDGnJQYp4g3ejJHnA/s400/Estonia+PPI.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5437094028616247170" /></a><br /><br />So the sad truth is that, whether from inside or outside the eurozone, despite some extensive and painful sacrifices made in not having government spending to fall back on during an extraordinarily deep recession - but then, <a href="http://krugman.blogs.nytimes.com/2010/02/09/anatomy-of-a-euromess/">as Krugman would say</a>, Estonia's problems were never fiscal ones anyway, they were always competitiveness ones - there is still a long hard road out there in front. Whatever the advantages and disadvantages of the chosen path one thing is for sure, it will be absolutely impossible for the country to leave the job half done.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOu3VCdDCd3ezPJoVkB5Vdy0xQ2AedtPkK0kBWvSf1pwOA9T4lYdFhLStonNDy4eNsiFEjqIaCRBZDsPRkCf2EZAdZPjYv7sQwaICp_8bw8ydmrxFbMsH31WqCFkRr4CO-3bLe8fBYKiNk/s1600-h/Estonia+government+consumption.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjOu3VCdDCd3ezPJoVkB5Vdy0xQ2AedtPkK0kBWvSf1pwOA9T4lYdFhLStonNDy4eNsiFEjqIaCRBZDsPRkCf2EZAdZPjYv7sQwaICp_8bw8ydmrxFbMsH31WqCFkRr4CO-3bLe8fBYKiNk/s400/Estonia+government+consumption.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5437096781518212466" /></a>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-14702343148025781892010-02-10T11:00:00.001+01:002010-02-10T13:18:58.219+01:00Latvia's Economy Contracts Almost 18 Percent in Q4 2009Well, as we say in English, it never rains but it pours. Latvia, which has had the deepest recession of all 27 European Union member states, contracted by nearly 18 per cent in the fourth quarter of 2009. 'Compared to the same period of 2008, gross domestic product (GDP) value has decreased by 17.7 per cent,' according to the national statistics office statement.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHAs53EV1G2Os5JoymAhm9FlRQb6adV_mfGh-442BQnJNs8MM_QgkYHPQ1jElpMo0VFH2NlOPDEYq7NzvWIO051UJD9QZubXKkIjlQuX21kMvtziwh0QqE_dNVvu49SsiZnCKDLtVDmVOK/s1600-h/Latvia+GDP+YoY.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 197px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5436542256659793906" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHAs53EV1G2Os5JoymAhm9FlRQb6adV_mfGh-442BQnJNs8MM_QgkYHPQ1jElpMo0VFH2NlOPDEYq7NzvWIO051UJD9QZubXKkIjlQuX21kMvtziwh0QqE_dNVvu49SsiZnCKDLtVDmVOK/s400/Latvia+GDP+YoY.png" /></a><br /><br /><br />The fall was led by a 30-per-cent annual drop in the retail sector. Retail sales are now down by 36% from their April 2008 peak and there is little sign of any turnaround at this point.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEib3zfOL4uzlO-jdgBTkD07jPqQbdm5m0ha03adSDAgcaOyKixLbYFunCc2UnpgyoFvJ-RnTnaJggB_USFLnt7QGRkeASTviRNLWF-QY-F0NXIqp473Be35tUqV3WwZ59pM4qjlm-k9oAOQ/s1600-h/latvia+retail+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 224px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5436543286133635666" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEib3zfOL4uzlO-jdgBTkD07jPqQbdm5m0ha03adSDAgcaOyKixLbYFunCc2UnpgyoFvJ-RnTnaJggB_USFLnt7QGRkeASTviRNLWF-QY-F0NXIqp473Be35tUqV3WwZ59pM4qjlm-k9oAOQ/s400/latvia+retail+index.png" /></a><br /><br /><br />Industrial output, which rose slightly over the quarter, fell back again in Deecember (by a seasonally adjusted 4.2%) following a sharp rise in November. Output is still down more than 17% from the February 2008 peak.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhXjM-b2c_MNVoynpVwvTmOmXCh36tdPS76Wnsr25Q-5WLlML4o_IR0DHd0DHCcoR-e6wwc4crBvFlE-sF9w91kU5ZmZ-CCYd-_0SWd2wUfyCcG4zCWchXJnvBeW-if1aRWjicDMiV2-_O0/s1600-h/latvia+IP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 226px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5436546621511946114" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhXjM-b2c_MNVoynpVwvTmOmXCh36tdPS76Wnsr25Q-5WLlML4o_IR0DHd0DHCcoR-e6wwc4crBvFlE-sF9w91kU5ZmZ-CCYd-_0SWd2wUfyCcG4zCWchXJnvBeW-if1aRWjicDMiV2-_O0/s400/latvia+IP.png" /></a><br /><br />Latvian exports were down again in December, making for the second consecutive monthly fall. Despite all the fuss about internal devaluation the CPI was only down by 3.1% in January over January 2009. Prices are still far from being competitive, and no early rebound in export growth is to be expected. Over 2009 as a whole exports - at 3,571.6 mln lats – were down over 2008 by 19.4%, but imports - at 4,633.7 mln lats – fell even further, by 38.4% which is why the trade deficit reduced substantially, but note there was still adeficit. The deficit fell from 225.3 mln Lats in January to 69.7 mln Lats in December. Over 2009 as a whole foreign trade turnover totalled ay 8.2 billion lats, a drop of 31 per cent when compared to 2008.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuJohMme_D97i5lTNafP9-QQGeAKpd3z3sUX8aVLLGqDBGMEXGmV0Nhl0qutJ0DtxyXet2-YYcvil5ounKr1DtPygU4Sk5shkonQLtO_-SLPLbAV6GTIOYTuT5PPyTmm9JDv459Fs6vxJF/s1600-h/Latvia+exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 258px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5436546761902762994" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiuJohMme_D97i5lTNafP9-QQGeAKpd3z3sUX8aVLLGqDBGMEXGmV0Nhl0qutJ0DtxyXet2-YYcvil5ounKr1DtPygU4Sk5shkonQLtO_-SLPLbAV6GTIOYTuT5PPyTmm9JDv459Fs6vxJF/s400/Latvia+exports.png" /></a><br /><br />Unemployment hit 22.8% in December according to Eurostat data, the highest in the European Union. <br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0lNXdHMFnT3mtVw2sci1Cf1B6bmw80NpY0xr5fOzVfT6C8BYEZZh7j8OfMUDoWEPiNZ3eTKV0ONFEcd1sw37hT72cgQTs3a6QHx0Sa4u7eQAJu4nD8yDXRhctxbHm7XiTqBZz5VJliYVZ/s1600-h/latvia+unemployment+rate.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 221px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5436548666466176130" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi0lNXdHMFnT3mtVw2sci1Cf1B6bmw80NpY0xr5fOzVfT6C8BYEZZh7j8OfMUDoWEPiNZ3eTKV0ONFEcd1sw37hT72cgQTs3a6QHx0Sa4u7eQAJu4nD8yDXRhctxbHm7XiTqBZz5VJliYVZ/s400/latvia+unemployment+rate.png" /></a><br /><br />And even that famed "internal devaluation" seems to be working hellishly slowly. As I say, prices were only down by 3.1% in January 2010 over January 2009 (and probably even less on the EU HICP measure) according to the latest data from the Latvian statistics office. <br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipwj_PgTDk3b3FMV-OtcxyDzNO_DoyJdA9T94On2t1fyakUNiIiaQ8Qvpv1W7TosWFlYnjCPBJj75TzYFPxkfRCsgMwLxdku7s7NbjG6DkUvsM7thZz4KrvjhtyYRcXx2uWPNRFxy_deM8/s1600-h/latvia+CPI.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEipwj_PgTDk3b3FMV-OtcxyDzNO_DoyJdA9T94On2t1fyakUNiIiaQ8Qvpv1W7TosWFlYnjCPBJj75TzYFPxkfRCsgMwLxdku7s7NbjG6DkUvsM7thZz4KrvjhtyYRcXx2uWPNRFxy_deM8/s400/latvia+CPI.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5436550644988916450" /></a><br /><br />Even the statistics office statement that GDP actually grew by 2.4 per cent compared to the third-quarter offers cold comfort, since this data is not seasonally adjusted, and the economy will almost certainly be back down again in the first quarter of 2010.<br /><br /><br />Meanwhile the consequences of this strong recession in Latvia - more and more Latvians are leaving in search of work elsewhere, while fewer and fewer young people feel confident enough to have children (see chart below) - will leave a long scar, which will be hard to heal, and which make the long term future and sustainability of the country even more uncertain.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3USnaHi95Yw5DQbWFuVOf3QN6dzptE2a5vzLQuwBn8SeRWAybu2rsIS_1kLKO5ucjNDhrPJH2afiMAsMjo9tp4ZgSZzVvnb3HVU-Ja7WtkdF3pKRqWy5cG6uG4U4OCv-ostcFyerv_5FW/s1600-h/latvia+births.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 220px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3USnaHi95Yw5DQbWFuVOf3QN6dzptE2a5vzLQuwBn8SeRWAybu2rsIS_1kLKO5ucjNDhrPJH2afiMAsMjo9tp4ZgSZzVvnb3HVU-Ja7WtkdF3pKRqWy5cG6uG4U4OCv-ostcFyerv_5FW/s400/latvia+births.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5436550886207064066" /></a><br /><br />As <a href="http://www.cepr.net/index.php/publications/reports/latvias-recession-cost-of-adjustment-internal-devaluation/">the Washington based CEPR argue</a> "the depth of the recession and the difficulty of recovery are attributable in large part to the decision to maintain the country’s overvalued fixed exchange rate, because it prevents the government from pursuing the policies necessary to restore economic growth". Maybe next time someone will learn the lesson before tragedy strikes, and not afterwards.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-41862122954125004142010-02-03T13:04:00.001+01:002010-02-03T13:04:46.835+01:00Global Manufacturing Continued Its Expansion In JanuaryThe global manufacturing expansion continued to gather momentum in January. Coming in at 56.1, up from 54.6 in December, the JPMorgan Global Manufacturing Purchasing Managers’ Index registered its highest reading for five and a half years. The latest improvement in overall operating performance reflected accelerated growth of production and new orders, while there was a slight gain in staffing levels for the first time since March 2008.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6a3wfpSGzdloqIiIf1FDBOiG6XBl2X8s6V1fQIMR1TePXiUjISQyixac7PdyWhqSPUI3Uuw8giDYUr8rurwGb6xy_Wpt1q0vQUiKxgIID_0NTX_zbr3pTIlWHy5aiRapgpFGIu7KP8UgI/s1600-h/Global.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5433757007511525106" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj6a3wfpSGzdloqIiIf1FDBOiG6XBl2X8s6V1fQIMR1TePXiUjISQyixac7PdyWhqSPUI3Uuw8giDYUr8rurwGb6xy_Wpt1q0vQUiKxgIID_0NTX_zbr3pTIlWHy5aiRapgpFGIu7KP8UgI/s400/Global.png" /></a><br /><br />Production increased for the eighth successive month in January, with the rate of expansion hitting a 69-month high. The improvement in the performance of the United States manufacturing sector was most noticeable. The Institute for Supply Management output index rose by 6.5 points since December to reach its highest level since April 2004.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLjZZidMOVQt_-NQY13pkJldX2ukumN15nB4wM2smT4okpcZQP2ePrh-Uhq1Z8CNj8ouMB7Ssp2PKDjwnSUaI_KnV7LI-fkfmKqJVJQh3cmMZ70Vgiu1sGUDTe19_9g6y33k3nQvd3YSwA/s1600-h/United+Syayes.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5433757256952720402" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjLjZZidMOVQt_-NQY13pkJldX2ukumN15nB4wM2smT4okpcZQP2ePrh-Uhq1Z8CNj8ouMB7Ssp2PKDjwnSUaI_KnV7LI-fkfmKqJVJQh3cmMZ70Vgiu1sGUDTe19_9g6y33k3nQvd3YSwA/s400/United+Syayes.png" /></a><br /><br /><br />Elsewhere the position was much more uneven, with West European and Japanese manufacturing having a much more qualified start to 2010, with rates of expansion growth well below the global average, - and in the case of some countries well below. Meanwhile emerging economies like Brazil,India and Turkey continued to show a strong performance.<br /><br /><strong>Asia and Emerging Markets</strong><br /><br />In Japan activity slowed, although at 52.5, the seasonally adjusted Nomura/JMMA Purchasing Managers’ Index pointed to a moderate improvement in operating conditions in the Japanese manufacturing sector at the start of 2010.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhU1lhpOgQwm11cajrSYAxTXTS1YasMd1wawTLRkjlrbV2r5tvlNVO0Eur3sqBvdzjOGdFfCDr8v8h0cJkWhTtmq_q9-VW8vKFmp2V2YNMNN2Agd9gRlSdbJuKd9VT1RK_IMtxeq-7zuFsc/s1600-h/Japan.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 221px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhU1lhpOgQwm11cajrSYAxTXTS1YasMd1wawTLRkjlrbV2r5tvlNVO0Eur3sqBvdzjOGdFfCDr8v8h0cJkWhTtmq_q9-VW8vKFmp2V2YNMNN2Agd9gRlSdbJuKd9VT1RK_IMtxeq-7zuFsc/s400/Japan.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433757536237873794" /></a><br /><br /><br /><blockquote>Commenting on the Nomura/JMMA Japan Manufacturing PMI data, Minoru Nogimori, Economist of Financial & Economic Research Centre at Nomura, said:<br /><br />“The Japan Manufacturing PMI fell 1.3 points to 52.5 in January. It remains above the key dividing line of 50.0, but has continued to fluctuate in recent months. Although the PMI has been holding firm, the sharp rebound phase from February through to August in 2009 has lost steam. Furthermore, the New Export Orders Index fell rapidly, by 3.2 points to 51.5, signaling that the yen’s appreciation has depressed exports which are the main factor behind the current recovery in the Japanese economy. Exports are an important factor of the future of the Where an expansion of production was signalled, panellists generally attributed growth to higher intakes of new orders, which increased for the seventh month running in January. However, the latest improvement in firms’ order books was the slowest in that sequence amid concerns over the sustainability of economic growth. Export sales placed at manufacturers rose again in January, extending the current period of expansion to eight months. Nonetheless, the pace of expansion was the slowest since last June. Anecdotal evidence suggested that increased new business from China and other Asian countries continued to support export growth.<br /><br />January data signalled that backlogs were depleted at the fastest rate since last June, largely as a result of slower new business growth and a robust rise in output.</blockquote><br /><br />Elswhere in Asia, both China and India showed strong expansions. At 57.4, up from 56.1 in the previous month, the headline HSBC China Manufacturing PMI rose to a record high at the start of 2010, signalling a continuing improvement in operating conditions in the Chinese manufacturing sector. The index has now risen more than sixteen points since posting a record low in November 2008. Export sales also rose in January, increasing at a near-record rate. This was in sharp contrast to the severe reductions seen at the beginning of 2009.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjli6Q8zxZd6J2wwSUNowRQzJdyR5CeXOuG7gSPltmcA0ZRbC9gzyuhJTMaPoKZeyxKucJEpLmb3_7g-e2NCPYj6n_OiWDaiX8G_Snw8t8ELGbVnnau7yj1p-Fh2P3k4HAq0ntHSVfSPddP/s1600-h/China.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 240px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjli6Q8zxZd6J2wwSUNowRQzJdyR5CeXOuG7gSPltmcA0ZRbC9gzyuhJTMaPoKZeyxKucJEpLmb3_7g-e2NCPYj6n_OiWDaiX8G_Snw8t8ELGbVnnau7yj1p-Fh2P3k4HAq0ntHSVfSPddP/s400/China.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433975504186983410" /></a><br /><br /><blockquote>Commenting on the China Manufacturing PMI survey, Hongbin Qu, Chief Economist for China at HSBC said:<br /><br />“Industrial activity continues to accelerate, implying stronger GDP growth in 1Q. But rising input and output prices also point to greater inflationary pressure, which will likely prompt more tightening measures in the coming months.”</blockquote><br /><br />The Indian manufacturing sector expanded at fastest pace for nearly one-and-a-half years in January. Climbing to 57.6 in January, its highest level for seventeen months, the seasonally adjusted HSBC Markit Purchasing Managers’ Index signalled a considerable improvement in operating conditions faced by Indian manufacturers. The headline index has now signalled expansion of the sector since April 2009, and at increasing rates for the past two survey periods.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPQkTprLdIdICEpsWQZbYSXlDLK3yXVfaaP78gyOcpBze-fvlzGyrQbJWeKgkchMJ9J4zxkwPcIPJcO2ys2v19RAsyDpbWyYlts4diWZjmLCPUX7lS4H9xeQ48Muf9QEwmjIm46xvB8U0f/s1600-h/India.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 223px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgPQkTprLdIdICEpsWQZbYSXlDLK3yXVfaaP78gyOcpBze-fvlzGyrQbJWeKgkchMJ9J4zxkwPcIPJcO2ys2v19RAsyDpbWyYlts4diWZjmLCPUX7lS4H9xeQ48Muf9QEwmjIm46xvB8U0f/s400/India.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433976418384960690" /></a><br /><br /><blockquote>Commenting on the India Manufacturing PMI survey, Robert Prior-Wandesforde, Senior Asian Economist at HSBC said:<br /><br />“Any lingering concern that India's manufacturing recovery was tailing off should be well and truly put to rest by this strong release. A second consecutive rise in the PMI has taken the series to a new cycle high, consistent with on-going double digit rises in industrial production. The most impressive part of the release was the more than 5 point jump in the new export orders index, which took it to its highest level since October 2007 and indicated that the recovery is by no means dependent on domestic demand alone.<br /><br />“At the same time, however, price pressures are clearly intensifying. The rate of increase in input prices was the largest since the PMI began nearly 5 years ago, while the survey suggests that companies are more willing to pass on these rises in the form of higher output prices - something which the RBI is unlikely to take too kindly to. Admittedly, the employment index only inched above 50 but it can't be long before job hiring picks up more aggressively.”</blockquote><br /><br />Elsewhere among emerging economies, the Brazil performance stood out, with the sector expanding at a considerable pace as shown by the fact the headline seasonally adjusted Brazil Manufacturing PMI climbed to 57.8 in January, its highest level since data were first available in February 2006.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKjgmVS4KXPyrRqg3Iat3ZvcFXgEeWZiv7aNRIpnc-lmk60BrcT8FIn1XFbaTDzOXCzG4lDkKP6eU-NPkiwxWkqE3pwuVqKlTH0nG6uOwX6H4GBFRL8sbtDOqeHLpzqSpdG9TOTSJvKyaz/s1600-h/Brazil.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 224px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKjgmVS4KXPyrRqg3Iat3ZvcFXgEeWZiv7aNRIpnc-lmk60BrcT8FIn1XFbaTDzOXCzG4lDkKP6eU-NPkiwxWkqE3pwuVqKlTH0nG6uOwX6H4GBFRL8sbtDOqeHLpzqSpdG9TOTSJvKyaz/s400/Brazil.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433977139035117314" /></a><br /><br /><br /><blockquote>Commenting on the Brazil Manufacturing PMI survey, Andre Loes, Chief Economist, Brazil at HSBC said:<br /><br />“The Brazilian manufacturing industry expanded at a survey record pace in January. The Manufacturing PMI reached 57.8, up from December’s 55.8, with all five of its components supporting the strong performance of the composite indicator.<br /><br />“In our view, the particularly strong growth of output, new orders and input stocks – all of them reached series record peaks – indicate further vigorous expansions in manufacturing going forward. Employment also grew faster, but as a variable that normally lags production, its expansion fell short of the three components mentioned above. Last but not least, charges rose, albeit modestly, for the fourth month in a row.<br /><br />“All in, January’s Brazil Manufacturing PMI confirms the very favorable dynamics of manufacturing activity. This highlights the concern recently expressed by the BCB, that the quick reduction of idle capacity could result in increased inflation pressures.”</blockquote><br /><br />While the South African PMI continued to show an increase in activity. The index surged to its highest level in 21 months in January, indicating that a recovery in manufacturing is gathering pace as consumer spending picks up, according to Kagiso Securities who prepared the report. The seasonally adjusted index increased to 53.6 from 52.5 in December. The PMI has now been above 50, which indicates an expansion in factory production, for three consecutive months.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdzrZxcfeng7QgQVaXpaUeQwUNcy8Qt1led-tIFszkPjT1Io-59qsOuOaR9giodsplx1fuEBcDuRbc95MHk1QW0sXBW8lU6i_liAjtjExH7YosGXyIV49m5qw1ULrbkwH9egtlpsuISq9t/s1600-h/south+africa.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 238px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdzrZxcfeng7QgQVaXpaUeQwUNcy8Qt1led-tIFszkPjT1Io-59qsOuOaR9giodsplx1fuEBcDuRbc95MHk1QW0sXBW8lU6i_liAjtjExH7YosGXyIV49m5qw1ULrbkwH9egtlpsuISq9t/s400/south+africa.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433979554981419042" /></a><br /><br /><strong>Western Europe</strong><br /><br />In Europe, solid expansions in output were recorded in Sweden, France, Germany, the Netherlands and Austria, but these were in marked contrast to the deeper recessions in Spain, Ireland and Greece. <br /><br />The Eurozone PMI hit a two-year high, with France and Germany leading the recovery, while Spain and Greece fell further behind. The headline final Eurozone Manufacturing PMI – a composite index based on measures of production, orders, employment, inventories and supplier performance – posted 52.4 in January, its highest reading for two years. The index value was above both its earlier flash estimate of 52.0 and the final reading of 51.6 posted in December. The level of the PMI has risen in each month since hitting a record low last February and has now remained above the neutral 50.0 mark for four consecutive months.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTVVoSQak56xuyfb7VQGzfEJsuiY4Kbw3007XClOKRMF6vhfazRC7NUwodPiLx7xKaZYAVCgYtA6L1Zj5UAcpy3YLlpmsAtBP_G019O3-hkwhBqBz78h0EAb9rvfzAMXGXi18LVgI9qINq/s1600-h/eurozone+manufacturing.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTVVoSQak56xuyfb7VQGzfEJsuiY4Kbw3007XClOKRMF6vhfazRC7NUwodPiLx7xKaZYAVCgYtA6L1Zj5UAcpy3YLlpmsAtBP_G019O3-hkwhBqBz78h0EAb9rvfzAMXGXi18LVgI9qINq/s400/eurozone+manufacturing.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433983060683833650" /></a><br /><br /><blockquote>Commenting on the PMI data, Markit Senior Economist, Rob Dobson said:<br /><br />“The January final PMI readings confirm that the Eurozone manufacturing sector has built on its positive end to last year, with growth of output and new orders the fastest since mid-2007 and above the earlier flash estimates. However, the recovery is becoming two-track, with Spain and Greece in particular falling further into recession when growth in most of the other nations, led by France and Germany, is accelerating. Manufacturers are also continuing to focus on reducing headcounts and lowering stocks despite gains in output. This suggests that they retain a cautious outlook, especially while sales are still being supported by price discounting.”</blockquote><br /><br /><br />But the West European picture was characterised by two extremes. On the one hand we have France and Sweden, were economic activity is rebounding strongly, and on the other there is Spain and Greece, where the contraction continues, and the outlook seems bleak.<br /><br />Business conditions in the French manufacturing sector improved for a sixth consecutive month in January. The headline Purchasing Managers’ Index posted 55.4, up from 54.7 in December. The rise in the PMI reflected faster expansions of both output and new orders during the latest survey period, while supplier delivery times lengthened at a sharper rate. Manufacturing production increased for the seventh month running in January. Furthermore, the rate of growth accelerated to the strongest for almost nine-and-a-half years, with over one-third of panellists reporting a rise.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZB_AEDBWXgv_fJN8gnPEa2_mheyl49-nxtT7e759nTPNXCtusYVBWghB-duEkakZCYUfYjA57-oH3zMnr-J3zRASWM4C63E-QMG5D-dpsJqHv4Vnw4wU24NZzACZ6rI2Rq9_cKmZoGx2Z/s1600-h/France+manufacturing.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 213px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjZB_AEDBWXgv_fJN8gnPEa2_mheyl49-nxtT7e759nTPNXCtusYVBWghB-duEkakZCYUfYjA57-oH3zMnr-J3zRASWM4C63E-QMG5D-dpsJqHv4Vnw4wU24NZzACZ6rI2Rq9_cKmZoGx2Z/s400/France+manufacturing.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433983125778104706" /></a><br /><br /><blockquote>Commenting on the Markit/CDAF France Manufacturing PMI final data, Jack Kennedy, economist at Markit, said:<br /><br />“The recovery in the French manufacturing sector remained intact at the start of 2010. Output rose at the strongest rate for almost nine-and-a-half years in January, as the rebound from the record contraction seen in early 2009 continued. While domestic demand remained the primary driver of growth, there was also evidence of strengthening export sales, indicating a broad-based expansion. However, staffing levels continued to be cut as manufacturers targeted cost savings and productivity gains at a time when input price inflation reached a sixteen-month high.”</blockquote><br /><br />In Sweden, activity simpled roared ahead, and the Silf / Swedbank Sweden Manufacturing Purchasing Managers' Index stood at a seasonally adjusted 61.7 in January, well above December's 58.2. The production sub-index surged to 70.2 in January from 59.7 in the previous month. The new orders sub-index climbed to 66.8 from 63.7, with the new export orders sub-index gaining 4.2 points to 62.3. Despite the improvement in new orders and production, employment levels were slashed again. The employment sub-index stood at 49.6, up slightly from 49.5.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgNnP0Q9-A2iZ8uFfYeguxxD18AIRn3UkHIe6PlZMYAnejZ2D0ynuVXfBYB1aoyrRlyAZHDY4xXRLtde20qJhUvTsIN1Xfs_CIL-qMR3Iek3osVFb6jMemkXV4Y6Rgx3TetrtpSTW4x4EDb/s1600-h/Sweden.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 227px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgNnP0Q9-A2iZ8uFfYeguxxD18AIRn3UkHIe6PlZMYAnejZ2D0ynuVXfBYB1aoyrRlyAZHDY4xXRLtde20qJhUvTsIN1Xfs_CIL-qMR3Iek3osVFb6jMemkXV4Y6Rgx3TetrtpSTW4x4EDb/s400/Sweden.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433981708754860818" /></a><br /><br />In Spain January data pointed to a further deterioration of operating conditions at Spanish manufacturing firms. Both output and new orders fell at faster rates than in the previous month, while employment continued to decrease sharply. Companies offered discounts to clients in an attempt to boost sales, despite input costs rising again during the month.<br /><br />The seasonally adjusted Markit Purchasing Managers’ Index remained well below the 50.0 no change mark, edging up slightly to 45.3 in January, from 45.2 in December, indicating that business conditions deteriorated for the twenty-sixth successive month. Production contracted for the sixth month running in January, and at a steeper rate than was registered in the previous month. The latest decline reflected a further reduction in new business.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiW5QFBktbuGdnBAjIB7ndfBl6giJGyr-OKTlyArVz7q0RH9VUx2vmINJQRCSGUSH2FfsGK-BRqciDc2MRBb-qt9ssssbw4IvspKmNjiLg7bhWqjr7-nXSTAcIaTqFQhPmuZpKWQNu-_64/s1600-h/Spain.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 220px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5433245535933587218" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiW5QFBktbuGdnBAjIB7ndfBl6giJGyr-OKTlyArVz7q0RH9VUx2vmINJQRCSGUSH2FfsGK-BRqciDc2MRBb-qt9ssssbw4IvspKmNjiLg7bhWqjr7-nXSTAcIaTqFQhPmuZpKWQNu-_64/s400/Spain.png" /></a><br /><br /><br /><blockquote>Commenting on the Spanish Manufacturing PMI survey data, Andrew Harker, economist at Markit, said:<br /><br />“The Spanish manufacturing sector began the new year with output, new orders and employment all continuing to fall. The steepest decline in input buying for seven months highlights the lack of confidence in the sector, with firms reluctant to invest in new stock until sales have been secured. Manufacturers were again forced to cut prices in January as weak demand made it difficult to pass on higher raw material costs to clients.”</blockquote><br /><br /><br /><strong>Central and Eastern Europe</strong><br /><br />Turkish manufacturing sector started 2010 on positive footing as output and new orders rose at robust rates. Increased new orders from overseas continued to provide support to expansion of sector, and the growth in employment was sustained. Higher input cost inflation however droves a further rise in output prices. The headline index posted 53.0 in January, indicating a solid improvement of business conditions in the Turkish manufacturing sector. The rate of expansion accelerated since December, and was the strongest in four months.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiObjLWxehXxYL9_oXwex1z4ahU80XsTsD3GFuXAYN11fximhE5U0Pjhdgjixdhp_-aOTPj5N9DAGHB5q8ldiWbm3HBIvn_0dbIl-8VdSu9reUYuDIoWDUEH50eUv6jLiVuM9-nQ5d43w2D/s1600-h/Turkey.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 222px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiObjLWxehXxYL9_oXwex1z4ahU80XsTsD3GFuXAYN11fximhE5U0Pjhdgjixdhp_-aOTPj5N9DAGHB5q8ldiWbm3HBIvn_0dbIl-8VdSu9reUYuDIoWDUEH50eUv6jLiVuM9-nQ5d43w2D/s400/Turkey.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433983255991553314" /></a><br /><br /><blockquote>Commenting on the Turkey Manufacturing PMI survey, Dr. Murat Ulgen, Chief Economist for Turkey at HSBC said:<br /><br />“The Turkish manufacturing sector has started 2010 with a solid expansion rate, thanks to robust increases in new orders and output. Overall manufacturing activity has also gained traction, breaking the five-month streak of deceleration in the pace of growth since July. Export order growth was also strong, reflective of an improvement in Turkey’s export markets. Manufacturers continued to slash their finished goods inventories in order to partially fulfil rising orders, while backlogs of work were also reduced for the third month. Employment conditions maintained their favourable trend, improving for the eighth consecutive month. On the other hand, the ominous outlook on cost pressures remained intact in January, as input prices continued to rise much faster than output prices, possibly because of soaring raw material prices. This tells us that inflationary pressures are in the pipeline and businesses may pass on rising costs to their end prices when they feel more comfortable about aggregate demand conditions.”</blockquote><br /><br />Business conditions in Russia’s manufacturing sector showed tentative signs of recovery at the start of 2010, according to January survey findings from VTB Capital. Output rose for the sixth straight month, and at a faster rate as new orders increased for the first time since last October. Employment continued to fall, but at a much slower rate than the trend pace recorded over late-2008 and 2009. Inflationary pressures strengthened, but remained relatively weak. The headline seasonally adjusted Russian Manufacturing PMI posted above the no-change mark of 50.0 for only the second time in the past eighteen months in January, indicating an overall improvement in operating conditions in the sector. The latest PMI reading reflected stronger positive contributions from the output, new orders and suppliers’ delivery times indices, and less negative effects from the employment and stocks of purchases components. That said, the latest reading of 50.8 signalled only a marginal overall improvement in conditions, and was below the long-run trend of 52.1.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHU1igx-y-7s-68dFtu8SxOW2vHaK9G7W3yWqUJepBZYS70PVa18fVi7vXgWqsTN7H_u4vqtZYQYcaSGqxeqojYaSYpKgGwHs5BiLk5EQJClqAS4tlnFZa1ipT3yrKjXZzKIUYjjt99UrJ/s1600-h/Russia.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 241px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHU1igx-y-7s-68dFtu8SxOW2vHaK9G7W3yWqUJepBZYS70PVa18fVi7vXgWqsTN7H_u4vqtZYQYcaSGqxeqojYaSYpKgGwHs5BiLk5EQJClqAS4tlnFZa1ipT3yrKjXZzKIUYjjt99UrJ/s400/Russia.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433984089208173554" /></a><br /><br /><blockquote>Commenting on the survey, Dmitri Fedotkin, economist at VTB Capital, reported:<br /><br />“January’s Manufacturing PMI rose to 50.8, the second reading pointing to an expansion across the sector over the past 18 months. The headline number was supported by new orders crossing the no-change 50 level to reach 53.0, while new export orders also rose (50.8). The output index rose to 52.3, pointing to production rising for six straight months and supporting the recent upturn in official statistics. In addition, at 48.2 the employment index improved for the fourth month running with further stabilization expected on the job market. The input price index rose to 61.4 amid higher commodity prices and freight charges while the output price index rose to 54.0 as companies tried to pass rising costs on to customers.”</blockquote><br /><br /><br />Hungary's manufacturing purchasing manager index (PMI) jumped 4.4 percentage points to 53.5 points in January 2010, the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM) reported on Monday. This marks a halt in the contraction of the manufacturing industry that had started in September 2008. Hungary's manufacturing PMI stood at 53.5 in Jan 10, up by 4.4 ppts from Dec 09. This is the first time since August 2008 when the index is above 50. (The Dec reading was revised upward to 49.1 from 48.5 originally).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEzvH5ng1MTBJBOR3aEmOBYFJdiOOrHd6ZFYsPgDtE7gr3ERjxWGTXZtUPWJGL56hqaWrISNCDpAADkSgIjq_Qi3NLFBx77uC3oQhNf_Nl-mUknMFA1zZM0BtqmzXUvn8XONzzXHh3dogK/s1600-h/Hungary.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 229px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiEzvH5ng1MTBJBOR3aEmOBYFJdiOOrHd6ZFYsPgDtE7gr3ERjxWGTXZtUPWJGL56hqaWrISNCDpAADkSgIjq_Qi3NLFBx77uC3oQhNf_Nl-mUknMFA1zZM0BtqmzXUvn8XONzzXHh3dogK/s400/Hungary.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433984668575785282" /></a><br /><br />HSBC survey data for the Polish manufacturing sector signalled an overall improvement in business conditions in January, in stark contrast to the marked contraction posted one year earlier. The headline HSBC Poland Manufacturing PMI posted 51.0 in January, having been unchanged at a near two-year high of 52.4 in the previous month. Any figure greater than 50.0 represents an overall improvement in business conditions. The PMI remained above its long-run trend of 49.5 in the latest period.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgC0Xpot9CKD2BN2trw5E3PRqXcwe3C8j7xxt8ue50hWVzSSmcsFw1gKaFBGWp3_T75RRCg69JO0RvNX6-6kx1HKT_nkC55vuz4SwqLfA416WPLYCTwkgSiRXF-P2uTYFeBPUQGnaY3dEax/s1600-h/Poland.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 231px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgC0Xpot9CKD2BN2trw5E3PRqXcwe3C8j7xxt8ue50hWVzSSmcsFw1gKaFBGWp3_T75RRCg69JO0RvNX6-6kx1HKT_nkC55vuz4SwqLfA416WPLYCTwkgSiRXF-P2uTYFeBPUQGnaY3dEax/s400/Poland.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433984955961388546" /></a><br /><br /><blockquote>Commenting on the Poland Manufacturing PMI survey, Kubilay Ozturk, economist at HSBC, said:<br /><br />“The headline PMI remained above break-even in January, but the momentum that prevailed in the last two months of 2009 appears to have lost some steam, with slower expansions in output and new orders. Domestic and external demand continued to improve over the month, albeit at a slower pace, particularly for the former. A decline in the employment index after a long-awaited rise in December confirms the labour market is not out of the woods yet, while the noticeable drop in output prices indicates a benign inflation environment ahead. Overall, the reading is a reminder that a straight-line recovery may not be that likely, although the Polish economy will continue to outperform its regional peers in 2010.”</blockquote><br /><br />Czech manufacturing output grew at fastest rate since March 2008 and the latest PMI data compiled by Markit for HSBC showed an overall improvement in business conditions for the third month running in January. Moreover, the rates of growth for both output and new orders accelerated, and were sharper than the averages over eight-and-a-half years of data collection for the survey. Meanwhile, manufacturers shed jobs at a slower pace and continued to cut charges to support sales drives. Supply delays were again registered as firms raised purchasing volumes. The headline HSBC Czech Republic Manufacturing PMI rose to 53.1, signalling a robust overall improvement in business conditions.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjUcxiVJ1wnpKnYBdGkrLKt4a894Np4JaYyvxRIPpnyZkdFhhDlhQXCZHrOFRVIonmy90x_hs1gOXnCmEtcMimFggs86hy8HWclpOc5byzxwhECO581Jooef4feuKlDpXz-mv-FsXrmx0L4/s1600-h/Czech+Republic.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjUcxiVJ1wnpKnYBdGkrLKt4a894Np4JaYyvxRIPpnyZkdFhhDlhQXCZHrOFRVIonmy90x_hs1gOXnCmEtcMimFggs86hy8HWclpOc5byzxwhECO581Jooef4feuKlDpXz-mv-FsXrmx0L4/s400/Czech+Republic.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5433985419146239090" /></a><br /><br /><blockquote>Commenting on the Czech Republic Manufacturing PMI survey, Kubilay Ozturk, economist at HSBC said:<br /><br />“The headline index improved noticeably in the first month of 2010 on the back of a remarkable increase in output and a solid rise in new orders, underlining the uninterrupted improvement in demand. Both external and domestic markets appear to have been on the mend in January, suggesting a wider economic recovery is under way. The latter was also confirmed by a leap in firms’ purchasing volumes over the month. However, subdued increase in EMU manufacturing PMI in January and the downside surprise in a flash estimate for German 2009 growth suggest the impact of fiscal stimuli and car-scrappage schemes in Western Europe may fade earlier than expected, implying recovery may be gradual and bumpy.”</blockquote>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-69571304946751922242010-01-21T16:58:00.000+01:002010-01-21T16:59:04.490+01:00Hungary Isn't Another Greece........Now Is It?I couldn't help being struck earlier this week by the following statement in an interview <a href="http://www.ft.com/cms/s/0/a73eb1ce-03a1-11df-a601-00144feabdc0.html"> the Financial Times had with Hungarian Finance Minister, Peter Oszkó</a>:<br /><blockquote>"Structural reforms of the pension and social welfare systems, plus a rebalancing of the tax system, should allow the government to report a 3.9 per cent budget deficit in 2009, on a par with the preceding year and in line with IMF requirements".</blockquote>"Structural reforms", I asked myself, "exactly which structural reforms are we talking about here?" Certainly the EU Commission and the OECD have been pounding away at the Hungarian authorities on the pressing need for major changes in the health and pension systems (these areas - and the way they are rising as the population ages - are, after all, the underlying cause of the structural deficit in the Hungarian budget). In fact it seems to me that the FT is merely re-iterating here Peter Oszko's own claim that the government's austerity measures are working (and no matter how many times you repeat something, it doesn't make it true).<br /><br />As I have argued <a href="http://hungaryeconomywatch.blogspot.com/2009/12/hungarys-economic-correction-still.html">time</a> and <a href="http://hungaryeconomywatch.blogspot.com/2009/09/as-hungarys-correction-heads-for-dead.html">time</a> (and <a href="http://hungaryeconomywatch.blogspot.com/2009/07/hungary-struggels-to-apply-its-own.html">time</a>) again, major doubts remain about whether the recent "austerity" measures (whether we are talking about the post June 2006 package, or the 2009 one) have really done anything substantial to restore long term competitiveness to the Hungarian economy, since the only measures which could come near to being called "structural reforms" which have been implemented to date are the withdrawal of a 13th month pension payment together with cuts in the maternity leave system (and these are not really "reforms" at all, but deficit reducing measures). The rebalancing of the tax system the FT refers to is the shift from payroll and income to indirect taxes, which could make labour cheaper to employ, but since the reduction is countebalanced by an increase in consumption tax (which weakens domestic demand) to date the only visible consequence has been a sharp fall in retail sales, while we have seen little in the way of noticeable impact on either employment or on Hungarian exports.<br /><br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjI-kLotaeUM7B7zDwZICtWXkh8SxwdnWnwqKrAn6uD3xOcWOCEfUEVbRlo-DoigiJeJwiaHFA-Xf1kocjovRdaKCkgRGy0oUkrW6BTjENMzk_bsoI61Uyyt2nl6WXSFX1pCJmntrVNXR8/s1600-h/Total+Employment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5429091294915306194" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjI-kLotaeUM7B7zDwZICtWXkh8SxwdnWnwqKrAn6uD3xOcWOCEfUEVbRlo-DoigiJeJwiaHFA-Xf1kocjovRdaKCkgRGy0oUkrW6BTjENMzk_bsoI61Uyyt2nl6WXSFX1pCJmntrVNXR8/s400/Total+Employment.png" /></a><br /><br />Indeed the situation is rather worse than the above chart suggests, since the anti crisis measures have lead to a sharp increase in public employment.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2dUoySg-zPiikxSHrNqJJ7gUdyaA65BQGo6oYhu3XRz7DzlCx-vnCQylVLYyEiic-RWDZOyaR_wsTPiyNYTMV9bxAV2XOdj0sfGK-galxakulGCqhrm8EVodMnmIFV9V5vN_FSvnYEYc/s1600-h/Hungary+public+sector+employment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5429091831319746002" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh2dUoySg-zPiikxSHrNqJJ7gUdyaA65BQGo6oYhu3XRz7DzlCx-vnCQylVLYyEiic-RWDZOyaR_wsTPiyNYTMV9bxAV2XOdj0sfGK-galxakulGCqhrm8EVodMnmIFV9V5vN_FSvnYEYc/s400/Hungary+public+sector+employment.png" /></a><br /><br />while private sector employment has fallen quite sharply.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiL5hkO2FbMpmYujxOBzPmGnXD1cxU7_GyA7ma-s5IuZMCv97npsuBeRgzrr7xhMY38wBMBHXCq9Y2lGxI1yawGcNkrbgbLOvTf5qxH6DWS3VLdzSRSE6SVP8Bq6fS_P0e-hukO2DTEWJ0/s1600-h/hungary+private+employment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5429092225283192274" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiL5hkO2FbMpmYujxOBzPmGnXD1cxU7_GyA7ma-s5IuZMCv97npsuBeRgzrr7xhMY38wBMBHXCq9Y2lGxI1yawGcNkrbgbLOvTf5qxH6DWS3VLdzSRSE6SVP8Bq6fS_P0e-hukO2DTEWJ0/s400/hungary+private+employment.png" /></a><br /><br />Peter Ozsko has also been appearing in the press in recent days to inform us that Hungarian 2010 gross domestic product numbers could be positively revised when compared with an earlier government forecast for a 0.6 percent fall. His reasoning - as put to Reuters - is that "export markets will perform better so there is a better outlook for the country." In fact <a href="http://www.reuters.com/article/idUSWEA195420091119">what he said</a> was that he expected the country to return to quarter-on-quarter growth in either the second quarter or third quarter of next year - a possibility that is certainly not excluded. What he did not say - although some newspapers seem to have implied this - was that annual growth would be positive. "That does not mean growth, but at most a smaller contraction," <a href="http://www.budapesttimes.hu/content/view/13778/159/">the finance ministry told Reuters later</a>, in order to clarify the reported comments. </p><br /><p>The correction to the earlier optimistic interpretation seems totally warranted, since the Organisation for Economic Co-operation and Development currently expect eurozone real final domestic demand to stagnate in 2010, with the Germany economy being forecast to grow by only 0.2 per cent, so it is hard to see the export market in the country that is Hungary's main customer giving that much-needed lift to Hungarian exports.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhD87oz9wAh9yLNQ1EYugcxjOM6Aqj6TO_slK2wIDY5xs-Nf_IzeSgRzmy6PcOSj_vUjQpw-OgtVU5A5PtKo7F-sVAjEFdVFQLjZGnjzgzqqLCDImHdD7LgX6c6cDEmgDFbzpg4oCA6U7g/s1600-h/hungary+exports+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 222px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5429179528429354162" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhD87oz9wAh9yLNQ1EYugcxjOM6Aqj6TO_slK2wIDY5xs-Nf_IzeSgRzmy6PcOSj_vUjQpw-OgtVU5A5PtKo7F-sVAjEFdVFQLjZGnjzgzqqLCDImHdD7LgX6c6cDEmgDFbzpg4oCA6U7g/s400/hungary+exports+two.png" /></a><br /><br />But even beside this point, it is hard to see any forseeable increase in exports making up for the drop in domestic demand. In the first place Hungary has badly lost international competitiveness in recent years.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjIqr1uTuT6BbfS1UOpeQ1kq1r8fd0vIxc0JtsD8cf4ePT_9-3Ho3VSeuEBSeZRMg6nAlFDOiUYb8aIqbs5nXLxs4MfTZQ0IBh574oq6xwjm3Zsfvtx9726ndJZzpurigEF4UUjXtpD0YU/s1600-h/Hungary+REER.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5429180268377133266" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjIqr1uTuT6BbfS1UOpeQ1kq1r8fd0vIxc0JtsD8cf4ePT_9-3Ho3VSeuEBSeZRMg6nAlFDOiUYb8aIqbs5nXLxs4MfTZQ0IBh574oq6xwjm3Zsfvtx9726ndJZzpurigEF4UUjXtpD0YU/s400/Hungary+REER.png" /></a><br /><br />And in the second both the Forint and consumer price inflation have been rising of late, only adding to these competitiveness problems. The best guess is that the Hungarian economy contracted by around 7% in 2009, yet despite this Hungarian consumer prices continued to rise, and are now up a whopping 72% on the 2000 level, yet the Forint has only fallen around 8% over the same period.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4ucSgaicUoPgWRynqreX1s8kxoS7fXB7-qR8MD8xRD_HhTDO0q2WML6XjlqQR18G0jjTMHRMaxc1Yhz9UZ9ZAqITrVJhB4M_IK6U-SfPI9aU5x2-YKMFFE9OctAPT_qCyEFmxpRGFtyc/s1600-h/Ten+year+forint+chart.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 248px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5428440654955708690" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj4ucSgaicUoPgWRynqreX1s8kxoS7fXB7-qR8MD8xRD_HhTDO0q2WML6XjlqQR18G0jjTMHRMaxc1Yhz9UZ9ZAqITrVJhB4M_IK6U-SfPI9aU5x2-YKMFFE9OctAPT_qCyEFmxpRGFtyc/s400/Ten+year+forint+chart.png" /></a><br /><br />Something seems badly out of line in Hungarian policy. As Mark Pittaway, Senior Lecturer in European Studies at the UK Open University points out, the difficult issue for Hungarian economic management has always been what to do about the external debt. </p><br /><blockquote>The key is public debt, and the decision to which every Hungarian government has held to, not to ask for any re-scheduling and to insist on its precise repayment. This has forced the government to pursue consistently policies based on overly high interest rates to attract capital into the country - and this has been consistently the case since 1988-9.<br /><br />During the transition period this had two effects - to deny domestic businesses of credit, and to make it difficult for them to export given that the consequence was an overly strong Forint. In addition, the first post-1990 government was among the first to fully implement its bankruptcy law (earlier than Poland, and way earlier than either the Czech Republic and Slovenia) in 1991, in the depths of the first recession. The real economy was sacrificed on the altar of the financial stability of the state given the decisions made about public debt (remember the Czech debt was small, Slovenia de-facto defaulted on its share of the Yugoslav debt and eventually renegotiated it, and Poland gained partial forgiveness).</blockquote><br /><br />Hungarian gross government debt is now expected by the EU Commission to hit over 80% of GDP in 2011, but this is hardly the issue, since unless growth and competitiveness can be restored to the economy, the ageing and shrinking working age population problem will lead to what Moodys recently called (in the Greek and Portuguese cases) a slow death.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvld8ul3lHKJwBzmslsPsCghl4UPS6vevGR96dWXWOwyuigF_edjztIOX1fbj-ORmSJPGxp8UxpubjC5hyphenhyphenIDUSatfTbBQ0-pB6kiyZqfuAeCCan4mqvjLTSxa5XED-SF1ddZwvlhAz0t4/s1600-h/Hungary+gross+government+debt.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 226px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5429188801393399090" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjvld8ul3lHKJwBzmslsPsCghl4UPS6vevGR96dWXWOwyuigF_edjztIOX1fbj-ORmSJPGxp8UxpubjC5hyphenhyphenIDUSatfTbBQ0-pB6kiyZqfuAeCCan4mqvjLTSxa5XED-SF1ddZwvlhAz0t4/s400/Hungary+gross+government+debt.png" /></a><br /><br />And to the large government debt must now be added the indebtedness of households in Swiss Francs, which simply reinforces an "unrealistically" high forint policy, as Mark says, sacrificing the future of the real economy to the needs of maintaining financial stability.<br /><br />And during the term of the present government the situation has only worsened, since last week the Hungarian Central Statistical Office announced that the consumer price index rose 5.6% year-on-year in December (see chart above), up from the 5.2% growth in the previous month, and well above the average consumer price inflation for 2009 of 4.2%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLQdacACS_H0qJ7q1hziaheY6zW4FuJPh0LRkRzvqdtnW7DS0l_89fYKz05bqnBNFELk81BIXzPDrxeG1MyVFTzZqGFurLMD6F15M3BHomUfEQbdJCK-6xsZws5Mcj3U6uH72HfI7vGDw/s1600-h/hungary+CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 229px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5428447940433506242" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLQdacACS_H0qJ7q1hziaheY6zW4FuJPh0LRkRzvqdtnW7DS0l_89fYKz05bqnBNFELk81BIXzPDrxeG1MyVFTzZqGFurLMD6F15M3BHomUfEQbdJCK-6xsZws5Mcj3U6uH72HfI7vGDw/s400/hungary+CPI.png" /></a><br /><br /><br />And the culprit isn't hard to spot, since the government raised the VAT rate in June by 5%. The impact on retail sales was not that hard to imagine either - they were down an annual 7.5% in October, and by a seasonally adjusted 0.6% on September.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvpyF2caRVW4iERhMHDPOm6NbFXeHYgUOVkVJsYaMcdBjBBIUOmzUvH47gGYgz2oMgZTK7gVUPSS6iTvyhrPIZqFw-NNff0Vudm_dVAj18RGcxCrh1itWLw0NDK49ZkdR9ySWZ8XEUBwA/s1600-h/hungary+retail+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 232px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5428443260417978626" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgvpyF2caRVW4iERhMHDPOm6NbFXeHYgUOVkVJsYaMcdBjBBIUOmzUvH47gGYgz2oMgZTK7gVUPSS6iTvyhrPIZqFw-NNff0Vudm_dVAj18RGcxCrh1itWLw0NDK49ZkdR9ySWZ8XEUBwA/s400/hungary+retail+two.png" /></a><br /><br /><strong>Elections Loom In Hungary</strong><br /><br />And on top of all these issues, Hungary is shortly to have elections, a situation which is leading to all sorts of speculation about what might happen to the deficit. According to a recent research report from HSBC analyst Kubilay Ozturk, there is a clear risk that Hungary's budget deficit could deviate from the current fiscal path agreed with the International Monetary Fund (IMF), if - as seems likely - opposition party Fidesz assumes power later this year. While this year's budget deficit may well come in on target, economists close to the opposition party have been warning that the 2010 deficit could balloon again to 7% of GDP. The ins-and-outs of the argument are complex (since the figure is based on incorporating debt accumulated in state owned entities), but clearly the IMF would not be happy at such a development. But then Peter Ozsko argues <a href="http://www.portfolio.hu/en/cikkek.tdp?h=16&k=2&i=19313">Hungary may well no longer need the IMF money</a> - which is only well and good, since the lending agency <a href="http://www.portfolio.hu/en/cikkek.tdp?k=2&i=19337">have specifically warned against declaring this level of deficit</a>, and may be hard to convince if the deficit figure starts to head north again.<br /><br /><blockquote>Today, the IMF has warned Hungary again that it would not tolerate the country’s budget deficit swelled to 7.0% of GDP this year, a level envisaged by the opposition party Fidesz, the likely winner of this year's general elections. The government targets a budget shortfall of 3.8% of GDP, under its IMF-European Union credit line. In an interview with Dow Jones, IMF Hungary representative Iryna Ivaschenko noted that "the definitions [of government debt]are not always comparable, so you should not compare the 3.8% [of GDP] with the 7%. You cannot say they are not right, but it is comparing apples and oranges." "But if you do take, consistent with our definition, the deficit all the way to 7% [of GDP], such policies can clearly not be tolerated, because that would undermine fiscal sustainability and be detrimental for market confidence," Ivaschenko added.</blockquote><br />But what if Fidesz simply didn't want to accept the unpopularity for a policy which may not be working, and a further fiscal squeeze? The political logic of coming straight out with a "they have overspent" type of argument could be compelling, although it should be remembered what just happened to the last government who did this (in Greece), or what happened in Hungary in June 2006, after the then Prime Minister Ferenc Gyurcsany's "<a href="http://news.bbc.co.uk/2/hi/europe/5359546.stm">lies morning noon and night</a>" speech.<br /><br /><blockquote>"I know that this is easy for me to say. I know. Do not keep bringing it up against me. But this is the only reason it is worth doing it. I almost perished because I had to pretend for 18 months that we were governing. Instead, we lied morning, noon and night. I do not want to carry on with this".</blockquote><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1YCbuabehgXgnLOop0JztS5C-fejR-s_JCtl-0KzyUFLGooTcmvbJ_ZFXkHJy0ishyphenhyphendZr3A-ajsJ_xJxAGHNEaoOBxY-oTanN6JgH3UmNFsB5DmHJSpMsF3amHkDZXdNbj8HXtu7KEAU/s1600-h/Hungary+fiscal+deficits.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 228px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj1YCbuabehgXgnLOop0JztS5C-fejR-s_JCtl-0KzyUFLGooTcmvbJ_ZFXkHJy0ishyphenhyphendZr3A-ajsJ_xJxAGHNEaoOBxY-oTanN6JgH3UmNFsB5DmHJSpMsF3amHkDZXdNbj8HXtu7KEAU/s400/Hungary+fiscal+deficits.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5429198827992261474" /></a><br /><br />That time the country had to admit to a fiscal deficit which was way beyond what they had been talking about previously, and the country then enetered a financial crisis which has now lasted three and a half years. Of course, this time nothing so dramatic will have been happening (there has been an IMF programme in place), but this does not mean problems may not arise, since financial markets are, after all, extremely nervous. And certainly analysts are anticipating upward movement in the 2010 deficit level. <a href="http://www.portfolio.hu/en/cikkek.tdp?k=2&i=19346">As Portfolio Hungary notes</a>: "The market is now more convinced than a month ago that Hungary will not meet its budget deficit target in 2010, the consensus estimate of analysts showed in a Reuters poll on Thursday. The median forecast for Hungary’s 2010 budget deficit came to 4.4% of GDP, up from 4.1% a month ago". <br /><br /><br /><strong>Greece Serves As the Example</strong><br /><br /><blockquote>"We don’t need IMF money any more and my expectation is that since Hungary is targeting the same track for the future, we won’t need financial help." <br />Peter Oszkó, Hungarian Finance Minister<br /><br />'We are not expecting anyone to come to our rescue. Greece has not asked for it, nor is it expecting anything of that sort....We will be able to satisfy our borrowing requirements in international markets in the next weeks and months, according to the schedule we have,' <br />George Papaconstantinou, Greek Finance Minister</blockquote><br /><br /><br />So if Hungary does, as seems quite possible, decide not to take up more loans from the IMF, where exactly does that leave the country? Who will have the leverage to ensure the structural reforms which evidently are still needed. Evidently Greece can give us some indication, since while at the present time it is not totally clear whether or not the Mediterranean country will finally have to go the IMF itself, Europe's institutional structure is changing rapidly as a result of the challenge which Greek statistics and debt have presented for all the other EU countries. Only this week Europe's Finance Ministers warned Greece that it had to step up its efforts to tackle a fiscal crisis that threatens to spread to other countries across the region. <br /><br />Indeed the bulk of the discussion an the finance ministers meeting was occupied up with their concerns over Greece, since despite being in the eurozone, the country's credit ratings have plunged following the revelation that its government deficit estimates for 2009 were grossly understated.<br /><br />Greece has now presented the commission with a new plan aimed at cutting its deficit from the currently estimated 12.7 per cent of gross domestic product to below the EU's threshold of 3 per cent of GDP by the end of 2012. As a result of that report, the commission will propose an action plan in February and will 'lay down certain dates from June onwards in order to launch a discussion at least three times during the rest of the year on how the programme and reforms are going to be implemented,' according to Commissioner Almunia. That is, progress in deficit correction procedures will now be carefully monitored. As many observers have commented, this is the closest the EU has so far come to putting its hand directly on the economic policy of a eurozone member. 'The Greek programme concerns Greece firstly, but also concerns all the eurozone,' Luxembourg Finance Minister Jean Claude Juncker said on leaving the meeting.<br /><br />The Credit Rating agency Moody's Investors Service maintained its negative outlook on Greece following the announcement of country's stability and growth program saying that while the Greek government's plan to restore its fiscal credibility, reform its tax system and combat tax evasion is relatively well designed, at least for the short term, uncertainty remains about the Greek government's ability to implement the program. That is to say, it is action not words which now matter in the financial markets, and both Greek and Hungarian governments would do well to remember this.<br /><br /><strong>Where Does Greece Go From Here?</strong><br /><br />The next step is for the EU Council to set a deadline for when the Greek government must achieve its goals. This deadline is likely to be 2012, simply because the Greek government itself has set this target. All the relevant recommendations will finally be endorsed by euro zone finance ministers at their next meeting on Feb. 15-16 when they formally give notice to Greece to reduce the deficit, marking the last stage of the procedure before sanctions of various kinds that are provided for under the EU Stability and Growth Pact.<br /><br />Greece will then have four months, so until June, to act on the recommendations for policy action endorsed by the ministers. If it acts in a way which the Commission consider to be consistent with the undertakings given, the excessive deficit procedure will be then held in abeyance, until Greece reaches its target of a deficit below 3 percent. If, at the end of the three year period the Commission believes that the improvement is sustainable, it will ask the ministers to end the excessive deficit procedure.<br /><br />If on the other hand the Commission decides in June that Greece has not complied (unlikely), the Finance Ministers can then consider imposing sanctions. Since such measures should be imposed no later than 16 months after the decision that Greece had an excessive deficit, which was taken on April 27, 2009, the time scale would imply August 2010.<br /><br /><br /><br />The sanctions envisaged in EU agreements first take the form of a non-interest-bearing deposit with the European Commission and comprises:<br /><br />* a fixed component equal to 0.2 percent of GDP;<br /><br />* a variable component equal to one tenth of the difference between the deficit as a percentage of GDP in the year in which the deficit was deemed to be excessive and the reference value of 3 percent of GDP.<br /><br />The deposit cannot, however, be higher than 0.5 percent of GDP per year. If Greece were to find itself at that stage, this is how much it would have to pay.<br /><br />Sanctions could also include:<br /><br />- stopping the EU's cohesion funds to Greece.<br /><br />- stopping credit from the European Investment Bank.<br /><br />- asking Greece to issue additional information, as specified by the ministers, before issuing bonds and securities.<br /><br />If Greece continued to ignore the recommendations, ministers could in 2011 intensify the sanctions by requiring an additional deposit equal to one tenth of the difference between the deficit as a percentage of GDP in the preceding year and the reference value of 3 percent of GDP.<br /><br />If, after two years, the deficit still remains above 3 percent, the deposit is converted into a fine. If the deficit falls below 3 percent, the deposit is returned.<br /><br />The interest on the deposits lodged with the Commission and the yield from any fines is distributed among EU countries without an excessive deficit, in proportion to their share of the total gross national product of those eligible.<br /><br /><strong>Commission Powers Now To Extend Well Beyond Monitoring Deficits</strong><br /><br />Luxembourg Finance Minister Jean-Claude Juncker also announced that there was about to be an overhaul of how the 16 nations using the euro coordinate their economies, with countries being be formally warned if they are running much higher inflation, average wage rises or current account deficits than their neighbors. Juncker said Finance Ministers are about to get involved into a range of far wider issues on how the economy is run, including government policies on structural reforms - such as making labour markets more flexible.<br /><br />From next month, countries will probably be warned by the European Commission if their countries differ too much from the rest of the euro zone on broad policy guidelines or on specific areas such as inflation, wages or current account deficit. That warning would not be backed by any penalty.<br /><br /><blockquote>"We need to broaden surveillance in the euro area," Juncker said, adding that closer monitoring should also extend to European countries whose currencies are linked to the euro and who hope to join the currency zone, such as Estonia and Latvia.</blockquote><br /><br />So, Hungarian politicians be warned- You are not Greece right now, but you could so very easily end up where that poor, unfortunate country finds itself, and especially so if you make wildly optimistic growth scenarios, and debt to GDP forecasts, and doubly so if you think that coming out of the loving arms of the IMF will leave you free to go about your business as you see fit. The world around you is changing, and you need to get ready to adapt to those changes.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-53941902034885238602009-12-29T12:16:00.000+01:002009-12-29T12:17:28.185+01:00Hungary's Economic Correction Still Fails To Convince<blockquote>"Hungary’s potential economic growth should be 2 percentage points over the corresponding EU figure in order to ensure convergence".<br />Prime Minister Gordon Bajnai, speaking in London in October </blockquote>Two contrasting pieces of news about Hungary's economic plight have caught my eye over the last week. In the first place, and in an evident sign of the times, retail sales reportedly fell at their fastest annual rate in over ten years in October, whilst secondly, and more surprisingly, I learnt that Hungary’s economic-sentiment index rose to its highest level since October last year, when the gale force wind sent by the fall of Lehman Brothers engulfed the country. How can this be, I thought? These two pieces of information would, at least on the surface, seem to be pretty contractictory, with the former suggesting the deepest recession in living memory is getting even worse, while the latter seems to add backing to government claims that the worst is now behind them.<br /><br /><strong>Gloomy Days Ahead For Consumer Spending</strong><br /><br />Hungary’s retail sales dropped 0.6% month on month in October, just slightly more than they did in September (-0.5%). In fact Hungary’s retail sales have risen only twice in monthly terms over the past 12 months, and one of these months was June (+0.2%) when consumer anticipation of an impending 5% VAT hike drove large crowds into furniture and household electronics stores. Not unexpectedly this was followed by the July numbers, which saw the largest monthly drop in a decade (-2.3%).<br /><br />But a glance at the chart below should also reveal that the decline in retail sales is now long term, and not just a product of the recent crisis. Sales peaked in mid 2006, and have since been falling steadily, and while the year-on-year drop was as large as 7.5% in October - another decade long negative record - in fact they are now down nearly 12% from the August 2006 peak, and there are no strong grounds for believing that this trend will now reverse. And the reasons are obvious, since in addition to shrinking personal income levels, and a tighter credit environment credit, Hungary's ageing and declining population is also increasingly acting as a damper on household consumption.<br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1qb2ZUVfc_Szg4xKP7nhx7A_3GI4yA_jdLnjYdEfRpwBZ4aScfvKzr6Q8B5IjQIBcWr8XKkbYwLgmWoB7SmFRl4jjfgvEzGTsjVGqNb3cQ9Dd9fS27EJRGZZhwn6em5hoTMVNzDd7Y8U/s1600-h/hungary+retail+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 232px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418870002665822866" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh1qb2ZUVfc_Szg4xKP7nhx7A_3GI4yA_jdLnjYdEfRpwBZ4aScfvKzr6Q8B5IjQIBcWr8XKkbYwLgmWoB7SmFRl4jjfgvEzGTsjVGqNb3cQ9Dd9fS27EJRGZZhwn6em5hoTMVNzDd7Y8U/s400/hungary+retail+two.png" /></a><br />In fact the situation with vehicle and auto part sales (which are not included in Eurostat retail sales) is even worse than the above data indicate, since given that Hungary is in the midst of a fiscal crisis, there is no room for a cash for clunkers type programme, and sales volume fell an annual 40.1% in the ten months to October, with the decline in October alone being 50.5% (following a 52.3% annual drop in September).<br /><br />And there is worse news to come for the car sector, since even though the government hiked both the excise tax on petrol and the rate of VAT to 25% from 20% in July, sending fuel prices up like never before, yet another excise tax increase is now on its way. The excise tax on fuel is set to go up as of 1 January 2010 driving the price of gasoline and diesel up by roughly HUF 11 and HUF 7 a litre, respectively. As VAT is levied also on the excise tax, the VAT burden will also increase even if the rate itself won't change.<br /><br /><strong>Confidence Rises</strong><br /><br />On the other hand according to the GKI sentiment index, confidence is now back at its highest level since October last year, when the credit crisis engulfed the country. The rise follows widely publicised government forecasts that the economy is now heading out of its worst recession in 18 years. The GKI sentiment index rose to minus 25.4 in December from minus 27.5 in November and a record-low of minus 46.2 in April. Business confidence rose to minus 16.7 from minus 18.9 and consumer confidence increased to minus 50.1 from minus 51.9.<br /><br />According to Finance Secretary of State Tamas Katona Hungary’s economic decline bottomed in the third quarter of 2009 and the rate of contraction should ease in the final three months of the year. Katona suggested the economy may shrink 5 percent in the fourth quarter after contracting 7.1 percent in July-September. The economy is likely to contract an annual 6.7 percent this year and 0.6 percent next year before a return to growth in 2011, according to government forecasts (the EU Commission forecast a 6.5% decline in 2009, and a 0.5% one in 2010, while the IMF are predicting a 6.7% drop this year followed by a 0.9% drop next year). In the short term therefore, all are agreed that the economy will keep contracting, even if the possibility of a quarter of positive growth (which would technically mean exiting recession as currently defined) is not excluded.<br /><br />The real issue facing students of Hungarian economic growth is thus not 2009, but the extent of any rebound in 2010 and beyond. It is on this rebound, and the level of inflation associated with it, that the future Hungarian fiscal deficit numbers, and the even more critical debt to GDP numbers, sensitively depend. The EU Commission currently forecasts 3.1% growth in 2011, while the Hungarian Central Bank is forecasting 3.4% growth in 2011 (see chart below).<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheH9DiQvaC9Mx_fbrZGLxDKb0zBAMZtzd42z6hU_LShzRgQ_NR0bQKf7lk2llZ5u5HIXV1tKaSd0-M4it_lijYMURW4q2rg06oalI4aPaxua58h6wB4hy1mm6gEI-4wG5unjzTdjuOWrM/s1600-h/bank+of+Hungary+GDP+forecast.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 264px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420217663096376914" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheH9DiQvaC9Mx_fbrZGLxDKb0zBAMZtzd42z6hU_LShzRgQ_NR0bQKf7lk2llZ5u5HIXV1tKaSd0-M4it_lijYMURW4q2rg06oalI4aPaxua58h6wB4hy1mm6gEI-4wG5unjzTdjuOWrM/s400/bank+of+Hungary+GDP+forecast.png" /></a><br /><br />The question is, are these expectations for such a strong rebound in 2011 really realistic, and even more to the point, <a href="http://www.xpatloop.com/news/hungary_pm_bajnai_dreams_about_4_gdp_growth">is there any evidence for Prime Minister Bajnai's claim that a large number of analysts share his governments view that Hungary’s long term GDP trend growth potential is around 4%</a>. Or put another way is there evidence for support for such an optimistic view of Hungary's growth future beyond the limited circle of economists who promoted the reform manifestoes (like Oriens, CEMI etc) on which current government policy is based? Certainly I can say that this analyst doesn't share that view, and reading around I have difficulty identifying others who do. Even the reasonable and ever moderate Portfolio Hungary were moved to raise an eyebrow at this claim, saying they "read Bajnai’s statement with a measure of surprise, as GDP estimates for Hungary have been typically way below 4%". The most pessimistic forecast they had seen was below 2% (this would certainly be my view, possibly 1% trend growth would be realistic at this stage), and they stated they were unaware of any "serious estimates above the 3% mark". <br /><br />What is so striking (and in my view so unrealistic) about the kind of rosy estimates which are being circulated (as illustrated in the Bank of Hungary forecast chart above), is that not only do the median estimates seem to assume a "V" shaped rebound, even the outer limit, worst case type scenarious are based on the idea of a fairly strong rebound, and almost no consideration is given to the possibility that this may not happen, and that the country may be stuck nearer to an "L" shaped non-rebound, where rates of contraction slow, and slow, but growth proves to be surprisingly elusive and hard to come by.<br /><br />These issues are not new, and I have blogged about then before (in this post - <a href="http://hungaryeconomywatch.blogspot.com/2009/05/hungarys-trend-growth.html">Hungary's Trend Growth And Debt Sustainability</a> - about the scenarios offered for debt repayment in a paper by Lajos Deli and Zsuzsa Mosolygó from the National Debt Agency). Despite protests to the contrary, and despite the IMF's argument that "In emerging market countries with debt overhangs, the “Keynesian” effect of fiscal adjustment is likely to be outweighed by “non-Keynesian” effects related to expectations and credibility" it is really all about growth, more growth, and only about growth. <blockquote>Non-Keynesian effects have to do with the offsetting response of private saving to policy-related changes in public saving. In particular, if fiscal adjustment credibly signals improved public sector solvency, a fiscal contraction could turn out to be expansionary, as private consumption rises based on the view that future tax hikes will be smaller than previously envisaged.<br />IMF - Hungary, Request for Stand-By Arrangement, November 4, 2008</blockquote>The simple issue is, if domestic demand is (for demographic reasons) not able to rebound as the IMF (and the signitaries of the very influential Oriens Report "Recovery, A Programme For Economic Revival In Hungary") imagine, then how is GDP growth going to be strong enough to reduce the weight of debt to GDP?<br /><br />As everyone recognises, if domestic demand remains weak, growth will critically depend on exports, but the export potential of the economy will depend on the pace of recovery elswhere in the EU, and on relative prices as expressed through the value of the HUF, but almost no serious consideration is being given to the possibility that either the HUF is overvalued compared to the need to export or that EU growth may also be weaker and harder to come by than most median forecasts are assuming.<br /><br />And indeed things are worse than they seem at first sight, since Hungary (and Hungarians) are, by and large, not in debt in their own currency, so allowing excess inflation does not sweat down the debt, since it only make export prices less competitive, unless you devalue to compensate, in which case the relative value of the debt is unchanged. But if you refuse to devalue, then, quite simply, you get hoisted on your own petard, which is basically where Hungary is right now.<p></p><p>So, the real question, as ever, is where the ingredients for growth are going to come from. Remember, Hungary's population is now declining steadily.<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi30VVQukqiMPG4wNyG5gFNZjGWRLfEM6lZxaCGwcI1mFBxgQVxIWjMCRf44pm4vD0IpLmBIY-yglx9z9vK7yV8ZAbFYV7KvZzRlulEjKFfTcM3eeWIXQwTQfyM-gGqQ0w5doM6FtsP98g/s1600-h/hungary+population.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 219px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420224174103877746" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi30VVQukqiMPG4wNyG5gFNZjGWRLfEM6lZxaCGwcI1mFBxgQVxIWjMCRf44pm4vD0IpLmBIY-yglx9z9vK7yV8ZAbFYV7KvZzRlulEjKFfTcM3eeWIXQwTQfyM-gGqQ0w5doM6FtsP98g/s400/hungary+population.png" /></a><br /><br />and ageing<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdhZkMo_dfv4Oq0glxnZqYKhHgl8iKh3N8E6e1NdaA9aXD_ikm3G-oEbWwwo7Eca45v6bAjCnzENghT-kK1w2vjHTaGBFXP371oVwU7QmezAj67rFF9QSye63B-I862YqWfBJGDlblNV7M/s1600-h/hungary+median+age.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5339801643991065634" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjdhZkMo_dfv4Oq0glxnZqYKhHgl8iKh3N8E6e1NdaA9aXD_ikm3G-oEbWwwo7Eca45v6bAjCnzENghT-kK1w2vjHTaGBFXP371oVwU7QmezAj67rFF9QSye63B-I862YqWfBJGDlblNV7M/s400/hungary+median+age.png" /></a><br /><br />and the working age population is also irredeemably falling.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM1GLPlzbtLXstgsu1zjAydjq9-B22xVneLQZhaxMTgv8RggmH2CjRWN0eRxB4Eq5oKvjS0HGGUYYFSwv7mP-rJc-2pdlkR5C-F6YliAjLsK3AZ9DLZcofLQ-d9V2Zqk_NFb1pYKhFTt4/s1600-h/Hungary+Working+Age+Population.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 206px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420225441831055330" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM1GLPlzbtLXstgsu1zjAydjq9-B22xVneLQZhaxMTgv8RggmH2CjRWN0eRxB4Eq5oKvjS0HGGUYYFSwv7mP-rJc-2pdlkR5C-F6YliAjLsK3AZ9DLZcofLQ-d9V2Zqk_NFb1pYKhFTt4/s400/Hungary+Working+Age+Population.png" /></a><br /><br />As I said about the retail sales data above, these have now been falling since mid 2006, so it is hard to believe that we are going to see any significant resurgence (taking retail sales as a proxy for private consumer demand), especially as it seems Hungarian's are not now borrowing to anything like the extent they were two or three years ago (see below), and that (for age related reasons it is unlikely the earlier pattern will return. So I will correct myself: it isn't all only about growth, it is all about how to get the exports which can produce the growth. Anyone not recognising that is living, quite simply, in cloud cuckoo land, and after 40 odd years of Stalinist surrealism one would have thought that Hungarians in general had had enough of all this. But perhaps not. Look at the confidence index, and at how many people are prepared to accept Bajnai's assertion that Hungarian trend growth is 4% per annum.<br /><br /><strong>Where Is The Growth Going To Come From?</strong><br /><br /><blockquote>"Looking at the structure of the Hungarian economy I frankly have difficulty seeing where the growth is going to come from. Without a major devaluation (and even then given international circumstances) Hungary will have problems attracting FDI in even the reduced quanities it has been doing over the last five years. The domestically owned private sector has enormous problems and is tied closely to the level of state spending. The financial sector and business services suffers from international problems and it isn't as if Hungary's largest bank - OTP - doesn't have some fairly serious problems of its own tied up in Ukraine, Bulgaria etc. Agriculture and food processing? Well, perhaps - but that isn't in that great a state either."<br /><br />"It is worth pointing out that except for a brief period at the end of the 1990s when privatization receipts and above trend economic growth eased the situation Hungary has had a long term problem with its external debt going back to 1978 that it has never really escaped from. Successive Hungarian governments have prioritised the precise payment of the debt and have refused to seek rescheduling or restructuring on the grounds that this would damage business confidence. One can actually read the history of economic policy prior to 2000 as being about securing Hungary's public financing needs given this policy choice, to the detriment of the needs of the real economy. I read the relaxation of budgetary discipline after 2000 (and especially post-2002) as being about the interaction of mounting frustration at low living standards among the population with the dynamic of party competition." <p></p><p>"That having been said, if one looks at the long view it is difficult to believe seriously that Hungary's debt burden will ever be paid off. Given that servicing these debts will depress the level of economic growth, I think it really is time that the EU, IMF and the authorities in Budapest swallowed hard and accepted reality - a realistic debt consolidation/restructure that takes in both the public and private sector debt is a fundamental condition of stablizing the situation. This is what no-one wants to recognise."<br />Mark Pittaway, Senior Lecturer in European Studies, UK Open University</p></blockquote><br />Hungary’s third-quarter GDP contracted by 7.1% year on year in the July-September period compared to the 7.5% fall in Q2 .Quarter on quarter the economy contracted by1.8%, the sixth quarter in a row that the economy has shown negative growth. <p></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNM5WvembslkUbvyjiPOgDVhH2Bt3doFljlGhF4HeL9gfmD2q7gDzH7dghWWqxMcqLWUVRzJb7_snSiesLy18zBgMazbYwBB431brAJxhfw5KcpIy_dklhyUvB2Ie73Pij-Nqd4XJYlGg/s1600-h/gdp+2.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 233px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418876847461025794" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNM5WvembslkUbvyjiPOgDVhH2Bt3doFljlGhF4HeL9gfmD2q7gDzH7dghWWqxMcqLWUVRzJb7_snSiesLy18zBgMazbYwBB431brAJxhfw5KcpIy_dklhyUvB2Ie73Pij-Nqd4XJYlGg/s400/gdp+2.png" /></a><br />Quarter on quarter Hungary's export-driven economy shrank 1.8 percent following a revised 1.9 percent contraction in the second quarter. This was the sixth quarter in a row that GDP growth was negative. The rate of contraction is down considerably on the 2.6% rate of fall seen in the first quarter, but the velocity of contraction is still alarmingly high.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEirciTpUKQWdWYkPu1UN-KeMG6OgDfFQ-arcr0TRdmKOSy05GD3gExgh24gP9GleaERN1cKkIEdsiskcqIStYTU2OqBNMe0I8a23Y3qsb4WIn8hdF0nbwourpzawpLzX7lyMLvwqPvHyI0/s1600-h/GDP+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 199px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418877243562969090" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEirciTpUKQWdWYkPu1UN-KeMG6OgDfFQ-arcr0TRdmKOSy05GD3gExgh24gP9GleaERN1cKkIEdsiskcqIStYTU2OqBNMe0I8a23Y3qsb4WIn8hdF0nbwourpzawpLzX7lyMLvwqPvHyI0/s400/GDP+one.png" /></a><br />In fact domestic demand fell by 13.3% year on year in the third quarter (see chart below), so the fall in GDP would have been much larger if it had not been for the impact of net trade.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-uampBprg1BfAKSuABVP0EX-zXDJx6NCyv00nI7NqRLZN9fxQoTSuVwTpsCXLoDeDtcOyQlkIYK-zVUZ9kGem7_-4ThPQBKgdobLePrzHdDeXVqQHDXdjebkbYfF9wSb5YFhbgLaghn4/s1600-h/hungary+domestic+demand.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 221px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420333345628375490" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-uampBprg1BfAKSuABVP0EX-zXDJx6NCyv00nI7NqRLZN9fxQoTSuVwTpsCXLoDeDtcOyQlkIYK-zVUZ9kGem7_-4ThPQBKgdobLePrzHdDeXVqQHDXdjebkbYfF9wSb5YFhbgLaghn4/s400/hungary+domestic+demand.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjClQ5AJ_qdc8AMinF5w8EaAJKElBWGIekPHaLgyOyDPWav23DKMn0oIulCd6Mxy1xPxm7mApGproihyphenhyphenY6brIsi0uApyItRx35xQfs6SGFoW5u08ENUvQnkkkw2w9dYACvLW4rdlXuU4Ok/s1600-h/Hungary+Net+Exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 226px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420333944921562370" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjClQ5AJ_qdc8AMinF5w8EaAJKElBWGIekPHaLgyOyDPWav23DKMn0oIulCd6Mxy1xPxm7mApGproihyphenhyphenY6brIsi0uApyItRx35xQfs6SGFoW5u08ENUvQnkkkw2w9dYACvLW4rdlXuU4Ok/s400/Hungary+Net+Exports.png" /></a><br /><br />As can be seen in the above chart, since the last quarter of 2008 Hungary's net trade impact has been possitive, and imports have fallen dramatically faster than exports. And the effect continues, since the export-import gap rose again in October, to 9 percentage points from 5.9ppts in September, following the high of 13.5 ppts in July, by far the largest seen in recent years.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-xhS4-PZfLbk-5tEm3MNwxasFMuuM58lS09XqBOtCChuG87-QjDT4PpwgxKu2dkUsugwTCS62ByjQ7OaOU6mARdh8gHkwKIDwkyYTEB7XFfBwYtJ3uEfn70kHM7jAvuJZdbeypsLv1y4/s1600-h/Hungary+exports+and+imports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 229px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420334206261673554" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-xhS4-PZfLbk-5tEm3MNwxasFMuuM58lS09XqBOtCChuG87-QjDT4PpwgxKu2dkUsugwTCS62ByjQ7OaOU6mARdh8gHkwKIDwkyYTEB7XFfBwYtJ3uEfn70kHM7jAvuJZdbeypsLv1y4/s400/Hungary+exports+and+imports.png" /></a><br /><br />This impact is not, of course, based on a strong recovery in exports, but rather by the fact that imports fall even more than exports (on an annual basis). Basically, when there is a movement in the net trade balance caused by a drop in imports GDP falls more slowly (following a pattern we have already seen in Spain, Greece etc). In fact, for statistical reasons a fall in imports appears as an INCREASE in GDP because the net trade position improves. But unless this drop in imports is accompanied by a significant improvement in the competitiveness of domestic industry (and hence a trade surplus driven by exports) then all you have is economic stagnation and falling living standards, since, for example, house prices will continue to fall, and everyone will feel worse off. Unemployment will obviously also rise, as those involved in the retail sector selling the imports will lose their jobs. People working in the ports for domestic directed external trade trade ditto.<br /><br />This is the whole argument for devaluation in these kind of circumstances (Greece, Spain, Latvia, Hungary etc), since the devaluation not only helps export industries, it also helps the domestic sector by making imports more expensive. Thus, if demand was there, then a fall in imports would be compensated by a rise in domestic supply, and your interpretation of the equation would not hold.<br /><br />The whole problem, however, in the cases of the former current account deficit countries is that the internal demand is now longer there, since it was based on unsustainable borrowing in the first place, borrowing that appeared to be supported by rising property values or state guarantees (in the case of fiscal deficits) as collateral. The property prices are now falling, and the deficits are now being slashed back, and neither are going to rise back again anytime soon and therefore the kind of borrowing we saw before isn’t coming back again anytime soon. So the bottom line is there is a sharp fall in consumption, whatever the headline GDP number says.<br /><br />In fact the causal mechanism is that the absence of capital inflows leads to a drop in consumption, which in turn means there are less imports. But my big point is that the accounting mechanism used to generate the GDP number (making Net Exports a positive input convention) masks to some extent the actual drop in living standards, since Net Exports was previously negative (and hence a drag on GDP), and the drop in domestic consumption and imports simply makes it less negative. </p><p>Of course, there are two ways to make imports less attractive, one is devaluation and the other is structural reform to make the domestic sector more competitive, and that is the Oriens/Bajnai approach, and there is little objection at all to much of what they propose, except that, as we are seeing in one country after another this procedure doesn't act quickly enough to undo the severe distortions that had been produced earlier, but then I doubt, from what they say, that the Oriens signitaries would accept that these distortions were as severe as I argue they are - just look, for example, at the drop in domestic consumtion - 13% - and this after three years of near economic stagnation. Hope against hope.<br /><br /><br />This having been said, exports, and the current account balance have been improving in recent months, although not by a long way fast enough to push the economy back up towards growth. Hungary posted another huge foreign trade surplus of EUR 471 million in October, according to the latest revised numbers released by the Central Statistics Office. October marks the ninth month in a row when Hungary posted a trade surplus in the EUR 320-550 million range.<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgR4A9uaHilopFF1yFgOWmt2byGjKx3elJd0mAFIr4YVV3p0Rtk1X6fvM_HMKhsi7-Mo8BIJ1BzjFLDq9ga1QdcS1lauLGtYod2wyoWUErPQl0buYtCP0dp1IVMng7fI2DvQmkJ5BOrt-4/s1600-h/Hungary+trade+deficit.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 202px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420335297208659890" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgR4A9uaHilopFF1yFgOWmt2byGjKx3elJd0mAFIr4YVV3p0Rtk1X6fvM_HMKhsi7-Mo8BIJ1BzjFLDq9ga1QdcS1lauLGtYod2wyoWUErPQl0buYtCP0dp1IVMng7fI2DvQmkJ5BOrt-4/s400/Hungary+trade+deficit.png" /></a> Despite this significant improvement in the trade balance the Current Account only just managed to sneak into surplus in the second quarter, largely as a result of the very strong negative balance in the income account, which is a product of the very negative net investment position of the Hungarian economy (ie non Hungarians own a long more of Hungary than Hungarian's own of the rest of the world, and this creates a huge imbalance, and as Mark Pittaway says the bullet will have to be bitten - one way or another - about what to do about this at some point.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLuqSrIJ8d99VzfrKMdj-pkQIuaDrIfKkc9EpgQboGjDuG8PMRXbXgTiZJhS4mitH4FK1NcWi5AIVWToK8NzCUeofWSY8TlQoTXL4b_VM6-QyAKPirbtCjoCkf67GuaD1OODSbk3pp-uU/s1600-h/current+account+balance.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 237px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420334917010526786" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLuqSrIJ8d99VzfrKMdj-pkQIuaDrIfKkc9EpgQboGjDuG8PMRXbXgTiZJhS4mitH4FK1NcWi5AIVWToK8NzCUeofWSY8TlQoTXL4b_VM6-QyAKPirbtCjoCkf67GuaD1OODSbk3pp-uU/s400/current+account+balance.png" /></a><br /><br />In October, exports dropped 11.8% year on year (on a euro basis), while imports plunged by 20.8% year on year.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiG8_VbdWU-030_3syXwlgvVtzGPm1SYVzMNHcLHrcKu_UXEqWQCJh7lw6k-E5RNGm-SQ2oYlV2jQqH6bg3Xq3zYewYH35y0Tjg9YBsSkWcFoBnwSXIovNSD91meHPjtZS_2pIaesPdMTY/s1600-h/hungary+exports+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 222px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420338286409312978" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiG8_VbdWU-030_3syXwlgvVtzGPm1SYVzMNHcLHrcKu_UXEqWQCJh7lw6k-E5RNGm-SQ2oYlV2jQqH6bg3Xq3zYewYH35y0Tjg9YBsSkWcFoBnwSXIovNSD91meHPjtZS_2pIaesPdMTY/s400/hungary+exports+two.png" /></a><br /><br />This gradual improvement in Hungarian exports has also lead to a modest recovery in the industrial sector, mainly due to stimulus-programme-induced stronger demand in western Europe. Industrial output fell 15.6 percent in the third quarter, down from a fall of 20.5 percent in the previous three months, while recent data showed output grew month on month for the second time in a row in October.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDDsYqi_Qlksj5JHZTEQxBtB4mE98nt7TdOuesIkM8Vs6LvFNL8Xy8DaTo6oIilRmGRY1149TYq0gRgY2mYaqBLpCRAHgzeNDgt0N2hRReM3X5v4yG7VLQGnS9w9FSPKwO3guRiOTLrWA/s1600-h/hungary+IP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 240px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420338880479874530" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDDsYqi_Qlksj5JHZTEQxBtB4mE98nt7TdOuesIkM8Vs6LvFNL8Xy8DaTo6oIilRmGRY1149TYq0gRgY2mYaqBLpCRAHgzeNDgt0N2hRReM3X5v4yG7VLQGnS9w9FSPKwO3guRiOTLrWA/s400/hungary+IP.png" /></a><br /><br />Against this background, weak exports, and domestic demand in full retreat it is not surprising that investment has been falling, and dropped 6.8% year on year in the third quarter.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDPsw4rNwxhl4T6wczTHUePc14ozz2DGaoOkry49JoU4-Nb5ailBnH0ZGVrV5LBGHaXXnajF1Yzzn5-eXIIMYoCHSuCYue4qbwA1oSUS6lXolk1iOa3kWexOkmEScOzPw7rar3WIlRZpA/s1600-h/Hungary+investment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 212px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420330760449524546" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjDPsw4rNwxhl4T6wczTHUePc14ozz2DGaoOkry49JoU4-Nb5ailBnH0ZGVrV5LBGHaXXnajF1Yzzn5-eXIIMYoCHSuCYue4qbwA1oSUS6lXolk1iOa3kWexOkmEScOzPw7rar3WIlRZpA/s400/Hungary+investment.png" /></a>What these continuing declines in investment mean is that the level of investment is now at much lower levels than it once was - below the 2005 level according to the rough and ready index I prepared for the chart below. <br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiam3StzQMoRVnyncp82q37q8ZfFraQfnhOUr17syU6eemqBARgV612YEkFLn466Qf8z5SP5tsrBTYBE3UyNDmKQBdR0EcgKZdOqf_iNWAtdgbVy-aM6jyM3bs8AmNTKQQVv8_lkgcUyzE/s1600-h/Hungary+investment+Index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 213px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420330618893038466" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiam3StzQMoRVnyncp82q37q8ZfFraQfnhOUr17syU6eemqBARgV612YEkFLn466Qf8z5SP5tsrBTYBE3UyNDmKQBdR0EcgKZdOqf_iNWAtdgbVy-aM6jyM3bs8AmNTKQQVv8_lkgcUyzE/s400/Hungary+investment+Index.png" /></a><br />Construction activity is also well down, and has been for some long time now, following the sharp drop between summer 2006 and summer 2007 on the back of the first austerity programme (see chart).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjcQePbmg9uAIBOp4KGizHdtyCbANuIc1LhwWho3g9Acwx106fkyGgPINLVLbJsbX1xYIucBN309Lwy2ajykkb7H9Odf9oISgpo47vF0wzPnaBlto3dkYJfUz6m9lpyZhqfGI0AXxTtV0/s1600-h/hungary+construction+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 213px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420339651009501490" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjcQePbmg9uAIBOp4KGizHdtyCbANuIc1LhwWho3g9Acwx106fkyGgPINLVLbJsbX1xYIucBN309Lwy2ajykkb7H9Odf9oISgpo47vF0wzPnaBlto3dkYJfUz6m9lpyZhqfGI0AXxTtV0/s400/hungary+construction+index.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ2ZYIZniCpoAFPTclwSuZpCx-gTy1q0lammOP0VDdBQEwhT_ncyjMVVUDEgYPrEt61OcEpt1n0noqEIwySElVCdpsFSaAxFzQJglZFvQPLz6ruX8iCE3bbRf7Phn-IZVn2n2zcb5W1OQ/s1600-h/Hungary+construction+P2P.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 211px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420339260005697698" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ2ZYIZniCpoAFPTclwSuZpCx-gTy1q0lammOP0VDdBQEwhT_ncyjMVVUDEgYPrEt61OcEpt1n0noqEIwySElVCdpsFSaAxFzQJglZFvQPLz6ruX8iCE3bbRf7Phn-IZVn2n2zcb5W1OQ/s400/Hungary+construction+P2P.png" /></a><br />Government consumption is also contracting due to the pressure to reduce the fiscal deficit.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJmDre0QWMvO6nFTOkJAXrQ9baqRFSBk2hz9vUL2lvvS6M8cDDrnyah0E3NEZuVrkQFMDxid5XC6C4Dw5tHMGyCWfh0-Z-SKVb7xQ1VRzxg0geJAErdH8eQ0GsduPKItYA653wzSqoqEI/s1600-h/Hungary+government+consumption.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 234px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420331659836048898" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJmDre0QWMvO6nFTOkJAXrQ9baqRFSBk2hz9vUL2lvvS6M8cDDrnyah0E3NEZuVrkQFMDxid5XC6C4Dw5tHMGyCWfh0-Z-SKVb7xQ1VRzxg0geJAErdH8eQ0GsduPKItYA653wzSqoqEI/s400/Hungary+government+consumption.png" /></a><br /><br />All in all, the third quarter GDP data indicate that Hungary's domestic economy is not showing any signs of recovery whatsoever, nor should we expect it to do so. The hike in VAT in July hurt private consumption while capital spending has been continually cut back given the failure of export demand to rebound as strongly as hoped. The need to maintain a restrictive fiscal policy stance will also indirectly weigh on consumer and corporate spending, with the consequence that in my view GDP will decrease by nearly 7% in 2009 and then by around 1.5% in 2010.<br /><br /><strong>Monetary Policy Tangle</strong><br /><br />Hungary's central bank (NBH) last week cut its base rate by 25 basis points to 6.25%. The move which suprised the market participants (the consensus had been for a 50-bp reduction in surveys conducted by both Portfolio.hu and Reuters) now means the benchmark rate has been cut by 3.25% since July. Not everyone was surprised however, since in an interview on 10 December, Centrak Bank MPC member Péter Bihari had said it would be wise to calm rate cut expectations. "Any overshoot in (rate cut) expectations can backfire later. We (the central bank) need to stay sober, and we also need to communicate this sobriety outside," he said.<br /><br /><br />Although Hungary’s inflation outlook might have justified a 50-bp cut, the recent weakening in the forint (the HUF hit a 6-week low vs. the EUR last week) and the rise in the 5-yr CDS spread to a 3-month may well have signalled the need for a more cautious move, since following events in Dubai and Greece questions are rising about how long the relatively favourable global investor mood can last. Also, the imminence of elections, and the dangers of fiscal loosening (either before or after the election) urge prudence, especially in the light of what we have just seen in Greece.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoHfsQ0xxQ5t0pWS9PqP3WA1xDojIuO1PXCWZDAGxDq9Ummahzh1Rrof4cdvm3G2u9iU3iqjTWFY1q84lSuQvYu_GT6CWyY7cNTPJHwMZU5Wt4zdxEEESjNDhBhX-ANrkCCFkcEMH_nC0/s1600-h/Hungary+interest+rates.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 245px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420340834826528786" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjoHfsQ0xxQ5t0pWS9PqP3WA1xDojIuO1PXCWZDAGxDq9Ummahzh1Rrof4cdvm3G2u9iU3iqjTWFY1q84lSuQvYu_GT6CWyY7cNTPJHwMZU5Wt4zdxEEESjNDhBhX-ANrkCCFkcEMH_nC0/s400/Hungary+interest+rates.png" /></a><br /><br /><br />The smaller than expected move also suggests that easing will be cautious in the first months of next year, and that the bank will be sensitive to any signs of worsening market conditions (especially ahead of next spring’s elections). Weaknesses in the real economy still argue for lower rates, and without moving towards closing down the interest rate gap forint loans will never become competitive with Euro or CHF ones" </p><blockquote>Despite this afternoon’s decision by the National Bank of Hungary (NBH) to cut interest rates by a smaller than expected 25bps to 6.25%, there is a good case for further monetary easing over the coming months. We continue to think that the profile for interest rates priced into the market is too high."<br /><br />"Both we and the consensus had expected a larger 50bps cut today, although the fact that one member of the Council voted for a smaller 25bp reduction in November did suggest that a slowdown in the pace of easing was possible. The forint gained 0.25% against the euro immediately after the decision."<br /><br />"Nonetheless, while policymakers may now move in smaller steps than we had previously thought, the case for further monetary easing remains strong. The decision to cut by just 25bps today is likely to have been motivated in part by signs that output in some sectors (notably industry) has started to pick up. But while the prospects for some parts of the economy have undoubtedly improved in recent months, the overall pace of recovery will remain subdued."<br /><br />"In particular, domestic demand will remain a significant drag on growth. A combination of a fragile banking sector, a high proportion of fx-denominated debt and the continued rise in non-performing loans, means that the overall availability of credit remains constrained."<br /><br />"And although the bulk of the tightening measures have now been implemented, a public sector wage freeze, and private sector wage restraint needed to offset the recent sharp rise in unit labour costs, means that the pain will linger into 2010 and 2011."<br />Neil Shearing, Capital Economics</blockquote><p><br /><br /><strong>Inflation Overshoots Expectations In November</strong><br /><br /><br />Hungary’s consumer prices rose 5.2% year on year in November, an acceleration from the previous month (4.7%). Month on month prices were up 0.3% . This was an upside surprise since analysts forecasts had been for a rise of 5.0%.<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7kx41joAYMdT2tKJZCykP_5v9yZ9e1x20JL7UJLBh8PthYrlwz9_1aUg9BGzmJGM3i8boFPXSDa9GyozX-_EnUvajwTGM84PALzNoFB2yvH8wQawGwCkICHWKUTxRbGlEboN61UpYi0Q/s1600-h/hungary+CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 231px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420344477848358850" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7kx41joAYMdT2tKJZCykP_5v9yZ9e1x20JL7UJLBh8PthYrlwz9_1aUg9BGzmJGM3i8boFPXSDa9GyozX-_EnUvajwTGM84PALzNoFB2yvH8wQawGwCkICHWKUTxRbGlEboN61UpYi0Q/s400/hungary+CPI.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgX95HYOZMxqvN_t6rJLmfzB2cIazCTZg45cStj7TOZtO2lYTCRUg08n6BrvRKqh8tbhEWUZ2DOtvU94Fb17mPSHxxAlPow3OvHva9wireAz4k_SbsH9_e0ZztRamiuaPS0xp2HTUPH5mM/s1600-h/bank+of+hungary+inflation+forecast.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 231px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420344314704094706" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgX95HYOZMxqvN_t6rJLmfzB2cIazCTZg45cStj7TOZtO2lYTCRUg08n6BrvRKqh8tbhEWUZ2DOtvU94Fb17mPSHxxAlPow3OvHva9wireAz4k_SbsH9_e0ZztRamiuaPS0xp2HTUPH5mM/s400/bank+of+hungary+inflation+forecast.png" /></a><br /><br />The main reason for the increase was an increase in the prices of unprocessed food (especially fruits and vegetables), energy and fuel. Disinflation is slowing in tradable goods, driven mainly by the durable goods sector (especially new and used vehicles and televisions), while market services disinflation came to a halt (most service prices increased except for tourism and books). </p><p>The impression is that the underlying disinflation process has started to slow and there are risks to the medium term inflation outlook. The seasonally adjusted core inflation has been stagnant at around 5% since July, while the CPI adjusted for tax changes started to accelerate in November (it moderated from 3.7% YoY in June to 0.9% in October and picked up to 1.4% in November).<br /><br />Which means the NBH’s inflation forecast of 1.9% for 2011 may come under pressure. Inflation may well accelerate to 5.6% in December and peak at around 5.8% in January and can then fall to below 3% by the end of 2010. As Neil Shearing says "Despite the uptick in inflation to 5.2% in November (from 4.7% in October), we support the Central Bank’s view that it will "significantly undershoot" the 3±1% target when July’s VAT hike drops out of the annual comparison." Still maintaining this sort of price range with the present Forint value is simply going to prolong and prolong the economic downturn.<br /><br /><br /><strong>Employment Falling As Unemployment Rises</strong><br /></p><p>Unsurprisingly, against this background unemployment is rising and rising, hitting 9.9% of the labour force in October, according to Eurostat seasonally adjusted data.<br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgID0O9WLF-8ou0TtSa8_2LzI6X_0GF70WhCjpCysYzeWpniW7PsbbmabmTvL5gfu653NXFO_YHGuSmye7ZvbAQ_UP90zA5bh5ySkMNiPkaTR8BiePYJQRMUU29hAh2v5ZktPbt1Iqmpvo/s1600-h/hungary+unemployment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 201px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420348176409972738" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgID0O9WLF-8ou0TtSa8_2LzI6X_0GF70WhCjpCysYzeWpniW7PsbbmabmTvL5gfu653NXFO_YHGuSmye7ZvbAQ_UP90zA5bh5ySkMNiPkaTR8BiePYJQRMUU29hAh2v5ZktPbt1Iqmpvo/s400/hungary+unemployment.png" /></a> Total employment has been on a downward trend since the middle of 2006.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtkqo9e2RijyX7zCOBoiKwqvNX2QqjZODxRHC4MxS8Jhn8oTf52qCZafc5S5mX57OFF_sVu1hitJWWrh1RZwLNZGB7nW7oPmtoFCiPIhdPzvkKErdQla_kfNY-T0-w_FoJAGsfKO-hixU/s1600-h/hungary+total+employed.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 216px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420347962953323602" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhtkqo9e2RijyX7zCOBoiKwqvNX2QqjZODxRHC4MxS8Jhn8oTf52qCZafc5S5mX57OFF_sVu1hitJWWrh1RZwLNZGB7nW7oPmtoFCiPIhdPzvkKErdQla_kfNY-T0-w_FoJAGsfKO-hixU/s400/hungary+total+employed.png" /></a></p><p>But one of the impacts of the economic crisis has been that employment in the public sector, after falling under the austerity programme has risen sharply since the spring (due to a number of employment schemes designed to keep unemployment down, especially in the regions), and is now back up above its earlier level.<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaCyldxfqcCejKyRqSSwTNnQMciyOKKEARo8PtIoMV3pcobdCQ8gnOryF0IAmjCRbOy9GYnLL9c5FUzqnJdXsVITfGOS4d1g2rD3cAVKpAG02RoiaEg_cCOL9pK3kvyiqLzd9S2g5u1XY/s1600-h/Hungary+public+sector+employment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420347784100302066" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhaCyldxfqcCejKyRqSSwTNnQMciyOKKEARo8PtIoMV3pcobdCQ8gnOryF0IAmjCRbOy9GYnLL9c5FUzqnJdXsVITfGOS4d1g2rD3cAVKpAG02RoiaEg_cCOL9pK3kvyiqLzd9S2g5u1XY/s400/Hungary+public+sector+employment.png" /></a> Real ex-bonus wages (the central banks targeted measure of wage inflation) has been in negative territory (by around 1%) since the summer.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgWCWeW9iEvH93Cm7UmZQ5mAUtwEwiJQaW0hp-k3o7aEQZYQtEmd_0b_xJ2VYc4CWdVdf3vp_bolhMDKiqszVVEto2zMJ2pXq4-U2wbiyeShLHbwk9dAGNECtRdOKUA0PXHrWL7EG3uM1c/s1600-h/hungary+real+wages.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 208px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420347595293738114" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgWCWeW9iEvH93Cm7UmZQ5mAUtwEwiJQaW0hp-k3o7aEQZYQtEmd_0b_xJ2VYc4CWdVdf3vp_bolhMDKiqszVVEto2zMJ2pXq4-U2wbiyeShLHbwk9dAGNECtRdOKUA0PXHrWL7EG3uM1c/s400/hungary+real+wages.png" /></a><br /><br /><strong>Bank Credit Turning Negative</strong><br /></p><p>As is well known a very high proportion of mortgages in Hungary are non-forint denominated (over 85%, mainly in Swiss Francs), but the HUF value of these mortgages has been falling for over a year now.</p><p><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_mEC2rWjEyITYMqcOP80Hth_J_IWERy1RcMVeLy5NlL1Tsml-dTpZXeBFGaTPpMe8MfpX_wgFsR-xxk4aazsJvY3oUhORyYSlET9by4CAYLH6F_OnD3UXQjAATWLo_yTaRZjzg7gQVRQ/s1600-h/forex+mortgages.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 239px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420347109363434050" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg_mEC2rWjEyITYMqcOP80Hth_J_IWERy1RcMVeLy5NlL1Tsml-dTpZXeBFGaTPpMe8MfpX_wgFsR-xxk4aazsJvY3oUhORyYSlET9by4CAYLH6F_OnD3UXQjAATWLo_yTaRZjzg7gQVRQ/s400/forex+mortgages.png" /></a> As has the total value of outsanding mortgages in any currency.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJYqCDJx4hrbcDTpkrGJ8JCeOulxyTgrvB6MUCBna189Us7nNE59fzJ24VYGCsNSlHktma_l4OO3EPGnLeveGIQdfjRnfVPOfXq6xCeJPOGTQsWvjKexFmKGmsG3zkxycCAaZo_uqU0eY/s1600-h/Hungary+-+total+mortgage+lending.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 237px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420346638437692082" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhJYqCDJx4hrbcDTpkrGJ8JCeOulxyTgrvB6MUCBna189Us7nNE59fzJ24VYGCsNSlHktma_l4OO3EPGnLeveGIQdfjRnfVPOfXq6xCeJPOGTQsWvjKexFmKGmsG3zkxycCAaZo_uqU0eY/s400/Hungary+-+total+mortgage+lending.png" /></a> Although the stock of mortgages had not been high by some West European standards (around 50% of GDP), they had been growing at a rate of around 20% per annum over the last several years (see chart) but the crisis brought this to an end, and the year on year increase was down to only 2% by October, and will more than likely be negative by the end of the year. Which means, credit expansion and new house construction will NOT be driving any coming Hungarian recovery.<br /><br />In the current climate, with unemployment rising, and wages falling, and an economy contracting at nearly 7% a year, it isn't hard to understand why not that much new bank lending is going on. Those who are creditworthy are trying hard to save, while those who need to borrow normally aren't that creditworthy, so pleading to the banks to lend more is rather like asking them to subsidise new bad debts, and that is really not something you can do. What kicked the whole current process off in Hungary was a short sharp credit crunch, but now it is the contraction in the real economy which is following its own dynamic, till someone finds a way to put a stop to it. It is the drop in output that is preventing banks from lending, and not banks being unwilling to lend that is causing the contraction to continue.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEguSnfwKJDSEM4MD5q707Caq_zzmMZFKMy8kPfYHJHo85SWMW6JWf7xcefkAvk-VlK2r7koHbDo2MHTO6mHv8XN92B1a_RjNU8bvLwkf-cJF0fNdMDvbyS2A5dhW_BAYI21z0a8uJFJx6g/s1600-h/Hungary+-+total+mortgage+lending+y-o-y.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 238px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5420346410323733730" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEguSnfwKJDSEM4MD5q707Caq_zzmMZFKMy8kPfYHJHo85SWMW6JWf7xcefkAvk-VlK2r7koHbDo2MHTO6mHv8XN92B1a_RjNU8bvLwkf-cJF0fNdMDvbyS2A5dhW_BAYI21z0a8uJFJx6g/s400/Hungary+-+total+mortgage+lending+y-o-y.png" /></a><br /><br /><br /><strong>Election Chaos Looming</strong><br /><br />Having seen the shennanikins which have recently taken place in Greece, it was obvious that the run in to the coming election was always going to be complicated, with accusation and counter-accusation being thrown from one party to another. The big problem is that neither party has exactly clean hands in this context, but one thing seems sure, that the 2010 budget is liable to slippage, whether because of the current ruling party moving invoices from 2009 to 2010 (on the assumption that they are going to lose the election, so what the hell), or because the incoming party is going to make promises which will lead to an overspend which they will then blame on their predecessors.</p><p>A group of economists close to opposition party Fidesz now claim next year’s budget "is full of tricks", including unrealistic macroeconomic assumptions that will lead to a deficit far larger than the cabinet’s projection. The current Finance Ministry Péter Oszkó played down the criticism as politicking ahead of the coming elections, and this may well be, but some of the points they make to not, for all that, lack validity. <br /><br />The 29 economists, who promoted a 'no’ vote on the 2010 budget bill in November, include Zsigmond Járai (Finance Minister of the Fidesz government and former Governor of the central bank), Ákos Péter Bod (Ministry of the Industry in the MDF cabinet and former Governor of the NBH), György Szapáry (former Deputy Governor of the NBH, currently responsible for international relations in Fidesz), Tamás Mellár (head of the statistics office (KSH) during the Fidesz government) and Károly Szász (head of financial markets watchdog (PSZÁF) in the Fidesz era).<br /><br />Zsigmond Járai argues that, on the one hand the 2010 budget is based on unrealistic macroeconomic assumptions - e.g. only a 0.6% economic contraction while GDP may well shrink by considerably more, possibly by as much as 1.5%, while on the other planned austerity measures, like reduced subsidies, will also worsen the balance. Among his list of "overestimation tricks" the former central bank head mentioned VAT and corporate tax revenues. The economists claim that the underestimation of the GDP contraction will result in something like HUF 200 bn less budget revenues, adding that another HUF 200 bn shortfall due to smaller-than-expected revenues from taxes and contributions.<br /><br />The current official estimate for the general government deficit in 2010 is 3.8% of GDP, a target which is considered to be realistic by both the IMF and the European Commission. The Fidesz economists claim the gap - without supplementary bufget changes - could be as high as 7-8% of GDP. György Matolcsy, a leading Fidesz economic spokesman stressed that such a large deficit would be unacceptable for Fidesz as well, and made clear that they are not saying such a massive budget overrun should be tolerated.<br /><br />Matolcsy said the 2010 budget included no reforms or system overhauls to jumpstart growth in the second half of 2010 as the cabinet expects, and that in his opinion a sustainable growth path is unlikely to be reached before 2013.<br /><br />The document has not been slow to attract criticism, and apart from Finance Minister Ozskó, Lajos Bokros, Hungary’s former Finance Minister and PM candidate from the minor opposition party MDF, lashed out at the group saying their argument was "ridiculous".<br /><br />In an interview with public television MTV, Bokros said that "the only alternative to sovereign default was to cut budget spending, take away welfare contributions, e.g. the 13th-month pension and 13th-month wage in the public sector that spun the economy into catastrophe and that led to (government) debt to surge sky high." "How do you create growth from these (measures)? Only via reforms," he stressed.<br /><br />A large part of the issue seems to revolve around what to do with the bulging debts of quasi governmental institutions like hospitals, the state-owned railway company MÁV and the Budapest Transport Company (BKV) . Fidesz seems to assume that these debts will need to be swallowed. Bokros does not agree: "If a budget were about consolidating the debts of every (state-owned) companies automatically and without restraint the next year, it would be but a rejection of any reform," he said. "Reforming" according to Bokros means not covering the debt of "inefficiently operating public institutions", because these liabilities had probably been accumulated due to their profligacy."So, what do you have to do then? [You need to implement] reforms and a create a competitive situation that will have inferior companies go bust and good-quality institutions double in size." </p><p>While sympathising with Bokros in the spirit, it is not clear to me that things are going to be so easy as he imagines in the letter. One thing is however clear, he is right that if solutions are not found for these issues, especially in the problematic pensions and health sectors, Hungary will go bankrupt.<br /><br />One thing is clear though, life is not going to be easy in post election Hungary. If Fidesz is voted back to power it will create a new budget, a new tax regime and a new labour policy for as early as July, according to György Matolcsy, and the new government should also sign a new Stand-By Arrangement with the IMF. Matolcsy reiterated that Fidesz has three scenarios for the tax system: one proposing a radical reduction of personal income tax with a flat family rate; another which would decrease rates on the entire spectrum of taxes; and a third which would cut social-security and health-insurance contributions for employers and employees alike. The only thing which doesn't seem clear is how he expects to pay for all these, especially since he doesn't anticipate a serious return to growth before 2013.<br /><br /><br />Matolcsy also claims that the budget deficit will be 3-4 percentage points higher than the targeted 3.8% of GDP, citing central bank staff projections in their Inflation Report that the gap is likely to be 4.3% of GDP. Fidesz expects the gap to come in at 4.5% and foresees that state-owned enterprises such as the railway company would need debt consolidation amounting to 3% of GDP. Matolcsy also pointed out that there may be other downside risks to next year’s budget beyond the 7.5% deficit he claims it already incorporates, including a larger-than-expected contraction in consumption, unemployment and a fall in lending to households that could lead to smaller tax revenues. All of these points are not without some validity. Further the ongoing drop in investment will continue to eat into tax revenues and lower-than-forecast inflation could decrease budget income next year, he added.<br /><br /><strong>Fidesz The Likely Winners, But By How Much?<br /></strong><br />The gap between Hungary’s two main political parties has narrowed slightly of late, according to the latest opinion survey by Medián. While an increasing number of voters reported a lack of strong party affiliation, Fidesz has witnessed some decrease in its supporter base. Support for Fidesz within eligible voters has been gradually melting away in recent months, and is now down to 40% in December from 43% in November and 47% in July. The Hungarian Socialist Party meanwhile saw a only a minor and not statistically significant increase in support. But this change in percentage support is more due to an increase in undecided voters than anything else, since 66 per cent of respondents — all decided voters — would vote for Fidesz in the next legislative election, up one point since October. <br /><br />The ruling Hungarian Socialist Party (MSZP) remains a distant second with only 19 per cent, followed by the Movement for a Better Hungary (Jobbik) with 10 per cent. Support is much lower for the Hungarian Democratic Forum (MDF), Politics Can Be Different (LMP), and the Alliance of Free Democrats (SZDSZ). <br /><br /><br /><blockquote>We should not forget that although Bajnai is portraying himself as being the head of a technocratic government, he is in reality the head of a government which is supported by MSZP. It is clear that the 2010 elections are lost. The game is already for 2014 elections. The government now have apparently stabilised the forint, slowed down the shrinking of the economy, and restored some kind of order and feeling of leadership. The price is high, but it seems that the population by and large accepted the situation as it is. The slight increase of popularity of MSZP and Bajnai himself may support this statement. Now, compromises have been made for a short time with major public service sector agents to accept the restrictions. But, somewhere around next August everyone will be up in arms for new financial support. The latest move of the government, to finally accept the long term and symbolic demand of FIDESZ to cut the VAT on the gas-price to 5% is already, I think, a mine for FIDESZ laid down to explode next year. All the messages of the members of the government are now portraying the government as a similar "responsible" stabilisation force as the 1995 Bokros package was, which would propel again Hungary into a "sustained" high growth as was experienced between 1997-2005 (of course now we all see better the price of this decade of growth). So what we are seeing here is a creation of a "new development" discourse, which it is expected will be destroyed by the "incompetence" etc of the Orban government. - Andras Toth, Sociologist</blockquote><p><br /><br /><strong>Huge Structural Reforms Gamble</strong><br /><br />Well, I think I have said more than enough already in this post, so I think I will leave your with the thoughts Gábor Egry (a Hungarian political scientist) expressed in an e-mail interview with me. Basically it seems to me that Gábor is right, the 4% growth target has no scientific basis behind it at all, and is just a hope that has been repeated so many time people now think it has become a reality. What is going on in Hungary now is a huge gamble, a leap into the dark almost, based on the idea that a shift in the tax structure, and a fiscal discipline to reassure would be investors can bring a growth surge, a growth surge which I argue is structurally impossible without doing something about the level fo the forint, the problem of the forex debt, and without getting domestic monetary policy firmly back in the hands of the NBH.</p><blockquote><p>Gábor Egry - Research Fellow, Poltikatörténeti Intézet (Institute for Political<br />History)<br /><br /><br />Maybe it is worth taking a look at the history of this idea of 4% trend growth. As far as I can recall it - apart from the constant remarks of politicians that Hungary needs a growth 2 points higher than the EU core states and this was somehow always expected to be 4% - both before and after the last elections a group of economists started putting forward ideas for the renewal of sustainable growth in Hungary and they elaborated a series of - let's put it this way - Slovak-type measures would very soon result in 4% trend growth. As the then government chose another type of policy mix for their budget consodilation, these critics never failed to emphasize that with this Slovak-type set of measures not only would the slow growth period after the budget (austerity, 2006) restrictions have been avoidable, but that these Slovak measures were the only possible way to elevate the trend growth to 4%. Usually it was the same guys coming with the same proposals, just branded differently. (CEMI, Oriens etc). Then, when in 2008 the Reform Aliiance was formed, they recycled these ideas. And even though the Bajnai government is an MSZP supported one at least initially it was the result of Gyurcsány's attempt to compell the party to accept the Reform Alliance program. From this persepctive Bajnai's statement is quite logical: they are implementing measures that were proposed by experts with the promise that they would lead to a 4% trend growth. Anyway, the idea that such measures will restore a higher and sutainable trend growth is deeply anchored in the Hungarian economist's thinking, and most of them - among others Bajnai, who was the loyal but critical supporter of these ideas in the Gyurcsány government - will adhere to it as it was the main component of their criticism of earlier policy and as such it is a core component of their common identity. </p><p> Beyond the historical anecdotes I see some serious faults and gaps in the reasoning behind the approach, especially as their reasoning is really causal, but rather based on the use of analogies. The main thrust of the approach is not simply to make production in Hungary wage-competitive by cutting the so called tax wedge, but also through making labor cheaper for local companies and attracting FDI, thus raising the employment rate. So, they work with both a direct causal relationship between tax rates and the employment rate and with an indirect one, but they then connect this second one causally to the tax rates again. I would argue, that such soft factors, as labour mobility have had at least as as important impact in the Hungarian case. According to Oriens, the FDI sector in Hungary is said to be overcapitalized, but I'm not sure whether this is because of the relatvely high labor costs or is a result of the immobility of the workforce. It is really important to observe how unemployment is geographically distributed in Hungary, and how this geographical distribution has not changed in the last two decades, despite efforts to change this situation with methods in principle similiar to the present ones, i.e. giving incentives indirectly through economic policy to market forces. </p><p>There really are areas where even near-starvation was not capable of moving people out of their villages and making them go look for employment elsewhere. I know that there are counter-examples in the sense that in huge areas a lot of people remained deliberately unemployed as they have found easier ways of making money in the grey or black economy, for example, near the Ukrainain border. Such people, instead of being moved by the modern dynamic of the market economy, resorted to - let's put it vaguely - pre-capitalist methods of work organization and resource redistribution. I don't really see how any kind of tax cuts will move them out from these places and as they have no significant taxable or taxed income it won't generate surplus demand for local companies either. Otherwise, I wouldn't neglect the fact that the fall of unemployment and the rise of employment in many Eastern countries coincided not only with lower taxes, but with EU accession, making it much easier for people to seek work in the West. And in fact millions did it. (For example at least 10% of the Slovak workforce worked abroad before the crisis.) But this is mobility is more or less lacking in Hungary, and Hungarians by and large never left for the West seeking work.<br /></p><p>On the question of the deficit, it wouldn't surprise me if there was some accountancy massaging going on behind the scenes. The government may well have put a part of this years deficit on last year's one, raising that from 3,2 or 3,4% to 3,8 and they try to convince the state railways not to reclaim their VAT this year etc. Oszkó conveys self-assurance but he is paid for that. I wouldn't be surprised to find out at the end that this year deficit will be higher than forcast, but I don't see too much room for the IMF to protest, either. <br /><br />They let Latvia raise its deficit a number of times, Romania is not only doing the same but may even finance the deficit (or in a more populist tone, this year's pensions) from IMF money and - at least as far as I can see - even accept political arguments regarding government incapability to implement unpoular measures before specific elections as arguments to support non compliance. Maybe Hungary will overshoot the deficit, but at least on the surface - in terms of measures implemeted - it is adhering to the terms. The government can simply tell them, ok, guys we did what you proposed, a slightly higher deficit was the result, accept it. Moreover, with the animal spirits currently prevailing around the world I really don't think the news of a 4,1% deficit will do any harm as long as markets are in love with recovery, while even a surplus can not prevent a collapse if their mood changes fundamentally... </p></blockquote><p></p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-28240831053870141302009-12-24T11:24:00.000+01:002009-12-24T11:26:10.821+01:00Latvia Is Back In The News, And Expect More To ComeThe Latvian government is getting nervous about the level of lending coming from Swedish banks. <a href="http://www.ft.com/cms/s/0/bceac44a-ef3d-11de-86c4-00144feab49a.html">According to the Financial Times</a>, "Latvia’s prime minister has warned Swedish banks they risk choking off recovery in the Baltic state’s crisis-hit economy unless they resume lending". The Latvian authorities are complaining, it seems, that banks such as Swedbank and SEB, which dominate the Latvian market, have reined in credit as they struggle to contain rising bad loans amid the deepest recession in the European Union.<br /><br /><blockquote>“The . . . abrupt stopping of credit is a very problematic issue,” said Valdis Dombrovskis, the prime minister. “We expect Swedish banks to start [lending] again. “Of course you can say that Latvians were borrowing irresponsibly but to borrow irresponsibly you need someone to lend irresponsibly,” he said. “We had very easy credit in a very overheated economy. Now we have almost no credit in a very deep recession.”</blockquote>Well, here is some of the background. After an extended period when private credit was rising at nearly 60% a year, the Latvian credit bubble suddenly burst, with very unpleasant consequences for everyone. Since mid 2007 the annual rate of new credit has been falling rapidly, and turned negative in June this year. In fact total credit has been falling since October 2008.<br /><br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHJoq4jEj3HvKVDgwQUE6gKGNkfVcaOYzGo8gLmQz3-bnunJexficEApZT53F3VPDjlkU3WEMpVDWbKK0fMuEHV2uG7ipWdDocjbKWA-c497QTiAQ10VdTHtihG7vbbowaxlVNpMpIEO2K/s1600-h/Latvia+total+Private+Lending+%25+change+y-o-y.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 262px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418481718826068610" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiHJoq4jEj3HvKVDgwQUE6gKGNkfVcaOYzGo8gLmQz3-bnunJexficEApZT53F3VPDjlkU3WEMpVDWbKK0fMuEHV2uG7ipWdDocjbKWA-c497QTiAQ10VdTHtihG7vbbowaxlVNpMpIEO2K/s400/Latvia+total+Private+Lending+%25+change+y-o-y.png" /></a> Lending to households alone has also fallen back, after shooting up dramatically over several years.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFlslnwA-5s7nrvTYY3uOA0g7CNyHbwrvv7Mxl7LintGiqKk9wn_D7zbkQelApZNVzpiBJnv-pgmMBsdMIKEPnVWlcDGOmcn54FTmxzNtPp7Dx1OnYZdfULjlX4dviS8FauUKU52gJoYNW/s1600-h/latvia+total+lending+to+households.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 261px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418481601553425746" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgFlslnwA-5s7nrvTYY3uOA0g7CNyHbwrvv7Mxl7LintGiqKk9wn_D7zbkQelApZNVzpiBJnv-pgmMBsdMIKEPnVWlcDGOmcn54FTmxzNtPp7Dx1OnYZdfULjlX4dviS8FauUKU52gJoYNW/s400/latvia+total+lending+to+households.png" /></a> And Latvian base money (M1) has also been falling.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgqnCB0ky486YSIQzDzkm8niIaJ3DrJs7_JUKUnqaU0toO2QIyBD53wx7Tr7oEGuNfzgwir8upKqZPkuFgvAfgJL7e7IZahV8uXWdcZU-C3Xht5UmUwDxJ3J5RPeOyiUBImPXnXtoBYZqxm/s1600-h/Latvia+M1.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 262px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418481805775683938" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgqnCB0ky486YSIQzDzkm8niIaJ3DrJs7_JUKUnqaU0toO2QIyBD53wx7Tr7oEGuNfzgwir8upKqZPkuFgvAfgJL7e7IZahV8uXWdcZU-C3Xht5UmUwDxJ3J5RPeOyiUBImPXnXtoBYZqxm/s400/Latvia+M1.png" /></a><br />In fact, and unsurprisingly (given that it is what we are seeing everywhere in the exploded bubble economies) the only sector which isn't deleveraging at this point is the government one.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3DED8zgHheK9P_Bv3WojycYnsEnlz3PvdMtu9-X4cTHXhAjljsbrQrtIRvP_fp99lJ0ya3YSitVUUdlVCqpw2nc-PnUchVk5MeGELg3m16DdfHPZctvNN3a6VujRrKd0tTP1mnKxP4hPW/s1600-h/latvia+debt+to+GDP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 259px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418488185204121570" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3DED8zgHheK9P_Bv3WojycYnsEnlz3PvdMtu9-X4cTHXhAjljsbrQrtIRvP_fp99lJ0ya3YSitVUUdlVCqpw2nc-PnUchVk5MeGELg3m16DdfHPZctvNN3a6VujRrKd0tTP1mnKxP4hPW/s400/latvia+debt+to+GDP.png" /></a><br /><br />So it seems hard to me to simply blame mean banks for not doing enough about a situation which many saw coming, but few were willing to do anything to avoid. Sure, the banks made a lot of bad decisions, but so did many other people, and each and every party is trying to extricate themselves from the mess as best they cab. In fact total Latvia debt is not in fact falling at this point in time, since while many individual Latvians have been frantically deleveraging, the government has been borrowing at a faster rate than ever, in part to bail out Parex bank, and in part to fund the ongoing fiscal deficit. In the meantime Latvian GDP has dropped sharply, falling back again in the third quarter at an even faster rate than in the second one. Which means that despite the fact that private indebtedness is falling, the level of private debt to GDP is still probably rising.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjI_WfuTeaMOf7-KFGWH-2r-gt9-xfgL4RVpdQYDxruousiR6ro-cBvg2hSaW65mED6R8Sx7yCQJ53NN3FmK5Iw91EBs4je0R2JYVGuTqLj-1tDlIaaMBfD3hYsj4NH0oeAkduaNkHdNEW4/s1600-h/Latvia+Quarterly+GDP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 252px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418491491182702498" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjI_WfuTeaMOf7-KFGWH-2r-gt9-xfgL4RVpdQYDxruousiR6ro-cBvg2hSaW65mED6R8Sx7yCQJ53NN3FmK5Iw91EBs4je0R2JYVGuTqLj-1tDlIaaMBfD3hYsj4NH0oeAkduaNkHdNEW4/s400/Latvia+Quarterly+GDP.png" /></a> This unfortunate situation is only further reinforced by the fact that prices are falling - not too fast as yet, only an annual 1.4% in November, but they are falling, and they will fall further, and this means that the percentage of debt to GDP will again rise, and this is especially bad news for the Latvian government (even though the drop in prices is a desired objective, no win-win strategy left to use now) since any fall beyond that anticipated is likely to push up the total debt level of 60.4% of GDP currently being forecast by the EU Commission for 2011.<br /><br />And the pain doesn't stop, since having cut 500 million lati ($1 billion) in spending in its 2009 supplementary budget, the government initially resisted the idea of finding an additional 500 million lati of savings in the 2010 budget arguing that with no policy change the deficit was expected to be lower than the 8.5 percent target. Valdis Dombrovskis said in October his government could cut only 325 million lati in the 2010 budget and still meet the 8.5 percent target agreed with international lenders. The lenders did not agree, and Swedish Premier Fredrik Reinfeldt even intervened to tell Latvia it “must correct” its deficit. Following the rebuke further measures were passed equal to 500 million lati for 2010, and the country now targets a deficit of 7.6 percent of GDP. This is to be followed by a budget deficit target of 6 percent of gross domestic product in 2011, in order to finally arrive at the magic number of 3 percent deficit in 2012.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJdzguTnqQTREz6T4eg4ywhb0ti-56pntKYO8f2JZb69cAM4m8v78nf-b2swEcxdlWSSymSO_K25uO83EVZJtFlHRp-cqx07eSsPUCNffLHtZVQUvOA_5ysKch4xVt0lUYuw9mgK-GmYrD/s1600-h/latvia+CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 226px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418491868184716370" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJdzguTnqQTREz6T4eg4ywhb0ti-56pntKYO8f2JZb69cAM4m8v78nf-b2swEcxdlWSSymSO_K25uO83EVZJtFlHRp-cqx07eSsPUCNffLHtZVQUvOA_5ysKch4xVt0lUYuw9mgK-GmYrD/s400/latvia+CPI.png" /></a></p><br /><p>But considerable doubt exists over the ability of the Latvian authorities to fulfil these objectives. Which is why Mark Griffiths, IMF mission head in Latvia, describes the situation facing the government as challenging, and why the EU Commission base their Autumn forecasts on much higher deficit levels. The problem is that with domestic prive deflation (which is, remember, what Latvia is aiming for, the so called "internal devaluation" what is called nominal GDP (that is current price, unadjusted GDP) is likely to fall faster that the so called "real" GDP (adjusted for inflation) and this has two very undersireable consequences. In the first place debt to GDP goes up even faster, and the revenue which government receives (which is based on actual prices) drops faster than GDP, causing more instability in public finances. The deflator has shown falling prices since early this year and the EU commission is forecasting a drop of 5% for 2010.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-nX8a6zuaeV6UiLSyit4mZUCGPs7gEJR4CxAp0eufyN4QbsPsCZb7cs0HC3a7XLCrFhFv3L_gsIsH2WKeK3f-wmH27q9S5pja0pcqnHIfXFx0EDOgDV5NY78LoR4wWNsg2PdyJXh3idUV/s1600-h/Latvia+GDP+deflator.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 198px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418507419458754658" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg-nX8a6zuaeV6UiLSyit4mZUCGPs7gEJR4CxAp0eufyN4QbsPsCZb7cs0HC3a7XLCrFhFv3L_gsIsH2WKeK3f-wmH27q9S5pja0pcqnHIfXFx0EDOgDV5NY78LoR4wWNsg2PdyJXh3idUV/s400/Latvia+GDP+deflator.png" /></a><br /><br />So basically, in this climate, with unemployment rising, and wages falling, and an economy contracting at nearly 20% a year, it isn't hard to understand why not that much new bank lending is going on. Those who are creditworthy are trying hard to save, while those who need to borrow normally aren't that creditworthy, so Dombrovskis' plea is rather like asking the bank to subsidise new bad debts, and that is really not something you can do, and especially not when you are going along the course you are following because you wanted to, and against one hell of a lot of external advice. What kicked the whole process off was a short sharp credit crunch, but now it is the contraction in the real economy which is following its own dynamic, till someone finds a way to put a stop to it. It is the drop in output that is preventing banks from lending, and not banks being unwilling to lend that is causing the contraction to continue.<br /><br />But there is another point in the FT article which should give food for thought. </p><br /><blockquote>Mr Dombrovskis...ruled out devaluation of the lat. While breaking the currency’s fixed exchange rate with the euro would help Latvia’s exporters, it would increase the burden of euro-denominated loans, which account for 85 per cent of lending, he said.<br /><br />“We would not see much benefit from devaluation because we are a very small and open economy which means that any competitiveness gains we may get would be very short-lived,” he said. “We would redistribute wealth from pretty much all the population to a few exporters.”</blockquote><br /><p><br />Well, we haven't advanced too far in all these months, now have we, if we are still wheeling out the argument that "external" devaluation will hit holders of euro denominated loans, since it should be generally recognised that the (very painful) internal devaluation which is now taking place is hitting Euro loan and Lati loan holders alike. And the argument is a strange one to use just shortly after the statistics office announced that due to the rapid reduction in the number of those employed <strong>and</strong> to the fact that many of them changed their working conditions from full-time to part-time, the number of hours worked in the 3rd quarter of 2009 fell by an annual 27.3%, while labour costs fell during the same time period by 30.1%. This fall in disposable income, and the continuing prolongation thereof, poses a far greater threat to the continuity of Latvian loan payments than the 15% reduction in the value of the Lat as compared to the Euro which the IMF proposed in the autum of last year would have done. Indeed, it is, in and of itself, one of the pernicious consequences of having resigned yourself to an "L" shape non-recovery. Stress on the banking system only goes up and up, as incomes and employment fall, and the government has less and less ammunition left to counteract the contractionary pressure.</p><br /><p>It is like sitting it out in freezing weather at the North Pole, in the vain hope that help will arrive. But help will not arrive, and the cruel truth about the post-crisis shock world we live in, is that nobody is coming to help you if you will not help yourself. In this sense, what Latvia doesn't need is more international borrowing (hasn't there been enough of that already) but some kind of meaningful strategy to start paying back the debt. But this means putting people back to work, and selling abroad, and financing Latvian lending from Latvian savings, and not pleading for yet more capital inflows to finance non-productive activities (attracting investment would be another matter, but as things stand right now the environment is far from "appetising", and according to the latest data from the Statistics Office, non-financial investment in Latvia was only 402.8 mln lats in the third quarter, a fall of 39% on the 3rd quarter of 2008).<br /><br />And just to be clear, what we have seen to date is not a 30% drop in unit labour costs (which would, of course, mean a great boost to competitiveness), rather it is a drop in earnings due to the fact that the output people could have produced just isn't needed, since no one is willing and able to buy it. In fact according to the data of the Statistics Office to hourly labour costs fell by only 3.9% in the 3rd quarter when compared with the same period a year earlier. Hardly a massive drop, and especially not when the large annual increases of ealier quarters are taken into account (see chart below). The internal devaluation has a long course still to run!</p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhTNtAQeSt9E9fwmRH098vg8YjJA5kQD92FXlwh4dXqjlZ_hnAydLqevPMomBzfd_pY2X4EDdrtDN9ZIanLce9xX606PP7bTr8jJMG291OTQ7VJQ2mVSK01XH_5mh0ephKOkz0RhHQJM1Qb/s1600-h/Latvia+hourly+labour+costs.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 182px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418526963747858530" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhTNtAQeSt9E9fwmRH098vg8YjJA5kQD92FXlwh4dXqjlZ_hnAydLqevPMomBzfd_pY2X4EDdrtDN9ZIanLce9xX606PP7bTr8jJMG291OTQ7VJQ2mVSK01XH_5mh0ephKOkz0RhHQJM1Qb/s400/Latvia+hourly+labour+costs.png" /></a><br /><br /><strong>Pensions Dilemma</strong><br /><br />But Latvia is back in the news today for more reasons, since the constitutional court has just ruled against the government pension cuts, drawing a question mark over Latvia's ability to meet the terms of its international lending commitments.<br /><br />"The decision to cut pensions violated the individual's right to social security and the principle of the rule of law," the court said in its judgement, which cannot be appealed. The pension cuts - in place since July - formed a vital part of the Latvian government's list of austerity measures, as it struggles comply with terms of the IMF-lead bailout, and the constitutional inability to implement them is another hammer blow against the credibility of the current Latvian administration.<br /><br /><a href="http://www.baltic-course.com/eng/legislation/?doc=21859">According to the Baltic Course</a>, Valdis Dombrovskis told Latvian State Radio that the Constitutional Court's ruling on pensions must be carried out, and not debated. I am sure this will really come as music to the ears of people in Brussels and Washington. Basically pension reform forms a key part of the mid term strategy for sustainability of Latvian finances, and without the ability of the Latvian government to carry these out, then frankly the coherence of the whole strategy falls apart. If the Latvian constitution does not permit pension changes, then the Latvian constitution has to be changed, and the only surprising thing is that all this wasn't forseen when the initial loan negotiations took place in late 2008. Basically, it is impossible for the EU Commission and the IMF to accept any other view, since if any state could ring fence a whole part of social provision before entering debt negotiations, then non of the structural reform programmes could possibly work. This may seem harsh, but it is the price you have to pay for becoming insolvent as a society. Latvia's problems are NOT short term liquidity ones, but problems of the sustainability of an entire economic and demographic model, and, as in the case of Greece, these problems will not be solved by two or three years of (rather painful) fiscal deficit cosmetics. Real changes need to be made, and especially in raising the long term growth potential of the country, and frankly it is these changes which we have yet to see evidence for.<br /><br />The issue is not simply one of limping into the Euro in 2012, even if as Mark Griffiths, the IMF’s mission head in Latvia, <a href="http://www.bloomberg.com/apps/news?pid=newsarchive&sid=alXf8C.EvBCw">said in Riga last week</a> the Latvian government does face a lot of “hard work” in trimming the budget deficit enough to qualify for euro adoption, and how much more so if they cannot constitutionally implement the cuts they agree to.<br /><br /><br /><blockquote>“The key is meeting the deficit targets, and meeting the Maastricht criteria and euro adoption, that’s the path,” Griffiths said. “The government needs to work hard over the next year to find the measures which will deliver that adjustment to meet those targets. It’s going to be a challenging task.” </blockquote>Oh yes, and Latvia was also in the news yesterday for another reason, since <a href="http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aSlZ1iQtyoUA">Latvian stocks dropped the most among equity markets worldwide</a> as small investors sold stocks before the government starts to tax investment gains. The OMX Riga Index fell as much as 4.3 percent to 271.55, its lowest intraday level since August 21. In dollar terms, the drop was the biggest among 90 benchmark indexes tracked by Bloomberg. The reason for the sell off was that Latvia’s 2010 budget includes measures which will impose taxes on dividends, gains from trading stocks and bonds and interest income. These measures were agreed to in order to ensure the continued transfer of the 7.5 billion-euro bailout from the European Commission and the International Monetary Fund.<br /><br />Latvian investors have increasingly sold their holdings ahead of the Dec. 31 deadline. Dividends and interest income will be taxed at 10 percent, while tax on gains from trading stocks and bonds will be 15 percent.<br /><br /><strong>As Unemployment Climbs, Latvians Start To Pack Their Bags</strong><br /><br />Finally one that wasn't in the news, but should have been, since while everyone knows that at 20.3% Latvia's unemployment is the highest in the European Union (see chart below), what they don't know is that more Latvian's than even are now being forced to leave their country in search of work.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1HnKRsWUo-etq59jkdc23LtMs3wBp6J42BfdT4JG0ObHBfue7S-hXeP-d1pv74wmjTblBYbO3EiueK5m6E6-RMTy2INO-iQrvbqS0CiiSUqd7NZjReua36lyEiO78416TW46EDPErxKv8/s1600-h/latvia+unemployment+rate.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 221px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418531934523074210" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg1HnKRsWUo-etq59jkdc23LtMs3wBp6J42BfdT4JG0ObHBfue7S-hXeP-d1pv74wmjTblBYbO3EiueK5m6E6-RMTy2INO-iQrvbqS0CiiSUqd7NZjReua36lyEiO78416TW46EDPErxKv8/s400/latvia+unemployment+rate.png" /></a><br /><br />According to <a href="http://www.bank.lv/eng/main/all/sapinfo/commentary/unemployment_emigration/">a report by Oļegs Krasnopjorovs</a>, economist with the Bank of Latvia, during the first half of 2009 8,300 Latvian residents left for Great Britain, a twofold increase over the year earlier period. 3,600 people emigrated to crisis-ridden Ireland in the first 11 months of 2009 - 3% more year-on-year. Among the new EU member states, Latvia has seen the sharpest increase in emigration to these two countries.<br /><br />According to Krasnopjorovs, the data (which comes from the UK and Irish social security systems) confirm the trend identified by the Latvian Statistics Office, who examined data on long-term migration. In the first ten months of 2009, the number of long-term emigrants was 6,300, up 18% more year-on-year; moreover the steepest rise took place in the last few months, reaching a ten-year peak. For several years now the number of emigrants has exceeded that of immigrants in Latvia, with the exception of the second half of 2007 when a sharp rise in salaries and a steep drop in unemployment were fuelled by the credit and construction boom, leading to labour force shortages and the expectation that incomes would rise even further.<br /><br /><br /><strong>Exports Still The Key</strong><br /><br />The real problem here, of course, is that the Latvian economy remains mired in deep recession, and shows few signs of real recovery, something which is not surprising given that domestic consumption is in limbo land (where it is likely to stay), while the Prime Minister seems to attach little priority to boosting exports, and regaining competitiveness. Indeed, the contraction has rather gathered than lost momentum in recent months, and on a seasonally adjusted basis Latvian GDP fell another 4% between the second and third quarters of 2009. This was much faster than the 0.2% contraction between Q1 and Q2.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEA5Fz3GLLvxlZqyMXRdCSWPYcn9wehKDK9sAZJ9GMp7IMxmjnYkAoNcPWD6ixVIhtva4fjlARcOkEUSpQLvzQa4QtdF4JnDJH8p-crRY74WEIH1r-VPPGWgkpCOVYdmD44ntasyb90juX/s1600-h/Latvia+GDP+QoQ.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 241px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418544829533318514" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjEA5Fz3GLLvxlZqyMXRdCSWPYcn9wehKDK9sAZJ9GMp7IMxmjnYkAoNcPWD6ixVIhtva4fjlARcOkEUSpQLvzQa4QtdF4JnDJH8p-crRY74WEIH1r-VPPGWgkpCOVYdmD44ntasyb90juX/s400/Latvia+GDP+QoQ.png" /></a><br /><br />Year on year Latvian GDP fell by 19.0% in the third quarter.The decrease was largely due to a 28.7% drop in external trade (share in GDP 15.6%), a 18.2% one in transport and communications (12.5% GDP share), an 17.4% fall in manufacturing (10.2% GDP share, incredible) and by a 36% drop in construction (7.5% GDP share, not far below manufacturing).<br /><br />Private final consumption fell by 28.1%. Government final consumption decreased by 12.4%, while expenditure on gross capital formation fell 39.4%. Goods exports (68.2% of total exports) fell by 11.7% and services exports by 20.5%. Goods imports (82.1 % of total imports) were down much more sharply - by 36.6% -and services imports by 29.1%. Which meant net trade was positive, otherwise the fall in GDP would have been greater, and nearer to the levels seen in domestic demand.<br /><br />And entering the fourth quarter there were few signs of any real improvement. Retail sales fell in October by 1.3% from September (on a seasonally adjusted, constant price basis).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiu8wTpcmFSlymAMGQykkN4sqdt1wHEsV2PxuaVUnqeSl5aIaYt1e50-JEo_-li2z72Rf9T83LgCRZGTha9RSF9IXA2_gcKyodfBCMLgkd1UTElasqO6vTxxh5roreiaDA-buJQcWbaBx9u/s1600-h/latvia+retail+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 226px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418547235474131138" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiu8wTpcmFSlymAMGQykkN4sqdt1wHEsV2PxuaVUnqeSl5aIaYt1e50-JEo_-li2z72Rf9T83LgCRZGTha9RSF9IXA2_gcKyodfBCMLgkd1UTElasqO6vTxxh5roreiaDA-buJQcWbaBx9u/s400/latvia+retail+index.png" /></a><br /><br />As compared to October 2008 sales were down by 29.1%. The drop was even larger in the non-food product group – 32.3%. According to Eurostat data, sales are now down nearly 35% from their April 2008 peak.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4BMpUcX8PX3E7dbHfnrrWZd40OyJ8ygTwUqljBGb4oz3mfZ8YqiuvbbKvKaZqDJ1RI0ZqqwGx1BXLicJxjmdqveLSRGtxvWlL6ZZW6Uo4rvXzUjGQxwo2YUhR9ebimr4_qaedkwrhRyGC/s1600-h/Latvian+retail+sales+P2P.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 226px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418734880320762658" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4BMpUcX8PX3E7dbHfnrrWZd40OyJ8ygTwUqljBGb4oz3mfZ8YqiuvbbKvKaZqDJ1RI0ZqqwGx1BXLicJxjmdqveLSRGtxvWlL6ZZW6Uo4rvXzUjGQxwo2YUhR9ebimr4_qaedkwrhRyGC/s400/Latvian+retail+sales+P2P.png" /></a><br /><br /><br />Industrial output, however, seems to be holding up a little better, and output has stabilised since the spring. The problem is that manufacturing industry is now such a small share in GDP that it will be hard to pull the entire economy on the basis of anything other than very strong rates of increase. Industrial production was up in October by 0.1% over September, marginal, but at least it wasn't a fall. Unfortunately most of the increase was in the energy sector, with electricity and gas up by 10.3%, mining and quarrying contracted, by 2.1% as did manufacturing, by 1.9%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiY-GZQT1AmJs2UZNgQ3HZACO2sznaMSCF01YfyHO1iFWLP43HtFk3q4yQBKg-sYiJzECwQ_e_lMNJyWmPRSai3JuqYbtyA_5i7zerDi69HQKuzY3I3LfBxkZkqiQST4E-V_-EuZaRvzF0V/s1600-h/Latvia+IP+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 225px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418547517659119666" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiY-GZQT1AmJs2UZNgQ3HZACO2sznaMSCF01YfyHO1iFWLP43HtFk3q4yQBKg-sYiJzECwQ_e_lMNJyWmPRSai3JuqYbtyA_5i7zerDi69HQKuzY3I3LfBxkZkqiQST4E-V_-EuZaRvzF0V/s400/Latvia+IP+index.png" /></a><br /><br />Compared to October 2008 industrial output was down by 13.5%, Output in manufacturing fell by 15.8%, in mining and quarrying by 11%, while in electricity and gas output was only down by 2%. Output is now down around 21% since the February 2008 peak.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQFyKAXtCM6u9vijfMWC4zRyI8vsEH5cOyNWO2s4-g_EShoZFFfGPrkDbFAH93Aaw-_SSTJmQTw0X4MhYNijx_hyphenhyphenLjRUF_dB5mt96W7H0jzeTN7129XJrolPPgjNIEq5vMhJpj7x5N-g9u/s1600-h/Latvia+IP+P2P.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 225px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418547442521941170" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQFyKAXtCM6u9vijfMWC4zRyI8vsEH5cOyNWO2s4-g_EShoZFFfGPrkDbFAH93Aaw-_SSTJmQTw0X4MhYNijx_hyphenhyphenLjRUF_dB5mt96W7H0jzeTN7129XJrolPPgjNIEq5vMhJpj7x5N-g9u/s400/Latvia+IP+P2P.png" /></a><br />There is one positive glimmer on the Latvian horizon at the present time, and that is, of course, exports which were up by more than 4.4% (or 31.7 mln lats) when compared with September.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiXkLpgMEqOp-k68p0A6c-vSyoXhYUNqEaMARo6de4EnUTqowW3UELP4TDN4Lnnr5F9RBrf0_Af3I2xjpEVlZZ91nCe4AxYd9tlkCQRXUwFhaMOW-L20rFnrvzUpi1Owp6DbtQh4RdUaihR/s1600-h/Latvia+exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 259px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418547704385116882" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiXkLpgMEqOp-k68p0A6c-vSyoXhYUNqEaMARo6de4EnUTqowW3UELP4TDN4Lnnr5F9RBrf0_Af3I2xjpEVlZZ91nCe4AxYd9tlkCQRXUwFhaMOW-L20rFnrvzUpi1Owp6DbtQh4RdUaihR/s400/Latvia+exports.png" /></a><br /><br />As a result, the surplus in the current account of Latvia's balance of payments reached 10.1% of gross domestic product (or LVL 327.9 million) in the third quarter. The surplus is however rather smaller than in the second quarter, which was 14.2% of GDP.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmTY8FO5952T255tBmaORuWtMGmC5ur4agMgKO2_evrmIK2DljgFfF6krcPh3czpiGjvymAPq8KflhbiHXNQS-BmBwsmKUPFDIyxA-Q-KdXxsTMPIjhMNfxwx-f73RMU8R1x1gZUfuSdeq/s1600-h/latvia+current+account.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 262px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418547838944346514" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgmTY8FO5952T255tBmaORuWtMGmC5ur4agMgKO2_evrmIK2DljgFfF6krcPh3czpiGjvymAPq8KflhbiHXNQS-BmBwsmKUPFDIyxA-Q-KdXxsTMPIjhMNfxwx-f73RMU8R1x1gZUfuSdeq/s400/latvia+current+account.png" /></a><br /><br />With export growth exceeding that of imports, the combined goods and services balance was positive for the second consecutive quarter, standing at 0.3% of GDP (or LVL 11.2 million). This effect is more due to services than to goods exports, since the goods trade balance is still in deficit (see chart), so there is still a long road to travel.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2VBNmmgR5DHcWKQ09iINS0XEDzN2wYSSg_7x4ZbTAMZYvZyPyS_nbbPJ2Q-F8_5SKhJNilPB3D35YlrFz3FEulezo6XI-PqzKzfagUkdTGKX2AHj5FJL13aTmRIgCBk4Jyu-WTEH7mL-H/s1600-h/Latvia+trade+deficit.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 260px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5418548154504459394" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2VBNmmgR5DHcWKQ09iINS0XEDzN2wYSSg_7x4ZbTAMZYvZyPyS_nbbPJ2Q-F8_5SKhJNilPB3D35YlrFz3FEulezo6XI-PqzKzfagUkdTGKX2AHj5FJL13aTmRIgCBk4Jyu-WTEH7mL-H/s400/Latvia+trade+deficit.png" /></a><br />The largest third quarter capital inflows registered under the capital and financial account were the result of government borrowing from the IMF-lead support programme. There was some new foreign direct investment in Latvian companies to the amount of LVL 370.2 million, which to some extent offset direct investment outflows. Net external debt shrank by LVL 0.5 billion in nominal terms, but due to the fall in GDP (as I explained earlier) the ratio of net external debt to GDP posted only a tiny drop, reaching 56.4%, and gross external debt to GDP (excluding foreign assets) was up, reaching 145.8%.<br /><br />So, as I say, a start has been made, even if there is still a long, long road to travel. Internal devaluation is the chosen path of the Latvian people, the best thing I can suggest at this point is to get it moving in earnest (in fact there is some evidence from November producer prices that the rate of price fall is now accelerating), and that Latvia's leaders start to value what they have (that is, export potential) instead of dreaming of what they can no longer have (dynamic domestic consumption driving growth). Living in the past is never a good idea, not even in the sentimental moments of Yuletide. A Merry Xmas to you all!Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-20362305479452239402009-12-04T14:28:00.001+01:002009-12-04T14:38:48.726+01:00Russia's Economy Slows In NovemberAs <a href="http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aMzKBq0lD89g">doubts grow</a> that in the post Dubai world Russia's central bank will be able to sustain a great deal of momentum in its ongoing programme of interest rate reductions, we learn this week that the pace of expansion in Russia's economy slowed back in November, following two months of steady advance in September and October. This time services activity also weakened its advance while manufacturing activity registered its second month of contraction. Yet the central bank may well show increasing restraint in lowering interest rates, even as the economy slows, the ruble rises, and bank retail lending continues to fall, having declined for nine consecutive months up to and including October, while corporate lending dropped for a second month in a row and hasn’t risen for six months (for more on the particular topic see my recent post - <a href="http://russiatooat.blogspot.com/2009/11/russias-consumers-get-carried-onwards.html">Are Russia's Consumers Getting "Carried Away" With Themselves?</a>). <br /><br />While the seasonally adjusted VTB Capital Total Activity Index remained in positive territory for the fourth month running in November, the latest figure of 52.8 indicated the weakest rate of growth in three months.<br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTUHEGpWa75rHpSxH9Oo15pLtN-Il51Ale1CWvoPa8OM9-pne5w5Sebl-Tj9vVoroKKS-D6YHvjc-ydq15Pq3sAYaqZuhr7f9DIBbcsO-gr_lGjRusoHfdQYE_LdexGHKEbqx9crD5RhGL/s1600-h/GDP+indicator+3.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 241px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5411359106996274402" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgTUHEGpWa75rHpSxH9Oo15pLtN-Il51Ale1CWvoPa8OM9-pne5w5Sebl-Tj9vVoroKKS-D6YHvjc-ydq15Pq3sAYaqZuhr7f9DIBbcsO-gr_lGjRusoHfdQYE_LdexGHKEbqx9crD5RhGL/s400/GDP+indicator+3.png" /></a><br /><br />The VTB Capital Monthly GDP Indicator, based on the PMI surveys for both the manufacturing and service sectors, continued to show an annual economic contraction in November, even if the the rate of decline eased for yet another month. At an annual minus 2.5%, down from a revised minus 4.0% in October, the indicator stood at its highest level since December 2008. Over the third quarter as a whole, the GDP Indicator suggested that the economy contracted by a revised 8.7% year-on-year, a better outcome than the record 9.9% fall posted during Q2. Data for the first two months of the final quarter show an average contraction of 3.3%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjrEyKmHAmWI-n0TEmWsfa6JfVrkKZC1GQjjuujVh9OY7n3GRwAFIiWBbfpDhzARV4cSY0AbzsCvV-ZEIvVePy912Mq4aukx_JckrpNXWbpiqibjTrXT_4p1Y69fSTG-zrMdVZN-nrQa5rA/s1600-h/GDP+indicator+2.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 244px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5411363072344891746" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjrEyKmHAmWI-n0TEmWsfa6JfVrkKZC1GQjjuujVh9OY7n3GRwAFIiWBbfpDhzARV4cSY0AbzsCvV-ZEIvVePy912Mq4aukx_JckrpNXWbpiqibjTrXT_4p1Y69fSTG-zrMdVZN-nrQa5rA/s400/GDP+indicator+2.png" /></a><br />By contrast the quarter-on-quarter rate slipped back to a bare 0.2%, treacherously close to the dividing line between contraction and expansion.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwsMNQnIv4NKiOsnRA-ajn5cByIxGbDkLoa6dmG31GZS41VK0R4uYKTxyrz40M1N8UaosB8qQbJY0DmS-l0stDu1zySHG1qFAnQestHkXmZl69StR7NQdEXRdlqdMEgHC6_mxNA8mRRtJX/s1600-h/GDP+Indicator+One.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 245px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5411363595830574578" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwsMNQnIv4NKiOsnRA-ajn5cByIxGbDkLoa6dmG31GZS41VK0R4uYKTxyrz40M1N8UaosB8qQbJY0DmS-l0stDu1zySHG1qFAnQestHkXmZl69StR7NQdEXRdlqdMEgHC6_mxNA8mRRtJX/s400/GDP+Indicator+One.png" /></a><br /><br />The outcome is not surprising when we take into account that November saw an overall deterioration in business conditions in Russian manufacturing for the second month running. Output rose only marginally, while incoming new orders fell for the first time since June. Growth of purchasing activity was maintained, but at a slow pace, while employment continued to fall. Thus the headline seasonally-adjusted Russian Manufacturing PMI remained below the no-change mark of 50.0 for the second month running, and although the November figure of 49.1 indicated only a marginal rate of deterioration, it was still slightly worse one than the 49.6 posted in October. The fall in the PMI primarily reflected slower output growth and falling new orders.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0qIw7hCoBwgGUCdC9Xgp_BvgLNypYiFKLrOAdjww4UpoFTzk44nqwrerZDiLtlxGyU39qLpIonP0WfW-KSfNmqT97ve9GmPSNRXTcR9TB6cSZ1GaSD4E21qc3soFWftAsC0j_5U59IIBo/s1600-h/russia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 247px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5411091571181203826" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg0qIw7hCoBwgGUCdC9Xgp_BvgLNypYiFKLrOAdjww4UpoFTzk44nqwrerZDiLtlxGyU39qLpIonP0WfW-KSfNmqT97ve9GmPSNRXTcR9TB6cSZ1GaSD4E21qc3soFWftAsC0j_5U59IIBo/s400/russia.png" /></a><br /><br />Business conditions in the Russian service sector, on the other hand, continued to improve during the month, albeit at a weaker pace than previously. The easing primarily reflected slower rates of growth in business activity and new business, which both remained well below pre-crisis levels. Meanwhile, inflationary pressures remained subdued, with input prices rising at a relatively weak rate and charges falling slightly for the second month running. </p><p><br />The headline seasonally adjusted Russian Services PMI came in at 53.3, down on the 54.3 registered in October, and well below the historic average of 56.9, highlighting the fragility of the Russian recovery. Restricted credit continued to be a theme in this months survey responses, although sector data pointed to a stronger rise in financial intermediation activity. The rate at which incoming new business increased slowed during the month and contributed to additional spare capacity at service providers and a faster decline in outstanding business. Backlogs of work have contracted every month since September 2008, and the latest rate of decline was at the most rapid rate since July.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPLYq8WeoKKGeo_9lHW1OakpW6AeIts56Sj1mUZj04ktZB6VoeigwirE9Hp7eRDUDsk4uW13ITQ9B5RjWmt_M3iEXdDlxqv8HPx30bjzDlibw4bjMQQIHzmS4iDE-YLHDr6wRQ2JLIoine/s1600-h/russia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 243px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5411355963628930578" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPLYq8WeoKKGeo_9lHW1OakpW6AeIts56Sj1mUZj04ktZB6VoeigwirE9Hp7eRDUDsk4uW13ITQ9B5RjWmt_M3iEXdDlxqv8HPx30bjzDlibw4bjMQQIHzmS4iDE-YLHDr6wRQ2JLIoine/s400/russia.png" /></a><br /><br /></p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-49888050557487874242009-11-26T15:26:00.000+01:002009-11-26T15:28:44.977+01:00Are Russia's Consumers Getting "Carried Away" With Themselves?<blockquote>“Cutting rates by 50 basis points here and there is not going really diminish the appeal of the ruble,” said Manik Narain, an emerging markets strategist at Standard Chartered Bank Plc in London. “In terms of nominal interest rates Russia (at 9% as of 24 November) is still offering the highest yields in the emerging market space and in an environment where oil prices are remaining relatively well supported we think that the ruble will continue to be seen as an attractive way to position for global recovery,” </blockquote><p><br />The world's central banks are having a hard time of it these days, having just gotten through the worst banking and financial crisis in living memory they now face a growing dilema between continuing to give support to the developed economies (which are yet to recover from those early hammer blows) and the danger of creating fresh global asset price bubbles in emerging economies, asset bubbles which could easily be being fuelled by low US interest rates and a weak dollar. The latest warning in this respect comes not from Nouriel Roubini (or even from me, <a href="http://fistfulofeuros.net/afoe/economics-country-briefings/the-dollar-as-a-funding-currency/">but see this post</a>, and <a href="http://www.forexblog.org/2009/11/interview-with-edward-hugh-the-dollars-demise-is-vastly-overstated.html">this recent interview I gave on Forex Blog</a>), rather it emmanates from Germany’s new finance minister, Wolfgang Schäuble. His comments - which were <a href="http://www.ft.com/cms/s/0/4ec41a1a-d616-11de-b80f-00144feabdc0.html">cited in last Saturday's Financial Times</a> - highlight official concern in Europe that the exceptional steps taken by central banks and governments to combat the crisis carry with them a series of undesireable side effects.<br /><br />Such openly expressed concerns only add further weight to <a href="http://www.ft.com/cms/s/0/85f1fac2-d1dc-11de-a0f0-00144feabdc0.html">recent statements made in China</a>, where only a week ago the banking regulator Liu Mingkao explicitly criticised the US Federal Reserve for indirectly fuelling the “dollar carry-trade” – a process whereby investors borrow dollars at ultra-low interest rates in the United States and the invest them in higher-yielding assets abroad.<br /><br />Wolfgang Schäuble went even further, saying it would be “naive” to assume the next asset price bubble would look just like the last one. “More likely today is a scenario in which excess liquidity globally creates a new [sort of] asset market bubble.” he said, and the fact “ that low interest rate currencies such as the US dollar increasingly being used as a basis for currency carry trades should give pause for thought. If there was a sudden reversal in this business, markets would be threatened with enormous turbulence, including in foreign exchange markets.”<br /><br />As I argued in my last post on the carry trade, the danger of a short term sudden reversal may be being overstated at this point, since exit from emergency life support will be at best slow and measured in the United States, while ample funding will continue to remain available in Japan, where the central bank <a href="http://www.ft.com/cms/s/0/c3a3be3e-d608-11de-b80f-00144feabdc0.html">has now formally recognised that the economy is once more back in deflation</a> (officially it exited in 2006, and the Bank did manage to summon up a full half percentage point worth of interest rate rise before falling back towards zero again, but in reality, if we strip out the oil price impact, the sad truth is that Japan never really left deflation).<br /><br />However, regardless of whether or not we are running the danger of having an overly rapid unwind effect, untold damage is in fact being done, with the structural distortions being produced by the massive “wall of liquidity” which is currently sweeping the planet being evident enough, showing up as it is in some unexpected places, like Russia for example.<br /><br /><br /><strong>Ruble Once More On The Rise</strong><br /><br />On the face of it the idea that investors who were rushing for the Russian door following the Roki tunnel incursion back in August 2008 may now be rushing back in again may seem hard to believe, particularly given the serious economic recession which followed, and in reality it isn’t quite like this, but what is clear is that a steady and significant flow of funds is now most definitely heading in Russia’s direction - even if the immediate objective is not to increase what Russia most definitely needs, namely capital investment. A brief glance at the charts for movements in the ruble vis a vis the US dollar (see below) shows immediately what has been happening. After hitting a low of $31.39 on September 2 the ruble has been steadily rising, and was at $28.65 on November 11, since which time it has been hovering, as investors vacilate waiting to see where policy and the currency go from here.</p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrM5A6hMV8dDK8-68qLr-XsM-z3VJ5dC3qcbG235o88W_hjn5EwQB7vE0-v3-piZzA6ZSTHVpKjQZD1BuwTAv9n6VYNKHme_tF1wcJV1S9XLEBrW2E6nCiJ6pIv8ifCpyiVniTWuiC69Qe/s1600/rouble+2.png"> </p><p><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 240px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408305743940365858" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhrM5A6hMV8dDK8-68qLr-XsM-z3VJ5dC3qcbG235o88W_hjn5EwQB7vE0-v3-piZzA6ZSTHVpKjQZD1BuwTAv9n6VYNKHme_tF1wcJV1S9XLEBrW2E6nCiJ6pIv8ifCpyiVniTWuiC69Qe/s400/rouble+2.png" /></a> At the same time, if we look at movements in the ruble-USD over a longer period of time (2 years in the chart below) it is plain the the ruble hit bottom on 4 February 2009 at $36.22 after falling steadily from 17 July 2009 when it touched $23.25.</p><p> </p><p><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRblulchzyDytKXOlreS__TyVKkRgRv331McF3WR6eB1ZOoAJvp1ZW07Zhm6rWgSWSt8CMif-XR7ZxQlA-COhxH0UcLZxDLr6wPImG8slFmpGWlK_R-oXJOvBfFaxb3pcFtCT5HC3NurAI/s1600/rouble+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 244px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408305680008748370" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhRblulchzyDytKXOlreS__TyVKkRgRv331McF3WR6eB1ZOoAJvp1ZW07Zhm6rWgSWSt8CMif-XR7ZxQlA-COhxH0UcLZxDLr6wPImG8slFmpGWlK_R-oXJOvBfFaxb3pcFtCT5HC3NurAI/s400/rouble+one.png" /></a><br /><br />In fact, as I say, while it is clear that Russia is on the receiving end of a steady inflow of funds, it is far from clear that these funds are of the kind she most needs at this point. Much of the money has been going into stocks, and Russian equity funds drew record amounts at the end of October, according to data provided by EPFR Global. In fact Bloomberg data show that the ruble has been the second-best performer among emerging market currencies after the Chilean peso over the past three months, gaining 8.7 percent in the period. And even foreign currency purchases from the central bank and lowering interest rates systematically to a record low (in Russian terms) has not worked. Indeed Russia's foreign currency reserves have now risen to $441.7 billion (as of Nov. 13) compared with the low of $376.1 billion reached on March 13. Whilethe Micex Stock Index has gained 116 percent this year, making the Index the best-performing benchmark equity measure globally since January (in local currency terms), again according to Bloomberg data. <br /><br />In comparison Russia’s foreign direct investment plummeted an annual by 48.1 percent, the most on record, to just $10 billion in the first nine months of the year, while overall foreign investment, including credits and flows into securities markets, was $54.7 billion, down 27.8 percent when compared with the same period a year earlier,according to Federal Statistics Service data. Other foreign investments, including loans from foreign banks and Russian companies’ foreign divisions, were down 20.9 percent in the period to $43.7 billion. The consequence of all this is that the decline in investment activity has been - as can be seen in the GDP growth components chart below - perhaps the greatest single drag on the domestic Russian economy over the past twelve months.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYCN5G3foB1IpRtodPomh1Kwe0fkTOxb4R_E03dRJQVFkz-7hs5GEnOB_jpNDsUHFcEtLlbXvUaZq8iRfy0iRIPlugKTvImfFK29ZOIX7a7BY6mKfY1-yBZu3P_U8iFM2eCiI3y3R0SmLt/s1600/russia+growth+components.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 297px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5407338743595927282" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjYCN5G3foB1IpRtodPomh1Kwe0fkTOxb4R_E03dRJQVFkz-7hs5GEnOB_jpNDsUHFcEtLlbXvUaZq8iRfy0iRIPlugKTvImfFK29ZOIX7a7BY6mKfY1-yBZu3P_U8iFM2eCiI3y3R0SmLt/s400/russia+growth+components.png" /></a><br /><br />But, as I am stressing this earlier overall impression of Russia as a country with problems of net capital flight now no longer gives us a precise up-to-date picture because, in a reversal of the earlier pattern Russia has seen, since mid September, significant capital inflows. In this sense some of the aggregate flow data is misleading, and even while the pressure from foreign lenders to repay sindicated loans continues and Russian borrowers continue to have difficulty rolling over their debt, the aggregate capital flow data to some extent masque a change in the underlying structure of Russian external debt - here, as ever, the devil lies in the details. As Guillaume Tresca, a Paris-based emerging market strategist with Credit Agricole’s Caylon Unit, argues the mounting weight of that huge wall of liquidity sweeping the planet means that something somewhere has to give, with the consequence that the Russian authorities are now under severe pressure to accept the inevitability of short term ruble appreciation since even though they “will try to do what they can to smooth the process, it’s very hard for them to go against the flow” since current “capital inflows are massive.”<br /><br />In fact a growing consensus seems to be now emerging that Russia’s central bank will find itself forced to accept a stronger ruble next year as the devastating cocktail of rising commodity prices and abundant liquidity simply prove to be too powerful a force for policy makers to counter. So while representatives of the Russian administration have repeatedly asserted that they will do all they can to cap the ruble’s advance, all may well not be enough, despite Vladimir Putin's repeated declarations that his government won’t allow excessive appreciation in a bid to give some support to struggling exporters. The Canute like task of driving back the ocean is hardly an easy one, and, as the IMF itself recently warned, all efforts to fight the ruble’s advance may simply prove to be “unproductive.”<br /><br />The problem has recently become even more complicated since, in the short term at least, letting the rouble rise also has its attractions for a Russian administration faced with simmering popular frustration with their inability to get the ongoing economic contraction fully under control. A rising ruble means slower inflation and more spending power for domestic consumers, consumers who have yet to get over the record 10.9 percent economic contraction which hit them in the second quarter. Given that the nine interest rate cuts introduced by the central bank since April have manifestly failed to unlock the credit flow to consumers as banks hold back their lending on concern borrowers can’t repay their debt (see chart below) a rising exchange rate certainly seems to be worth a second look as a way forward, since while a higher exchange rate coupled with near double digit inflation may cripple manufacturing competitiveness, it does transfer incomes directly into people’s pockets, something hard pressed politicians might see as quite beneficial.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixPVQ040t08mqAzJjunausAvhmg6xS66rGHIjieR2u8wjVFCxx83pHlR1WP6oLO5ZiJ4uK5EN6pE6GFIyxhWtstSPcGYMd8WSxMl9AsuJNuj460BUMTBW6F0LHlriLAv7b9slBeOMXSyAV/s1600/russia+credit+growth.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 327px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5407685003122500626" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixPVQ040t08mqAzJjunausAvhmg6xS66rGHIjieR2u8wjVFCxx83pHlR1WP6oLO5ZiJ4uK5EN6pE6GFIyxhWtstSPcGYMd8WSxMl9AsuJNuj460BUMTBW6F0LHlriLAv7b9slBeOMXSyAV/s400/russia+credit+growth.png" /></a> <br /><br />Lending is still - as can be seen in the above chart prepared by the World Bank for its latest report - a problem, and corporate (or non-financial corporation lending) fell by 0.7 percent in September from August continuing the ongoing decline. Lending to households dropped 1.1 percent making the eighth consecutive monthly decline, with year on year levels now in negative territory, while non performing retail loans rose, climbing to 6.4 percent from 6.2 percent.<br /><br />And the World Bank expect the many bank balance sheets will continue deteriorating as the share of non-performing loans increases. “In the environment of increasing credit risks, lending activities by the banks have remained limited despite improving liquidity conditions in the economy and continuing monetary loosening.” Bad debts in the banking industry may reach an average of 10 percent by the end of the year according to the Bank.<br /><br /><br />And when we look at ruble realities, as the IMF point out, efforts to stem the ongoing rise with intervention are far from being able to give the desired result. Bank Rossii bought a net $15.2 billion and 485 million euros in October, their largest foreign currency purchases since May, and went on to buy $6 billion during the first 17 days of November according to press reports citing central bank chairman, Sergey Ignatiev. Yet last week the Russian the ruble ended 0.1 percent higher at 35.0632 against the central bank’s target currency basket, its strongest level since December 23 2008. The ruble appreciated 3.4 percent in October against the dollar (for its second consecutive monthly gain) and has risen more than 1 percent so far in November. Thus the central bank has now moved on to use monetary policy to try and stem the rise, and said on October 29 that it would also use interest rates in an attempt to reduce the “attractiveness of short-term investments in Russian assets and stop the accumulation of risk”.<br /><br />The recent rise follows ruble a 35 percent slump against the dollar between August last year and January, raising the cost of imports (which make up about 49 percent of the consumer goods sold in Russia) and, in theory, making Russia's domestic industry somewhat more competitive externally. However, without a sound institutional infrastructure, and a coherent monetary policy, short term devaluation gains can easily be turned into medium term inflation, thus defeating the purpose of corrective price devaluation.<br /></p><p></p><br /><br /><br /><p>The current problems are not of recent making, but are the logical end product of steady and systematic long term mismanagement of Russia's monetary policy, a mismanagement which has now created a veritable Procrustean bed of problems for both Russia's economy and the wider society. Warnings were frequent enough, but went unheaded, and the continuing failure to address the underlying inflation problem between 2005 and 2008 now means that large structural distrortions have been accumulated in the economy, including a massive one of commodity export dependence, a problem which effectively turned the country into a veritable disaster waiting to happen if ever there should be a protracted lull in the secular rise in energy prices. That lull has most definitely now arrived, since while it is obvious that Russia's short term future depends on energy prices, it is far from clear what the future holds for those energy prices themselves. </p><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjn0n3Ucjy8dcSAbU6pJJCECE74KO68CLJCD49OZcLaVEWz60-trLZE8S8oHliL0op8502UqUqqXKCt_hj-IcP02UWIgTbrqkHCBJS1OsTJjxyUfrwfka9ovlo15TlyFcOYSA85SMbYzESL/s1600/world+bank+oil.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 283px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5407690218112776594" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjn0n3Ucjy8dcSAbU6pJJCECE74KO68CLJCD49OZcLaVEWz60-trLZE8S8oHliL0op8502UqUqqXKCt_hj-IcP02UWIgTbrqkHCBJS1OsTJjxyUfrwfka9ovlo15TlyFcOYSA85SMbYzESL/s400/world+bank+oil.png" /></a><br /><br />Weak global demand for oil has led to a sharp rise in excess capacity and OPEC's spare capacity has risen to levels not seen since 2002, when prices averaged USD25/barrel with OPEC’s pricing power staying very low. Up to now oil prices have remained in the USD70/barrel range, supported by OPEC output restraint and its stated desire to have prices reach what it calls "a comfortable level" - ie near USD75/barrel - as well as by expectations of rising demand. At its September 2009 meeting, OPEC left its production quotas unchanged but indicated it would take rapid action if prices dropped sharply. OPEC production, however, continues to edge higher, with compliance to its combined cuts of 4.2 million barrels per day falling to 66 percent in September from 71 percent in August. Thus there is evidence of OPEC strains and there is considerable uncertainty about real levels of 2010 demand, all of which makes for considerable uncertainty about prices. As can be seen in the above chart, World Bank oli price estimates (like their economic growth ones) have fluctuated, and have moved from a price estimate in March of around $62.95 for 2010 to the current (November) expectation of $75.29. While the earlier estimate may certainly be considered to be on the low side, the current one may well be too high, and a level of around $70 may not be an unrealistic forecast. It should be noted however that there are credible dissenters, and in a more or less reasoned analysis Capital Economics suggest that oil prices could well fall back again in 2010 to average somewhere around $50. If this forecast were to prove to be anywhere near correct, the Russian economy is going to be subject to major downside risks, due in particular to the difficulties posed by:<br /><br />i) financing the fiscal deficit<br />ii) rising unemployment<br />iii) growing bad loans in the banking system<br />iv) refinancing external debt<br />v) the continuing high level of consumer price inflation and the difficulties this poses for monetary policy at the central bank<br /><br />Added to all this, the economy will clearly not rebound as easily as many seem to foresee, adding to the risk element on all fronts.<br /><br /><br /><strong>A Return To Growth In The Third Quarter</strong><br /><br />Following the deep output drop sustained in the first half of the year (10.4% of GDP year on year), the slow recovery in global demand and rise in commodity prices has helped lift Russia’s economy up from its earlier lows. But the recovery has only been a modest one, since preliminary data indicate that the economy still registered a 9.4 percent year-on-year drop in the thrid quarter, indicating only a very small improvement (possibly a seasonally adjusted 0.6%) over the second quarter. More recent data also point towards a rather uneven progression, with the manufacturing sector falling back while rising real incomes means that consumer demand is producing stronger growth in the services sector.<br /><br />As in other countries, investment (both foreign and domestic) took a severe hit on the back of the credit crunch, and gross capital formation was indeedthe main demand side factor dragging GDP down in the first half of the year (by 14 percentage points), followed at some distance by consumption, which contributed 1.2 and 3.0 percentage points to aggregate output contraction rates respectively in the first and second quarters. Net exports, on the other hand, made a positive contribution (5.1 percentage points in the first quarter and 5.9 percentage points in the second) although <strong>as elsewhere</strong> the <strong>drop in imports</strong> was the key factor. When imports are looked at in volume (price adjusted) terms we find that real ruble depreciation (the real effective exchange rate depreciated by 5.9 percent in the first nine months of 2009) meant that the import contraction was more severe than it seemed, especially in the second quarter of 2009 when the drop in imports meant that net exports increased by 66 percent according to World Bank calculations.<br /><br /><strong>Unemployment Falls Back, But Problems Remain </strong><br /><br />Six million Russians were added to the government’s official poverty count in the first quarter of this year alone, and by the end of 2009, 17.4 percent of the population or 24.6 million people will be living beneath the subsistence level of $185 per month, almost 5 percent more than before crisis, according to World Bank estimates. Unicredit analysts forecast that the number of Russians with disposable incomes of more than $1,000 per month will fall 48 percent this year to about 13.6 million, or roughly 9.6 percent of the population. Thus this recession is likely to have lasting and important results.</p><br /><p>On the hand, employment statistics from the Federal Statistics Service indicate that a sharp downward adjustment in the labour market took place up to February this year, before moderating and then reversing. Unemployment seems to have peaked in February at 9.5 percent following the sharp decline in output, and the severity of the blow was especially strong in the industrial sector. </p><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjRJWai_g6NbKXECIl-w2d_6JH4i50ClH-QJ6yGq-6mZ_y3fvRoHGhE9WCznMjBqNh3GdCI9FgdrekBMkGHYCWuiPeLmZPjMDjfE0yQkzkf1OArYBDsteKzLSTocUGVjuw09QZVU-B2KPAH/s1600/russia+unemployment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 201px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5407695821023297026" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjRJWai_g6NbKXECIl-w2d_6JH4i50ClH-QJ6yGq-6mZ_y3fvRoHGhE9WCznMjBqNh3GdCI9FgdrekBMkGHYCWuiPeLmZPjMDjfE0yQkzkf1OArYBDsteKzLSTocUGVjuw09QZVU-B2KPAH/s400/russia+unemployment.png" /></a><br /><br /><br />Since the beginning of March 2009, however, with real level of economic activity bottoming out (see above chart), the labor market continued to show moderate improvement: by September the number of those in employment had increased by 2.6 million, and the rate of unemployment fell to 7.6 percent, down significantly but still much higher than in September 2008 (5.8 percent). According to the World Bank this steady improvement is rather misleading as it reflects significant seasonal gains in employment and a shift in labor adjustment towards labor hoarding in the manufacturing sector.<br /><br />As the World Bank also notes, the long term regional differences in Russian unemployment rates are striking ranging from a low of 1.6 percent in Moscow to a high of 52.1 percent in Ingushetia in August 2009. Traditionally unemployment is largely concentrated in the Southern, Far Eastern and Siberian federal districts. However, the crisis related unemployment shows a different pattern, with the largest increases in unemployment being found in the North Western District (from 4.8 to 7 percent) and the Urals (from 4.9 to 8.1 percent). Regression analysis carried out by the World Bank revealed that unemployment levels were higher in those regions with higher levels of manufacturing, and where industrial production accounted for a larger share of GDP.<br /><br />And while it is entirely possible that the economy will show a “modest” recovery in the second half of 2009, this is “unlikely to have significant impact on social indicators,” according to the World Bank. Unemployment will increase to 9 percent “as seasonal factors wane” from 7.6 percent in September and it may take three years before the number of Russians living in poverty falls to pre-crisis levels, the World Bank estimates. Indeed, in the short term real incomes are “likely to fall further". </p><br /><p><strong>Monetary Policy Mess </strong><br /><br />The political threat posed by growing unemployment and rising poverty must most certainly be one of the reasons behind Russia’s central bank recent decision to lowered its key interest rates for the eighth time in six months, in a bid to both stimulate lending and to stem the inflow of funds and the rise in the value of the ruble which is making the work of restoring competitiveness to the manufactured sector all the more difficult. Earlier this month Bank Rossii cut the refinancing rate to 9 percent from 9.5 percent and reduced the repurchase rate charged on central bank loans to 8 percent from 8.5 percent. Despite the reductions Russia still has the fourth-highest benchmark interest rate in Europe after Ukraine, Iceland and Serbia.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBJhJBNDVv18IV4IOe1RJhk1at9jCQ6owXs5IUfnP0H7s-HB-mxzw_2tDge5y5neowIqpgNQcCyzPbyGS9FaLCT3K6-X37JPcA8He3JtYMw80xWZ2NW98HUtjcxSjziV5qSR5sMqnldgCf/s1600/russia+interest+rates.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408181483981076626" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBJhJBNDVv18IV4IOe1RJhk1at9jCQ6owXs5IUfnP0H7s-HB-mxzw_2tDge5y5neowIqpgNQcCyzPbyGS9FaLCT3K6-X37JPcA8He3JtYMw80xWZ2NW98HUtjcxSjziV5qSR5sMqnldgCf/s400/russia+interest+rates.png" /></a><br /><br />The best thing that can be said about Russian monetary policy instruments is that they are hopelessly ineffictive. Even October consumer-price growth at 9.7% annually, while well down on the 15.1 percent peak hit in June 2008, is still horribly unacceptable, and it is extremely hard to understand how economic mismanagement and incompetence can have reached such a level that an economy which has been contracting at the rate of nearly 10 per cent a year can still have this kind of price inflation. There is no other word for it, this is a mess.<br /><br /><br />The bank is caught on the horns of a large dilema, since cutting rates further to stem inflows and the ruble rise may only risk fuelling more inflation, yet First Deputy Central Bank Chairman Alexei Ulyukayev stressed only this week (following the latest in rate decision) that the central bank did not exclude the possibility of further cutting its rates since it sees “no inflationary risks” next year and an inflation rate “much lower” than 9 percent. This follows explicit remarks at the end of October that the Bank was ready and willing to use interest rate policy as required to stem speculative capital flows that "threaten to undermine currency stability". <br /><br /><strong>Inflation Woes</strong><br /><br />One small consolation at least in this ongoing mess is that pressure on Russia’s producer prices have been easing, and factory gate prices have even been falling. According to the preliminary data from the State Statistics Service, the price of goods leaving factories and mines was in fact down an annual 10.8 percent in August following a record 12.3 percent drop in July. Evidently The with the 2008 spike in oil and energy prices the logic behind this is easy to see. What is not so easy to see is why domestic prices take so long in responding to general capacity utilisation signals and why the Economic Development Ministry still seems comfortable with the expectation that average inflation will range between 12 percent and 12.5 percent in 2009 only marginally down from last year’s 13.3 percent. Stunning!<br /><br /></p><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQHn8sktU9ZfvA1vfrh0jez0yjaG2VxTyj_SKVtcnVFs3vN4-Z91g3jUfxwN20x_MZYFWjl4q0V6AZgqiVJPnY1seHM-7PY7PwPyZgrPlW_7ZZU49Hf8sELHchBzXaUII-Ce4lAmUK434A/s1600/russia+inflation.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 243px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408002903880749650" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQHn8sktU9ZfvA1vfrh0jez0yjaG2VxTyj_SKVtcnVFs3vN4-Z91g3jUfxwN20x_MZYFWjl4q0V6AZgqiVJPnY1seHM-7PY7PwPyZgrPlW_7ZZU49Hf8sELHchBzXaUII-Ce4lAmUK434A/s400/russia+inflation.png" /></a><br /><br />And while consumer price inflation has been tame in recent months this good behaviour may not last long, since it could rise more than expected in November, according to Deputy Economic Minister Andrei Klepach, who does not seem to completely share Alexei Ulyukayev price optimism. Consumer prices could rise "by about 0.3% to 0.4%" in November, Klepach said in comments recently, and this prediction seems to be near the mark, since according to the latest data we have consumer prices rose 0.1% in the week to 9 November, bringing to an end a period of just over three months without inflation. Looking into the future price growth may be further spurred by an influx of budget spending in the fourth quarter, as well as by a planned 30% increase in pensions which is due to come into effect on 1 December.<br /><br />In fact, despite the fact that inflationary pressures have been easing in Russia in recent months, chiefly due to collapsing consumer demand and outlfows of capital following the crisis that hit the country a year ago, the official outlook for Russia's inflation in January 2010 is only that it will be "significantly below "the level of January 2009. This kind of argument is hardly reasssuring, since inflation last January was at an annual rate of 13.4%, although the short term outlook is for only a mild acceleration, with consumer prices increasing by between 0.2% and 0.3% in November and by about the same amount in December.<br /><br /><strong>Why Not Devalue?</strong><br /><br />Well, one way not to solve the problem, according to European Bank for Reconstruction and Development Chief Economist Erik Berglof, would be a ruble devaluation, since despite recognising that the country has a very difficult couple of years in front of it, Berglof argued recently that “this (devaluation) is the wrong way to think about the recovery in Russia”.<br /><br />As he said, Russia’s failure to wean itself off its reliance on commodity exports has condemned the country struggling to find economic growth in the face of a large drop in demand for its key export products. “If you want to have a flexible exchange rate, you need to get out of this dependence on commodities,” Berglof said. “It’s a major concern that in the last 10 years Russia has become actually more dependent on commodities. Unfortunately, not much progress has been made.”<br /><br />Well, this is exactly the point, and is why I have been arguing over the last two year about how <a href="http://russiatooat.blogspot.com/2007/12/inflation-in-russia-two-much-money.html">all those wage increases which the Russian administration seemed to rejoice in</a> (since they bought short term popularity, and fuelled consumption) simply stoked-up the domestic inflation bonfire and in the process did untold damage to domestic competitiveness. However it is evident Russia's industries cannot now simply be transformed overnight, and this is where I find a weakness in Berglofs argument, since some remedy is needed to straighten out the distortions and get of commodity export dependence. But what? If it isn't devaluation, then surely we will need to see very substantial wage deflation in order to attract the now much needed inward foreign investment. The current position whereby prices rise by an annual 10%, and living standards are maintained by a sharp rise in the value of the ruble (making imports cheaper) is quite simply unsustainable, for reasons which should be evident from looking at the chart below. If you look at the green line (which shows the Real trade weighted Effective Exchange Rate) we will see how this has risen sharply since 2003, with the exception of the drop in the value of the ruble in the second half of last year. If we then look at the blue line (which shows the non oil and gas current account balance) we will see how this has been steadily deteriorating (again with the exception of the short sharp shock occassioned by the crisis of last autumn). However, as we can also see, the green (REER) line has now once more resumed its upwards march - the consequence of all those financial inflows, and the associated rise in the ruble - and with the upward march comes the ongoing structural damage to the economy, precisely the can't of structural damage which Erik Berglof would like to avoid, and even unwind.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPdu1577umiq-wPLUpSkdfcI73cE95IOiKPWsAlhfvjn8Wr90cU5T51NN64Sk8aRtGe0UnUu_nmH7B4xxz0YiOKzMGuoO2lkurzIyosi6mIS0y8MJFS3iidBKdDrnqDu43eZk9Gm0_MnnD/s1600/Russia+REER.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 347px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjPdu1577umiq-wPLUpSkdfcI73cE95IOiKPWsAlhfvjn8Wr90cU5T51NN64Sk8aRtGe0UnUu_nmH7B4xxz0YiOKzMGuoO2lkurzIyosi6mIS0y8MJFS3iidBKdDrnqDu43eZk9Gm0_MnnD/s400/Russia+REER.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5408393036051349714" /></a> <br /><br />Of course not everyone agrees with Berglof, and the Russian Association of Regional Banks, whose 450 members include the Russian units of Barclays and Citigroup, has called for a devaluation of as much as 30 percent. Billionaire Vladimir Potanin, realist and owner of 25 percent of OAO GMK Norilsk Nickel, said in recent interview with the Russian Newspaper Vedomosti that the “interests of the economy” will lead the currency to depreciate in the “mid term,” allowing exporters to cut costs and modernize production.<br /><br />Nonetheless energy, including oil and natural gas, accounted for 69.1 percent of exports to countries outside the former Soviet Union and the Baltic states during the first seven months of this year, according to the Federal Customs Service, while metals were responsible for another 12%. So the commodities dependency is massive, and this situation can't be turned round easily.<br /><br /><strong>Getting Carried Away By Global Liquidity?</strong><br /><br />Bank Rossi are also not 100% convinced by the merits of Berglof's reasoning, as witnessed by the fact that they facilitated a 35 percent depreciation in the ruble during the second half of last year (see chart below), and as the collapse in raw material prices and the dramatic change in local credit conditions first pushed Russia's economy into recession the ruble’s trading range was widened to between 26 and 41 against the dollar-euro basket.<br /></p><br /><p>However, as I keep stressing, the central bank is now locked on the horns of a massive dilemma, since as risk appetite returns, with it comes the enthusiasm for buying the so called "high yield" currencies - like the South African Rand, the Russian ruble and the Hungarian forint. Instruments denominated in all these currencies offer investors substantial returns at the present time thanks to offering some of the highest interest rates among globally traded currencies.<br /><br />Indeed buying Russian rubles was one of the key recommendations made by Angus Halkett, currency strategist at Deutsche Bank in London, in a research report published back in April, and the market seems to have followed his advice The so-called carry trade works by investors borrowing in currencies with low interest rates and good prospects of continuing depreciation (the USD at the moment, for example) in order to buy higher-yielding assets, in countries with high domestic interest rates and continuing prospects for ongoing appreciation.<br /><br />In general, engaging in one or other form of the thousand-and-one-varieties carry trade is pretty standard practice during times when returns for real economic activity are low, and central banks hold down rates and supply liquidity. Indeed we may include here the kind of carry practiced by banks in borrowing from the central banks only to then lend - for a small, but very low risk, interest rate commission - to their national government, who at this stage in the business cycle will normally be running a fiscal deficit. So more than funding recovery, the watchword at the moment is very much "carry on carrying".<br /><br />But for those on the receiving end, the consequences of so much carry are far from innocuous, since the process simply funds all sorts of economic distortions, and far from allowing normal market corrections to occur, it simply amplifies the problem. Things are now becoming very detached from the so called "fundamentals" (whatever those might be in the topsy turvy world in which we now live), since it simply is not plausible that the currency should be rising in this way in a country with nine percent plus consumer price inflation and which badly needs to move away from commodity export dependency. The only conclusion which could be drawn is that the Russian economy now needs massive structural reforms, and on any imaginable scenario in the world in which I live these are simply not going to be implemented.<br /><br />On the other hand Russia’s central bank may have to accept a stronger ruble next year as rising commodity prices prove too powerful a force for policy makers to counter and as consumer demand plays a bigger role in the bank’s decisions. The authorities “will try to do what they can to smooth the appreciation, but it’s very hard to go against the flow,” said Guillaume Tresca, Paris-based emerging market strategist for Calyon, the investment-banking unit of Credit Agricole. “Capital inflows are massive.”<br /><br />Policy makers have indicated they will cap the ruble’s gains and Prime Minister Vladimir Putin has said his government won’t allow an excessive appreciation as exporters struggle to tap into a global trade recovery. Even so, efforts to fight the ruble’s advance may prove “unproductive,” the International Monetary Fund warned on Nov. 12, adding that “underlying factors” justify its strength. There is a growing consensus that Russia’s central bank is now close to accepting the inevitable, and will allow the ruble to continue appreciating to help domestic demand and cap inflation. As Clemens Grafe, chief economist at UBS in Moscow puts it, “A higher exchange rate, because it transfers incomes into people’s pockets, could actually be more beneficial,”<br /><br /><strong>Fiscal Resources Near To Running On Empty?</strong><br /><br /><br />According to preliminary estimates from the Ministry of Finance, the federal budget deficit totaled 4.0 percent between January and September, slightly below the expected level, in part due to the under execution of budgeted expenditures in the first three quarters of 2009. The federal non-oil deficit (which excludes drawing on oil revenues) amounted to 11.0 percent. This is managable, especially given the comparatively low level of Russian sovereign debt to GDP. However, as the World Bank point out under the likely scenario of a sluggish global recovery and modest growth, Russia will face a tightening budget constraint and need to reduce expenditures and the fiscal deficit over the medium term. Further, funding the planned increase in social expenditures, mainly related to increases in pensions, may well requires spending cuts in other expenditure categories. </p><br /><br /><p>The Ministry of Finance baseline federal budget estimates with conservative oil assumptions icorporate plans to reduce the federal budget deficit from 8.3 percent of GDP in 2009 to 3 percent in 2012, but the medium term fiscal outlook also indicates an extensive drawdown of Russia's Reserve Fund to finance the deficit. Given the size of the anticipated deficit, the Reserve Fund is likely to be depleted by the end of 2010 and borrowing will be required to offset the gap. Estimates of the Ministry of Finance indicate that the combined external and internal borrowing to cover the fiscal deficit will amount to 1.0 percent of GDP in 2009, 1.6 percent in 2010, 2.5 percent in 2011, and 1.5 percent in 2012. All of this is manageble, but the depletion of the Reserve Fund does mean that if downside risks materialise, and in particular if there are more writedowns in the banking sector needing government support that there is now little in the way of a cushion between managed adjustement and unstable dynamics.<br /><br /><br /><strong>Outlook – A Hard Road To Travel</strong><br /><br /><br />If one thing is clear hear it is that attaining a recovery in Russia's economic fortunes at this point is going to be no easy feat, as <a href="http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aC8Q3ycECRlw">Trust Investment Bank put it in their latest report</a>, October data for the world’s largest energy exporter suggest “an almost complete absence of clear signs of recovery” since industrial output slumped and capital investment fell. October capital investment was still down 17.9 percent while industrial output dropped an annual 11.2 percent in October worse than the September reading. Even unemplyment was up again, at 7.7%, although as the World Bank pointed out, this is the result of the same seasonal factors which lead to the fall in unemployment over the summer. <br /><br />On the other hand, this is by no means a one way street, since disposable incomes climbed a monthly 6 percent in October and rose 3.9 percent compared with the same period last year, registering their biggest annual jump since September 2008, according to provisional data from the Federal Statistics Service, while wage declines eased with wages falling an annual 4.5 percent, compared with a 4.9 percent annual decline in September. And retail sales, which had previously fallen for nine consecutive months, the longest period of declines on record, suddenly sprang back to life, with October retail sales rose 3.2 percent from September and declined by 8.5 percent on an annual basis as compared with a 9.9 percent drop the month before.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdmvcbj_VzNLvilO92R37eGTboaFUzpyDJd7vMMLx2G-S_iIP_L7uZEKWaGf7NVV0iLHDWGsppwTeDOR9gTDeahK3y8ezbkcZTdhkXGOmbp_JT0zeUqIXk6orBVfkp_teTs184md1zBsoU/s1600/russia+retail+sales.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408006395968774402" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhdmvcbj_VzNLvilO92R37eGTboaFUzpyDJd7vMMLx2G-S_iIP_L7uZEKWaGf7NVV0iLHDWGsppwTeDOR9gTDeahK3y8ezbkcZTdhkXGOmbp_JT0zeUqIXk6orBVfkp_teTs184md1zBsoU/s400/russia+retail+sales.png" /></a><br /><br />Other data also show this mixed picture. Monthly GDP Indicator data from VTB Capital, based on the PMI surveys for the Russian manufacturing and service sectors, continued to show economic contraction on an annual basis in October, butthe rate of decline eased for the fifth consecutive month. The Indicator showed a 0.6% annual contraction, the slowest rate seen suring the current eleven-month period of continuous decline.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvkyRoAkUlCamHbxVPeZvRjFeGsJPoaw9ATOrGk1Xn5iVLdV_fPkpcWULERg2c-vkWaM273_UlCmsGMr-X05JyHqWrotvjO7Jo58SikxcZC8Xt-RI4gqo86GY48E4p71umw07KZOrt07Ge/s1600/GDP+indicator+2.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 243px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408168501901732850" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvkyRoAkUlCamHbxVPeZvRjFeGsJPoaw9ATOrGk1Xn5iVLdV_fPkpcWULERg2c-vkWaM273_UlCmsGMr-X05JyHqWrotvjO7Jo58SikxcZC8Xt-RI4gqo86GY48E4p71umw07KZOrt07Ge/s400/GDP+indicator+2.png" /></a><br /><br />The seasonally adjusted Total Activity Index remained above the no-change mark of 50.0 for the third month running in October, indicating growth of private sector output. The Index improved fractionally over September, to 54.2, indicating reasonably robust growth (although it remained below its historic trend of 56.6). This was driven by a faster rise in services activity, while the rate of growth in manufacturing production slowed to a weaker pace. On a quarterly basis the indicator showed 0.4% q-o-q growth for the second month running.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3mwak6stjmqrzH5lvzMYaDNJbin4Mvsk1X6qDknT1Eit0y63rMwTqYGWOsdigj0rLOAE7xdjVnT94D16kEV9CrMPAU7opuzx3FvJtWGzlrNND9vPBu0TiYc73-RaYS3iXxhpHXzGpDox3/s1600/GDP+Indicator+One.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408166525313307218" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3mwak6stjmqrzH5lvzMYaDNJbin4Mvsk1X6qDknT1Eit0y63rMwTqYGWOsdigj0rLOAE7xdjVnT94D16kEV9CrMPAU7opuzx3FvJtWGzlrNND9vPBu0TiYc73-RaYS3iXxhpHXzGpDox3/s400/GDP+Indicator+One.png" /></a><br /><br /><blockquote>Commenting on the survey, Aleksandra Evtifyeva, Senior Economist at VTB Capital, reported:<br /><br />““The GDP Indicator continued to point to an improvement in economic activity in October. The manufacturing sector’s performance deteriorated slightly while activity in the services sector is approaching pre-crisis levels. This might be one of the consequences of higher oil prices and a stronger rouble as low export orders were the main drag on manufacturing. Another encouraging development highlighted by the October surveys was the deceleration in the pace of job cuts: the employment sub-indices now stand at around 47, which is already higher than last autumn.</blockquote><br />The GDP indicator reading was based on manufacturing sector survey findings which confirmed that overall Russian manufacturing business conditions deteriorated in October. Although output, new orders and input purchases all continued to grow, the rates of expansion slowed compared to September. Moreover, manufacturers shed jobs at a faster pace than in September.<br /><br />The headline seasonally adjusted Russian Manufacturing PMI fell from 52.0 in September to 49.6 in October, signalling an overall deterioration in the business climate at the start of the fourth quarter. It was the first month-on-month fall in the headline index since it plummeted to a record low (33.8) in December 2008, although the latest figure was indicative of only a marginal rate of decline. Of particular note, the new export orders index posted a strongish decline to 47.8, evidently reflecting the recent ruble appreciation. The input price index continued to point to strong rise in costs associated with metals, energy and oil-related items while output prices index pointed to a moderating growth in price charged.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAeILGw3d55U6mZtxbNTHkm8k389zC7GVkVDAiPEHEq6UXsioQ9Phbss5GVBKYY3PvDDhfVxBam8Uv-iyIRiaD3FMtZhe1e07ntxb1ARXwruQlEQ4ysM_XDYR-l8A39BijE8oQ_dLntefJ/s1600/russia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 244px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408173728407425314" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiAeILGw3d55U6mZtxbNTHkm8k389zC7GVkVDAiPEHEq6UXsioQ9Phbss5GVBKYY3PvDDhfVxBam8Uv-iyIRiaD3FMtZhe1e07ntxb1ARXwruQlEQ4ysM_XDYR-l8A39BijE8oQ_dLntefJ/s400/russia.png" /></a><br /><br />In contrast the rebound in Russian services activity rose continued in October, supported by a record fall in charges, and Russia's services sector, which accounts for about 40 percent of the economy, rose for the third consecutive month, reaching its highest level since September 2008, although the reading of 54.3 still remained significantly below the long-run series average.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMJgZiFKdqI39xmZpgvCyPgJLx0ShztffQOGvon_h2lBivFYMxjncY0jyOAKGh6-PL_nuyucup6LRZodOtjOyCiOYt7SvnJA8Qh9Q9ROQh1T50S8D-mxTL6ab-K6D5rW_gZUh88G25oRd5/s1600/russia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 243px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408174647684182274" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiMJgZiFKdqI39xmZpgvCyPgJLx0ShztffQOGvon_h2lBivFYMxjncY0jyOAKGh6-PL_nuyucup6LRZodOtjOyCiOYt7SvnJA8Qh9Q9ROQh1T50S8D-mxTL6ab-K6D5rW_gZUh88G25oRd5/s400/russia.png" /></a><br /><br /><br /><strong>So Where Do We Go From Here?</strong><br /><br />In contrast to the most recent PMI data and the opinions of analysts like Neil Shearing at Capital Economics and Trust Investment Bank , Russia's political leaders are markedly more optimistic. Russia’s economy may expand as much as 4 percent in the last quarter of 2009 following a timid return to growth in the third quarter, according to Deputy Economy Minister Andrei Klepach speaking at a conference in Moscow recently. The economy may show “quite strong growth” of between 3 percent and 4 percent in the fourth quarter over the previous three months, Klepach said. This is an interesting claim, and doubly so given that Klepach has been quite cautious so far this year in his claims. However, as Neil Shearing at Capital Economics points out Klepach’s claim that growth could rise to an annual 4% at some point is perhaps not as wild as it first sounds. Shearing estimates that output fell by over 9% between Q4 2008 and Q1 2009, which means that given the sizeable base effects which will exist the Q1 2010 year on year growth rate might well look look quite impressive.<br /><br />But this may be a kind of "mirage effect" since if the global recovery slows towards mid-2010 (and with it the level of energy prices) then Russian annual growth could easily fall back sharply over the second half of next year and into 2011. Thus the prospect of a renewed fall in energy prices would imply that the risk a double-dip recession in Russia is quite a real one. <br /><br />But this is all for the future, while here in the present the rising price of oil and the return of some financial flows into Russia continues to fire-up optimism, as do the numbers for retail sales, so we had better just grit our teeth and hope they don't also fire up the inflation process again, although with lending to households still stuck in gridlock, perhaps the dangers here should not be overstated. More worryingly, inflation may fail to fall significantly from its current high level, even as the central bank reduces interest rates in a bid to stem the ruble rise.<br /><br />Klepach's optimism is not shared, however, by the World Bank who in their latest report argue Russia’s economy will suffer a deeper contraction than they previously estimated this year even after a series of central bank interest rate cuts which have manifestly failed to ease the “prolonged” credit drought. The World Bank now expect the Russian economy to contract by 8.7 percent this year, compared with their June forecast for a 7.9 percent decline. The government is currently predicting the economy will shrink 8.5 percent this year and grow 1.6 percent next year.<br /><br /><br /><blockquote>“We expect that the central bank will continue lowering its policy rate in the near future to facilitate credit to the real sector,” the World Bank said. “The impact, however, appears to be limited. The policy rates are mostly indicative, while the cost of credit remains very high.”</blockquote>The OECD, on the other hand, seems rather more positive, arguing that Russia’s economy will enjoy a stronger commodity-driven rebound than first estimated, although, they hasten to add, authorities should avoid a sudden removal of stimulus measures to ensure the domestic economy keeps up the pace of its advance. They now expect the Russian economy to expand by 4.9 percent in 2010, compared with a June forecast for 3.7 percent growth, although output is still expected to contract 8.7 percent this year (broadly in line with the World Bank), more than the 6.8 percent estimated in June. The 2010 figure seems very optimistic in the light of the problems here identified, and more than adding to our appreciation of the Russian situation such numbers may rather cast doubt on the methodology being applied, and raise questions about some of the numbers being seen for other countries.<br /><br /><br /><blockquote>“Although recovery is in prospect, the large output gap and subdued inflation suggest that policy stimulus should not be removed too hastily,” the OECD said. “Fiscal policy should be managed to avoid dislocative demand effects from a surge of expenditures in late 2009 followed by a tightening in 2010.” </blockquote><br />According to the OECD, Russia’s economy will enjoy a stronger commodity-driven rebound than first estimated and “Fiscal and monetary stimulus and the recovery of global demand should result in a strong rebound of output towards the end of 2009". The basic OECD argument is that “A large part of the policy stimulus will be felt only late in the year, as fiscal expenditure is back-loaded and a series of interest rate cuts began only in the second quarter.”<br /><br /><strong>Long Term Impact On Russian Growth</strong><br /><br />But let us not underestimate the difficulties. According to the World Bank Russia’s real GDP will likely return to pre-crisis levels only in late 2012. And, the Bank says, without a more productive, diversified, and competitive economic base, its long-term growth is likely to be slower than in the past decade and than the pre-crisis expectation<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJfIQLtnZTz_kaShjefaEGuuxVN6v9v_yCN5Lz2if6IrpqjRfXYUBLhnnMRX2w8e_6v5GtFMvwMBrhFDc6DBV2es3NBioyxhf2FomqzA3DCqkfmszBkjQB4S4E1xdHG6u-taMOoL_cjnxQ/s1600/Russia+Trend+Growth.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 213px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5408178577978076034" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjJfIQLtnZTz_kaShjefaEGuuxVN6v9v_yCN5Lz2if6IrpqjRfXYUBLhnnMRX2w8e_6v5GtFMvwMBrhFDc6DBV2es3NBioyxhf2FomqzA3DCqkfmszBkjQB4S4E1xdHG6u-taMOoL_cjnxQ/s400/Russia+Trend+Growth.png" /></a><br /><br />Russia’s pre-crisis decade of prosperity was built on strong capital inflows, rising consumer and corporate credit, and significant capital investment. The post-crisis world will look very different: Russia will need to implement fiscal adjustment and diversify its economy in the context of sluggish global growth, low capital flows, and more limited access to foreign financing. So it is now time to look towards a new growth model based on increases in productivity and know-how and on more efficient allocation and use of investment, labor, and FDI. Next generation reforms should be geared to make Russia's monetary policy instruments much more effective, the Russian economy much more productive, diversified, and open—and more able to respond to future shocks. The success and duration of the transition from the current model of heavy dependence of natural resources to a more sustainable growth model depends, according to the World Bank on maintaining a competitive exchange rate, sustaining a prudent fiscal stance, improving the investment climate, more mobile capital and labor, making the financial sector deeper and more efficient, investing in infrastructure to eliminate key bottlenecks to growth, and strengthening governance and fighting corruption as part of the overall effort to improve the effectiveness of the public sector.<br /><br />The OECD more or less agrees: “Laying the foundations for sustained rapid growth will require unwinding some of the distortive consequences of the crisis". And, may I add, unwinding some of the distortive processes which lead the crisis to be such a severe one in the first place might not be such a bad idea either.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-49239261742715591622009-09-27T21:26:00.001+02:002009-09-27T21:30:37.045+02:00The G20 and Why Export Dependency And Global Imbalances MatterWith the timing of the latest G20 meeting set to coincide with the run-in to the German elections <a href="http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100001043/germany-declares-economic-war/">acrimonious debate has not been absent</a>, but even as the passions generated by the arrival of voting day subside, it is clear that just beneath the surface their lie some simmering problems which simply will not go away. Despite the fact that nothing is really on the table that will make that much difference in the short run, I think the structural transformation that they are carrying out at G20 level is going to be very important in the longer term in finding eventual solutions.<br /><br />According <a href="http://www.ft.com/cms/s/0/268529ce-a8ec-11de-b8bd-00144feabdc0.html">to Bertrand Benoit in the Financial Times</a> the G20: "will endorse a report from the Financial Stability Board that calls for bonuses to be linked to the long-term success of financial companies and not excessive risk taking." Well this of course sounds absolutely fine. I have absolutely no objection, but we need to understand that from a macro economic point of view it is virtually irrelevant, with the added detail that the implications are that a recovery in growth will be slower yet less risky. Evidently the issue of why there has been so much liquidity floating around (and this has been the heart of the problem) has little to do with bank bonuses and salaries.<br /><br />Having interest rates near zero in a significant part of the developed world for an extended period of time - the inevitable consequence of having such a huge excess in global savings - means the the money will still be there, very cheaply, for people to do just whatever they want with it. They might, for example, <a href="http://hungaryeconomywatch.blogspot.com/2009/09/as-hungarys-correction-heads-for-dead.html">like to buy Hungarian forint denominated assets</a>, as Deutsche Bank analysts have been advising them to do, and try to find out just how long it takes them to push the economy of that small country right off the edge of the precipice on which it is presently so perilously perched. Or they might like to do <a href="http://russiatooat.blogspot.com/2009/08/bank-rossii-eases-further-as-russias.html">something similar with the Russian Ruble</a>, and see if they can block Bank Rossii from being able to move towards a floating currency. Or, if they are really short of interesting ideas, <a href="http://southafricaeconomywatch.blogspot.com/2009/08/south-africa-recession-continues.html">they might like to buy the South African Rand</a> to see just how far out of line you can push the currency in a country which is suffering its worst recession in a couple of decades. Of course, all of this is not that risky for those who understand the finer arts of Forex trading, and the banks who lend them the money will run little risk. The risk here is for the poor people who live in Hungary's and South Africa's of this world. Risk in these cases is, of course, massive.<br /><br />The banks are also being pressurised to raise their capital ratios. While this is always well-advised in the boom times, it only makes matters worse in a downturn. The current drive to make banks less leveraged and safer may well have the perverse consequence of reducing money balances in the short term. At least this is what Tim Congdon from International Monetary Research argues. This process simply "strengthens the deflationary forces in the world economy, and that increases the risks of a double-dip recession in 2010," he says.<br /><br />Meanwhile everyone will continue to drive full speed ahead on open ended stimulus programmes, without being altogether clear what it is they are trying to stimulate (see <a href="http://spaineconomy.blogspot.com/2009/09/three-million-unsold-properties-in.html">the Spanish case</a> if you don't believe me). "The G20 will call for extraordinary fiscal and monetary stimulus to be continued until “a durable recovery is secured”". But, and here comes the rub, it will also call on countries to act together to ensure more balanced economic growth in future, with surplus countries – China, Germany, Japan and oil exporters – urged to raise domestic demand and deficit countries asked to reduce budget and trade deficits once the world has secured a recovery.<br /><br />This is evidently the sensitive point which has had everyone from Peer Steinbrück and Angela Merkel, to the newly elected members of the DJP in Japan and the governing elite in China twitching away furiously in recent days. The leaders of these countries have become nervous, since they feel they are being blamed for something they haven't done, and naturally they are lashing back.<br /><br />They need not worry so much, these exhortations will also be to no real avail. In order to see why, let's take a quick tour through the real heart of the problem.<br /><br /><strong>Who Runs The Current Account Deficits<br /></strong><br />According to the current director of the US president’s National Economic Council, Larry Summers, writing in an academic paper published in 1990, the United States economy was set to run current account deficits for a period of 15 years, with the consequence that more than 6 percent of U.S. assets would be owned by foreigners by 2010. However, as he saw it, high saving during the subsequent 15 years would result in the generation of current account surpluses and a reduction in foreign capital ownership to 3.5 percent. After 2025, or so the analysis ran, the rapid increase in the number of elderly, would once again lead the United States to run current account deficits.<br /><br />Since this forecast seems to come so near to describing a process we are now seeing unfolding before our very eyes – in a world where many hold economists can see nothing at all coming – we might like to ask ourselves how anyone could have known so much so far in advance? The answer to this strange questioin is Larry Summers used a very simple model to arrive at his “predictions”, a model based on the life cycle saving and borrowing mechanism, the description of which was to lead Italian economist Franco Modigliani to win a Nobel in 1995. Summers and his co-authors simply applied the individual Life Cycle model to a whole population, and as it appears came up with a fairly plausible outcome.<br /><br />Everyone is evidently only too well aware that all developed societies are ageing (some, of course, more rapidly than others), but what many observers do not seem to grasp is that this ageing process has very concrete and forseeable economic consequences, consequences which have now been captured in a whole generation of economic models, and which are described in the accompanying chart prepared by my colleague Claus Vistesen.<br /><br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhbaT5QV54b0o5VwUL2X9D9WInZDUhWZFCmGZ6z5kqDxdql5PeAkjOBLqguVQ0E5Ivq3w2hBRnUsDK16Q0OARj62B6ufAXY90r8xS7_5fGLHJ04ODmdhWuB8Ej809VSHhv67CLSdwQhuEus/s1600-h/Ageing+and+the+Current+Account.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 209px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5385500904060083762" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhbaT5QV54b0o5VwUL2X9D9WInZDUhWZFCmGZ6z5kqDxdql5PeAkjOBLqguVQ0E5Ivq3w2hBRnUsDK16Q0OARj62B6ufAXY90r8xS7_5fGLHJ04ODmdhWuB8Ej809VSHhv67CLSdwQhuEus/s400/Ageing+and+the+Current+Account.png" /></a><br /><br />As can be seen from the chart, as the demographic transition – identified in age bands following the nomenclature of the Swedish demographer Bo Malmberg - advances median population ages move steadily upwards, producing in their wake a whole series of economic phenomena, phenomena which tend to impact directly on the domestic consumption and the current account balance of a national economy. The thick blue line shows what happens to the current account as a given country moves through the age bands. Initially there is a tendency to sharp deficits and severe economic crises, such as are very characteristic of low income, high fertility, developing economies like Ecuador or Pakistan. Then, as societies develop socially and economically the tendency toward deficit remains, only this time on a more mature, and seemingly more stable, basis as seen most evidently in recent years in countries like the United States, the United Kingdom, Spain and France, who all have population median ages in the 35 to 40 range.<br /><br />But then something strange happens as population median ages rise past the 40 mark, and especially as they age past 42. The current account suddenly swings into the positive zone, and this can be seen in the real world in countries like Germany, Japan and Sweden, where the ageing population effect means that domestic consumption becomes steadily weaker, and if we look at the second (purple) line in the chart, which illustrates the level of export dependency, we can see that while this is weak at the lower median age ranges (due to the momentum derived from stronger domestic-credit boom dynamics), it steadily grows at the higher median ages.<br /><br />So, is there any empirical evidence for this phenomenon you may ask? Well just look at Germany, Japan and Sweden, and how the recent collapse in demand for their exports produced by the global crisis sent the economies in these countries spiralling downwards. On the other hand, during periods of economic boom, strong surplus countries need to find an outlet for the savings they accumulate. Hence the large current account deficit countries in the East of Europe, for example, were funded by Austrian, Swedish and German banks. The question we should be asking is not why banks in these countries were so stupid as to lose so much money, rather it is why they had so much money to lose in the first place. That is, why were their populations saving so much, and why were profitable domestic outlets for such savings insufficient? Once we can get hold of this, we can start to see one of the reasons why there have been such large global imbalances in the first place.<br /><br />One of the problematic aspects of this situation, looking at the chart, is there there is no steady state (or cyclical correction) mechanism at work here, since there is not, to use the jargon, homeostatis, and the need to export (the export dependency purple line) simple heads off exponentially towards infinity, while the level of deficit does the same in the opposite direction. The reason that the need to export moves exponentially upwards is that median age doesn’t just move up from one level to another, and sit there, but keeps climbing steadily upwards, and the more it rises, the less “bang for the buck” in GDP growth you get from any given level of exports. This is the situation we are seeing now in Germany and Japan, and this is why they will struggle mightily to pull themselves out of the present recession, and why the whole situation is evidently not sustainable. So, if the countries in question don’t do something, and do something now, to stop median ages rising too rapidly, more crises like the one we are presently living through are evidently guaranteed.<br /><br />This way of thinking about things is sure to form, in my opinion, one piece in the new, post-crisis, macro mindset that will emerge. Of this I have no doubt, since the present crisis is all about imbalances, and this is one simple and straightforward model for thinking about and understanding them. Basically one group of people - the current account surplus countries (China, Japan, Germany, Sweden) - were afloat with money, and spent their time rather recklessly lending it to another group of people - the current account deficit crowd ( the United States, Iceland, Ireland, the UK, Spain, Portugal, Greece, Romania, Bulgaria, the Baltics, Hungary and New Zealand etc, etc) - who needed to fund their deficit habit, and who did so by equally recklessly borrowing the money. So if you want to understand the banking crisis, you need, as the US economist Brad Setser would say, to follow the money and find source of all those surpluses and deficits.<br /><br />And all of this helps us understand not only the crisis, but also the problems we are going to have getting out of it, since as Larry Summers noted over lunch with the FT’s Chrystia Freeland “‘The global imbalances have to add up to zero and so, if the US is going to be less the consumer importer of last resort, then other countries are going to need to be in different positions as well.’<br /><br />As Freeland highlighted, on this possibility, Summers was absolutely bullish, and understandably so. “The very great enthusiasm for accumulating reserves that one saw globally is likely to be a smaller factor over the next decade than it has been in recent years” he predicts this time. And so too is economic growth (going to be a smaller factor over the next decade), Edward Hugh rapidly adds, since with everyone looking to export their way out of trouble, we have to ask, as Nobel Economist Paul Krugman pointed out, the tricky question about just who the customers with the current account deficits are now going to be to enable all those much needed exports. The current talk of a simple and straightforward recovery for the global economy is misleading, and a long hard road lies ahead for all of us.<br /><br />And the first evidence of this can be found in the latest quarterly US current account data. The deficit narrowed in the second quarter to $98.8 billion, the lowest level since 2001, reflecting a smaller shortfall in trade of goods as imports and exports both decreased. This is far from being a linear process, and the U.S. trade deficit was up again in July, rising 16.3% over June to hit $32.0 billion, according to Commerce Department data. Despite the fact that imports rose sharply in July on the back of the stimulus programme, total trade activity is still well below last year's level, and the trade deficit with China was $20.42 billion compared with $25.01 billion in July 2008.<br /><br />In addition US bank loans have been falling fast, and were down at an annual pace of almost 14% in the three months to August (from $7,147bn to $6,886bn). The M3 "broad" money supply, watched as an early warning signal of where the economy will be a year or so later, has been falling at a 5% annual rate. There is absolutely no sign of an imminent sharp rebound in US domestic demand, and little likelihood of a continuing strong current account deficit. The most likely path is for the deficit to steadily close of its own accord as the stimulus programem which is still supporting it is steadily withdrawn. Well, this is what the world wanted, and this is what it is now going to get. So everyone should be happy, I guess. </p><p>And while the deficit countries close them down, there is little liklihood of the surplus countries taking their place. It is like telling these countries, you know, you really should have had more children 30 years ago. Do people really think these countries can simply invent policies at the snap of a finger and convince citizens who are worried about the stability of their pension system to spend more now, just because it is in the interest of the global economic system? And what policies exactly. Buy one and get another one for free from the central bank? </p><p>But coming back to the G20, as I said at the outset, what I think really matters at this point is that our policymakers have set up a problem for themselves to solve, and they have also set up a structure through which they may solve it. And that is something. Now in all likelihood we will continue to thrash around trying-out false solutions for the next two or three years, but then maybe, just maybe, they will all be ready to talk about what we really might do. And here's the good news, there is another planet out there waiting to be exported to. And the planet has a name - the Emerging Economies. So all we have to do now is work out is a sensible and responsible framework (the so called "supportive environment") through which cheap credit can be channeled into these countries, without that is producing the kind of boom-busts we just saw in the Baltics, Romania and Bulgaria. Not a little task, but not an impossible one either.<br /><br /><br />(1) An Aging Society: Opportunityor Challenge? - written with David M. Cutler (Massachusetts Institute of Technology), James M. Poterba (Massachusetts Institute of Technology), and Loise M. Sheiner (Harvard University) and published in Brookings Papers On Economic Activity, 1990. </p>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-85436837057959731562009-09-20T18:42:00.000+02:002009-09-20T18:43:10.282+02:00As Hungary's "Correction" Heads For A Dead End, Time For A Change Of Course?Hungary's economic correction still fails to convince. Indeed I am not the only one who remains unconvined by the viability of what is currently taking place it seems, since according to the opposition supporting local daily newspaper Magyar Hírlap, none other than the Hungarian Prime Minister himself may be having doubts, as he is reportedly thinking of leaving the helm of the struggling ship placed under his charge before the next general election, which is scheduled to take place sometime early next year.<br /><br />If this version of events is ultimately confirmed it will only add to the IMFs growing problems out East, since events in Latvia are not going at all according to their liking - see FT Alphaville's Izabella Kaminska's "<a href="http://ftalphaville.ft.com/blog/2009/09/18/72706/another-latvia-wobble/">Another Latvian wobble</a>" of last Friday - and indeed Latvia’s government rapidly cobbled together another 275 million lati ($575.6 million) in spending cuts for 2010 yesterday after EU Economic and Monetary Affairs Commissioner Joaquin Almunia called on Latvia on Friday to “renew a national consensus”, and Prime Minister Valdis Dombrovskis paid a flying vist to Brussels, following a parliamentary vote against sending a real-estate tax bill through to the committee stage, implicitly rejecting part of an agreement with the IMF and EU. How many times this year does that now make it that the national consensus has had to be urgently renewed under directives from either Washington or Brussels, could someone please remind me?<br /><br />Further, Hungary's main opposition party - Fidesz - which looks well-positioned to win next year's general elections, are threatening to rewrite the current ever-so-carefully written 2010 budget when they comes to powe next year, according to the latest statements from party president Viktor Orban.<br /><br />"This (the IMF text, EH) is the most dangerous budget of the past 20 years ... never before has a budget put hundreds of. thousands, or even millions of Hungarian families at such grave risk," Orban told private broadcaster Hir TV in an interview late on Friday. "This budget will not remain in place, we will draw up another one instead," said Orban, a former prime minister, adding that if in power, his government would create one million new jobs in 10 years.<br /><br />Well, things certainly do not look good either for Gordon Bajnai or for the EU Commission/IMF team who are behind the budget. Perhaps that is why the IMF's representative in Hungary, Iryna Ivaschenko, told national news agency MTI yesterday that while the government was committed to its 2010 fiscal targets, there were economic and implementation risks on the nature of which she declined to elaborate.<br /><br /><strong>As Political Pressures and Bad Loans Mount, While The Economy Retreats Underground, It Is Hard To See How The "Correction" Can Work</strong><br /><br />Clearly the above mentioned report about the PMs intentions does come from a rather biased source, but it is interesting to note that credibility is being given to it by <a href="http://www.portfolio.hu/en/cikkek.tdp?k=2&i=18483">normally more impartial sources like Portfolio Hungary</a>, and as they themselves point out there has been no outright denial of the suggestion from government sources.<br /><br />Perhaps even more astonishing was <a href="http://online.wsj.com/article/BT-CO-20090918-708158.html">the statement by the Hungarian Finance Minister Peter Oszko to Dow Jones Newswire on Friday</a> that the most difficult reforms to address economic imbalances have now been completed. "I believe the most difficult part of our job is done - our package creates not only short-term but mid- and long-term fiscal balances" he said. I say astonishing, since as far as I personally can see (take a look for yourself at the charts below) the changes that are needed haven't even begun yet. The whole emphasis have been on cutting the deficit, with little serious thought being given about how the Hungarian economy can get back to growth - which is the only real way the fiscal balances can become stable - all that seems to have happened is a 5% VAT hike to squeeze domestic consumption even further, and some compensatory tax changes on the other side to stimulate employment, but the real economic imbalances have been left untouched. A supply side micro-economists paradise, whisper the words "long term steady state growth" to yourself three times, cross your fingers, and hope for the best. <br /><br />However, the underlying mirky political realities may soon burst their way into the parlour room, to disrupt this happiest of happy families. Indeed everything may well now hinge on getting the budget through parliament and then disrcetely leaving by the side entrance, since Magyar Hirlap suggest that the Hungarian Parliament may well be dissolved directly after the vote on the 2010 budget - which is currently scheduled for 30 November. Apparently everyone's calculations have been thrown awry by the early re-election of José Barroso, and the imminent reappointment of the EU Commission. Plenty of food for thought here.<br /><br />The paper also suggests that Prime Minister Gordon Bajnai now totally accepts that the forthcoming electtions are inevitably lost - the only bit of realism I can see in all this - and as a consequence seeks to have them advanced to February from the currently probable date of April or May.<br /><br />In this way Bajnai would be able to offer himself to replace the present Hungarian representative László Kovács, who is currently Commissioner for Taxation and the Customs Union. Bajnai, it will be remembered, has only been Prime Minister since last April, but then, with these sort of techniques it doesn't take that long to put a country straight, now does it?<br /><br />Advancing elections in a situation where the present budget proposals are massively unpopular may make perfect sense according to a certain democratic political logic, but the economics lying behind the idea must be making people in Washington and Brussels throw up their arms in despair.<br /><br />More evidence to back the idea that the current programme is not working came in the latest report released by the committee which monitors the long term legalisation of Hungary's underground economy. The process is not only not advancing - it has been thrown into reverse gear, it seems.<br /><br />According to Committee president, and Central Statistical Office analyst, Csák Ligeti some HUF 100 billion (EUR 369.17 million) in tax revenues were lost in the first half of the year due to a ressurgence in the growth of the black economy. In his report he noted, by way of contrast, that during the previous two years the state budget had received around HUF 200-250 billion (EUR 738.1-922.6 million) in extra revenue due to the "whitening" process initiated in the autumn of 2006 as part of a programme to correct the large fiscal deficits the country was running.<br /><br />On another front, the IMF warned last week that while Hungary's banking sector had so far weathered the crisis reasonably well - thanks to the multilateral rescue programme - and now has sufficient capital buffers, asset quality still looks set to deteriorate steadily due to weakness in the domestic economy, and especially rising unemployment. This, of course, is another good reason why they should have been including a rapid return to export lead growth in the correction strategy, since obviously if you simply sit back and wait to see what happens, there will be no big surprise - the percentage of Non Performing Loans will just go up and up.<br /><br /><br />"Developments in the banking sector have been positive; so far so good, and in line with one of the main objectives of the (IMF) program to preserve financial stability," Iryna Ivaschenko, the IMF's resident representative in Hungary, told Down Jones in an interview on Thursday.<br /><br />However she immediately added that the IMF projects the amount of non-performing loans, which stood at a "still moderate" 4.8% of overall loans at the end of June, "will peak and at least double in the first quarter of 2010,".<br /><br />This IMF warning follows a Standard and Poor's one at the end of August. The financial profile of Hungarian banks is set to weaken over the near term as a result of the country's ongoing recession, the weak and volatile national currency, and pressure on funding, according to the S&P report.<br /><br />The report, which was entitled "Banking Industry Country Risk Assessment: Hungary", followed the recent decision by Standard & Poor's to revise its ranking of the Hungarian banking system to reflect increased economic risks in the country (BBB-/Negative/A-3) and structural weaknesses in the country's economy and banking industry.<br /><br />"Hungary's significant external financing needs, which stem from high public-sector leverage and large external imbalances, represent a structural weakness that exposes the economy to the tight and expensive funding conditions in global markets," according to Standard & Poor's credit analyst Harm Semder, who wrote the report.<br /><br />The report argues that nonperforming loans and depressed recovery rates are likely to cause a material rise in credit losses, which will in turn subdue bank profits and capital through 2011.<br /><br />Credit risk is heightened by the rapid growth of unseasoned loans - particularly commercial real estate mortgages - over the past five years and a significant increase in loans denominated in foreign currency that lack the foreign currency revenues to service them.<br /><br />The report estimates that cumulative gross problematic assets, which include restructured loans and repossessed collateral, could increase to 25%-40% of total loans during the course of the current domestic recession. It further suggests that the eventual recovery will be slow.<br /><br /><strong>Which Way To Turn? </strong><br /><br />The entire situation in Hungary vis-a-vis wages, employment and inflation continues to be preoccupying. The country is in the midst of a huge correction, and depends on improving exports in order to attain economic growth.<br /><br />Yet the correction is not proceeding as planned. Inflation - at an annual rate of 5% in August, is far too high in contrast to benchmark German inflation which remained negative in August (minus 0.1% ) to be recovering competitiveness. Real wages have continued to rise, and only sneaked into negative territory for the first time in over six months in July - with a 1.1% drop in the benchmark ex-bonus hourly rate in the private sector. Total employment is falling slowly, but even this process masques an important shift towards public sector employment, as the number of public employees has risen substantially in recent months while the number of employees in the private sector has continued to fall - exactly the opposite of what was meant to be happening. Meanwhile the country continues to get ever deeper in debt thanks to the relatively generous financing conditions offered by the EU and the IMF. The point is where does this all end? Where is the correction here?<br /><br />The National Bank of Hungary is struggling to find an adequate monetary response. The bank lowered its benchmark interest rate by 50 bp to 8% last week, but this still represents a real interest rate of around 3%.<br /><br />The move followed a surprise 100-bp rate cut at the end of July. While a month ago, the market was expecting 50 bp easing, this time there was no real surprise. As for the future, the National Bank of Hungary release uses standard central bankspeak that intentionally remains ambiguos and guarantees the Bank Council is not committed in any particular direction. As long as there is no change in the international environment over the coming months, the the Council will be most likely having to decide whether to cut a further 50 bp or more.<br /><br />So while the bank has evidently eased policy considerably, monetary conditions are evidently still far too tight to stimulate dynamic activity in the private sector, which is almost literally wilting on the vine at the present time.<br /><br />Meanwhile, in a further sign that the recession is settling in for the long haul, Hungarian retail sales extended their decline to 29 months in June as IMF/government measures to narrow the budget deficit continued to sap consumer spending.<br /><br /><strong>True Love In The Eternal Embrace?</strong><br /><br />Well, despite the fact that many may think the expression "eternal triangle" in the present context refers to the Hungarian government, the EU Commission and the IMF, they would be wrong since one convenient way of thinking about what just happened in Hungary could be to use another kind of eternal triangle the one developed in Nobel Economist Paul Krugman’s model of the same name, which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.<br /><br />In the case of the Central Europe “four”, Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to “freefloat” and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.<br /><br />The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.<br /><br />A second problem which stems from this “initial decision” has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency decision, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it can no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.<br /><br />The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition to do so (which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion). The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.<br /><br />So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions - to such a degree that in both cases the IMF has had to be called in. At the same time both of them are still having to “grin and bear” higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability less dramatic, and both inflation and domestic interest rates are much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.<br /><br /><strong>Hungarian GDP - The Big Slide</strong><br /><br />While wages and prices more or less steadily wend there way upwards, we have no hurry hear, you understand, GDP has been in freefall. Year on year it was down an annual 7.5% in Q2 (and a seasonally adjusted 2% from the first quarter) . The Hungarian government currently expects the economy to contract 6.7 percent this year, in the largest drop in outout since 1991. My view is that we have a total policy trap in operation here, since neither monetary or fiscal policy are available to an adequate degree (even after today's change interest rates are still at 8%), and there is thus little support available to put under the economy at this point. The only way to break the circle in my opinion is to violently kick start exports by letting the forint drop, bringing down interest rates, and restructuring all those CHF loans.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgV-RHt8eYVfElCApIqr9_5D9cWHIGrDquz16_OYZN-RTZKGtzLX5hfm8FBE2utZ_4Lq_PoRrBjaTuAPOldnedufmqwaVIh7akQCKsdDf20XNL14l2r0_vXQul8dybNOu0PVKbv_hKsAuM/s1600-h/GDP+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 198px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383528067714758754" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgV-RHt8eYVfElCApIqr9_5D9cWHIGrDquz16_OYZN-RTZKGtzLX5hfm8FBE2utZ_4Lq_PoRrBjaTuAPOldnedufmqwaVIh7akQCKsdDf20XNL14l2r0_vXQul8dybNOu0PVKbv_hKsAuM/s400/GDP+one.png" /></a><br /><br />If, instead of browsing over all those diplomatic statements we look at what is going on on the ground, then we find that private sector employment is now well down, by 9.2% y-o-y in July. While in the same month industrial output was down 19.4% over a year earlier. Something just doesn't seem to be working as it should be here.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcC1O4f3sPGXuLb6FlzapBePCAN-UuXBCIqpItfI1OfE6w7lv9nIYLx9eU7IZ1Pz3xQ32656forDNS1K27zmZlp_YEciZaJybpDYNlPxtB7JX8BHtSq3rAqAaZ3KQfNNw5pHqPvKwn-6Y/s1600-h/gdp+2.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 235px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383528674861012434" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcC1O4f3sPGXuLb6FlzapBePCAN-UuXBCIqpItfI1OfE6w7lv9nIYLx9eU7IZ1Pz3xQ32656forDNS1K27zmZlp_YEciZaJybpDYNlPxtB7JX8BHtSq3rAqAaZ3KQfNNw5pHqPvKwn-6Y/s400/gdp+2.png" /></a><br /><br /><strong>Unbalanced Movements In Employment</strong><br /><br /><br />Not surprisingly given the strength of the contraction total employment fell back again, for the second consecutive month, in July, and stood at was 2.657 million. There were 1.803 million in the private sector and 765 thousand in the public sector. Total employment was thus down 4.4% over July 2008.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi86tJ5JhXA2lLc7890qG9Tpgrc31yBwaN2EEPKRksSGuxHFhiO_3_Uu6qgWiXlpnjZDiCc2QK3-wT21sWc9bO1GRrORz13Nuro0xy7iAweiGZZWx9_NEwk0yNcWXG4UgPUiMxNkfhVK0Q/s1600-h/Total+Employment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383529101482905266" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi86tJ5JhXA2lLc7890qG9Tpgrc31yBwaN2EEPKRksSGuxHFhiO_3_Uu6qgWiXlpnjZDiCc2QK3-wT21sWc9bO1GRrORz13Nuro0xy7iAweiGZZWx9_NEwk0yNcWXG4UgPUiMxNkfhVK0Q/s400/Total+Employment.png" /></a><br /><br />Private sector employment is well down in Hungary, by 9.2% y-o-y in July. <br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQsThpiyGHcO39zvX3PEIOa_sMC7hHvpwXoQplQz1dlxTIbiT6qKuj5D7VcGCM5q9dBE_PoJdAFk0ea1rXLBEnZz-WmqKpjO6zVwVVruDrh2l0MuEABg4dkUZk8NprvPeJ5e-q3fF_hdM/s1600-h/hungary+private+employment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 229px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383529460455600114" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiQsThpiyGHcO39zvX3PEIOa_sMC7hHvpwXoQplQz1dlxTIbiT6qKuj5D7VcGCM5q9dBE_PoJdAFk0ea1rXLBEnZz-WmqKpjO6zVwVVruDrh2l0MuEABg4dkUZk8NprvPeJ5e-q3fF_hdM/s400/hungary+private+employment.png" /></a><br /><br />On the other hand, public sector employment has been chugging away on the up and up, due to job creation under the short term stimulus programme, courtesy indirectly of the IMF, who have permitted a larger than anticipated budget deficit.<br /><br />But don't get me wrong, it's not the stimulus I am quibbling about here, it is what it is being used for, and the absence of a realistic plan. It's easy enough to run up debt, especially when the EU Commission and the IMF guarantee you, but its a lot harder to pay it down again later, and Hungarian debt to GDP now looks set to go through the 80% of GDP level in 2010. So, the outcomes we are seeing simply don't seem to me to be producing a large enough structural change in the right direction. On the other hand, even this public sector employment boost now seems to have started to turn, since even public sector employment fell back on the month in July - for the first time in six months - although it was still up 5.6% year on year.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5uJ5ikzab216_D04hcd_RV_DqCyIwVfVfC6XiiPIbAFI1ftYhmctY0F7qEfu0F43NitEC9Cbn1cewjrkX3U51tjI2zJkktc1s71WDwOQ5wpNYhhKqF2HvJE2xCxiELiSkmgevjM3qVIU/s1600-h/Hungary+public+sector+employment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 229px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383530086376145346" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5uJ5ikzab216_D04hcd_RV_DqCyIwVfVfC6XiiPIbAFI1ftYhmctY0F7qEfu0F43NitEC9Cbn1cewjrkX3U51tjI2zJkktc1s71WDwOQ5wpNYhhKqF2HvJE2xCxiELiSkmgevjM3qVIU/s400/Hungary+public+sector+employment.png" /></a><br /><br />Hungary's gross average ex bonus private sector real wages entered negative territory in June, for the fisrt time in over six months, and fell at annual rate of minus 1.1 percent.<br /><br />Real public sector wages continue to fall sharply, and contracted by an annual 11 percent year-on-year in July following a 13.4 percent contraction in June - although some of the volatility here is the result of a changed system of payment for the additional (13th) month's salary. What is happening in Hungary is really an obvious example of "sticky wages" if ever there was one as far as I can see, since employment in the private sector is falling, and unemployment rising, so you would expect the opposite effect to operate, and real wages to be falling sharply at this point. According to Erika Molnarfi of the stats office, the upward drift in average private sector salaries is the outcome of a sharp decline in production workers which was not accompanied by a decline in administrative workers, exactly the opposite result to that you want to see.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhZ18x_mZ-qCmgjg21ntUOQu8qwqEiXgTS3ZliWWqQtjFXudTcCI2I21jh07AU5BZ8YC59c6dA7JHPqghMkTQo7apiplgFjQds-fBYOjfsZUsY0CMbEzy3ZYNPO789fNbA7V3ITPJWDeL4/s1600-h/hungary+real+wages.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 207px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383531989533723138" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhZ18x_mZ-qCmgjg21ntUOQu8qwqEiXgTS3ZliWWqQtjFXudTcCI2I21jh07AU5BZ8YC59c6dA7JHPqghMkTQo7apiplgFjQds-fBYOjfsZUsY0CMbEzy3ZYNPO789fNbA7V3ITPJWDeL4/s400/hungary+real+wages.png" /></a><br /><br /><strong>Inflation Stubbornly High</strong><br /><br />Far from the current recession leading to a significant downward shift in wages and prices, real wages had been rising continuously until July, while Hungary's consumer prices were still running year on year at 5% in August - up from 3.7% in June due to the VAT effect, and still far to high to start restoring competitiveness. . If the current trend continues, and the HUF remains in the region of its current euro parity, then Hungary's agony looks set to continue unabated well into 2010.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQbwbiwHwRgzsW3jOHkm_u6mtV7R1WI65fPSjA9WQ4uHq5MjTFQLu0fPC7YB1I3r4WeUkiGpy2Ah3POjVlwWeG9kflGEbFBodeMjOi1Jz97TZ7Xv9_J8BOMyO8jiScb7-gGtJKjQwNsYY/s1600-h/hungary+CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 231px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383533663939667778" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgQbwbiwHwRgzsW3jOHkm_u6mtV7R1WI65fPSjA9WQ4uHq5MjTFQLu0fPC7YB1I3r4WeUkiGpy2Ah3POjVlwWeG9kflGEbFBodeMjOi1Jz97TZ7Xv9_J8BOMyO8jiScb7-gGtJKjQwNsYY/s400/hungary+CPI.png" /></a><br /><br />And Hungarian manufacturing output fell back again in July, and industrial output decreased by 19.4% compared to July 2008. The volume of production was 22.1% lower over the first seven months of 2009 than in the same period of the previous year. The volume of industrial production fell back in July by 0,7% on June according to seasonally and working-day adjusted indices. Industrial export sales declined by 25.2% in the first seven months of 2009 and by 19.8% in July compared to the same period of the previous year, as a result of a sharp fall in external demand.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6FwG58JJ4Wuje6hjXA2_-C0CR-pOkcm8Ky2ROa-l1O4B3RXEJnbb3Ppsa8WadRbkGMTuN-U9CkpUwPhieYa034w2Ht5lyKcpBV7QWO1QG3hyphenhyphenzXrMD3VI7IwfNgms7fwl5ucBDvab5wG8/s1600-h/IP+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 239px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383534164564347202" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6FwG58JJ4Wuje6hjXA2_-C0CR-pOkcm8Ky2ROa-l1O4B3RXEJnbb3Ppsa8WadRbkGMTuN-U9CkpUwPhieYa034w2Ht5lyKcpBV7QWO1QG3hyphenhyphenzXrMD3VI7IwfNgms7fwl5ucBDvab5wG8/s400/IP+two.png" /></a><br /><br />So Hungary is suffering from a generalised drop in demand - domestic, export, government, and investment - for which it is difficult to see any short term remedy.<br /><br />Investments fell in the second quarter of 2009 by 4.7% compared to the same period of 2008. In the first half of 2009 investments in the national economy were 6% down over the corresponding period of the previous year. Investments did however increased by 0.4% quarter on quarter, but when we break this down we find that of the 4.7%annual drop in investments in the second quarter those in machinery and equipment fell by 11.6%, while the volume of construction investments – due to investments in dwellings and motorway constructions – grew by 1.1% compared to the same period of 2008. But when we look at the construction data we find that the improvement in construction is all about civil engineering, so any increase in machinery and equipment investment is still some way off at this point.<br /><br />Evidently the first sign of any real recovery in the Hungarian economy will come when machinery and equipments investments stabilise and even start to increase, since that will be a reflection of the expectation of future demand arriving further down the pipeline, and will be a measure of real employment creating possibilities.<br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgW6lUsLqDG_GR-KKAceaOXj-zQCqIje-uFx9aySuOl_7vmdlG45hrQdfhD7irZNICftEc1AfMU604JncKBxsqEJUhlVisyApFqPu20IpbMB6e9MFGuCCK9QHeP-klsjNaiifsTahoM8go/s1600-h/hungary+IP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 240px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383533972147529202" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgW6lUsLqDG_GR-KKAceaOXj-zQCqIje-uFx9aySuOl_7vmdlG45hrQdfhD7irZNICftEc1AfMU604JncKBxsqEJUhlVisyApFqPu20IpbMB6e9MFGuCCK9QHeP-klsjNaiifsTahoM8go/s400/hungary+IP.png" /></a><br /><br />But things don't look set to improve soon, since Hungary's purchasing manager index dropped by 3.4 points to 45.8 points in August, according to the most recent report from the Hungarian Association of Logistics, Purchasing and Inventory Management (HALPIM). The latest data is highly disappointing not only because Hungarian manufacturing has now been contracting for 11 straight months, but because the August eurozone PMI index showed a larger-than-expected pickup. This thus suggests that Hungary is being left behind in the scramble.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8ORDYccqO2ud4MT1SfTh1j26XHyMQ9bjYJ69XMmfqItqfuF6ljXDtfQDEGytYTMsq4XhNQuWpXYuHdAW3zDKjB_212ayOUmbtuV-Ay3j-55B_Z0bAhVXbO8EpTy-L9zW49xjQZSaWDyw/s1600-h/hungary.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 228px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383535214992523890" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi8ORDYccqO2ud4MT1SfTh1j26XHyMQ9bjYJ69XMmfqItqfuF6ljXDtfQDEGytYTMsq4XhNQuWpXYuHdAW3zDKjB_212ayOUmbtuV-Ay3j-55B_Z0bAhVXbO8EpTy-L9zW49xjQZSaWDyw/s400/hungary.png" /></a><br /><br />E<strong>xports Remain Weak, And Imports Are Even Weaker</strong><br /><br />Hungary recorded its fifth monthly trade surplus in June, coming in at 457,3 million euros slightly below the 490.1 million euros acheived in May but well above the 30.8 million euros of June last year.<br /><br />Now good news is always good news, but it is important to understand that this result was almost entirely achieved via a dramatic drop in imports, which plunged an annual 30.4 percent in June (following a 32.3 percent decline in May). It is impossible to talk of any marked improvement in exports, since these fell by an annual 21.1 percent, decelerating from the 24.1 percent drop in May, but still very large. While in the short term this substantial drop in imports (and hence rise in the trade balance) is GDP positive, it is very negative for living standards in the longer term, and the whole situation needs to be reversed by a large boost in exports leading imports as the eurozone economy eventually recovers. But to be able to achieve this Hungarian industry needs to do more, much more, to achieve competitiveness.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSSs75ls5h6ZwyhMSSp0mYoW8eU19xe0AMyLUc4Oi1MdPJeMOn1PRy4IqImAgzA_v5AFE7ZTfzIJkW4EFSWG8p7Q5DVH4SGnFRVJbzevH8NRDwb2RdvDdl0fQkcIWlyC8-urq51aTFsb8/s1600-h/hungary+exports+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 219px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383535528268211394" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSSs75ls5h6ZwyhMSSp0mYoW8eU19xe0AMyLUc4Oi1MdPJeMOn1PRy4IqImAgzA_v5AFE7ZTfzIJkW4EFSWG8p7Q5DVH4SGnFRVJbzevH8NRDwb2RdvDdl0fQkcIWlyC8-urq51aTFsb8/s400/hungary+exports+one.png" /></a><br /><br />Over the January-June period, the volume of exports and imports fell by 20 and 25 percent, respectively, compared to the same period of the preceding year. The trade balance showed a surplus of HUF 606 billion (EUR 2,055 million), which meant an improvement of HUF 534 billion (EUR 1,766 million) compared to the surplus of HUF 72 billion (EUR 288 million) in January-June 2008. In January-June 2009, the forint price level of exports and imports both increased by 6 percent, respectively, The forint exchange rate had however weakened by 17 percent with repsect to a basket of leading foreign currencies, and within this by 14 percent to Euro and by more than 30 percent to the dollar. So, if getting the growth needed to drive GDP is the objective, and this is any evidence, then there is still a long long way for the forint to fall.<br /><br />Over January-June 2009, the export and import volumes of machinery and transport equipment, which constitute 60 percent of exports and nearly 50 percent of imports, fell by and above average 24 percent in the case of exports, and by 27 percent in the case of imports.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhz0U0aJl25bhN0osywYZAGTTpnwZSx6g8_GECmCw_bKFRP11ZFIEWgQFU4BO3ffNqyVndnH1bFNaCfJCA5lEz87_pryXjnlQehMi2TwMTWcbc3BqjyvNhrHCOtILETRR1lDdrKL1SRvEk/s1600-h/hungary+exports+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 205px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383535621102219570" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhz0U0aJl25bhN0osywYZAGTTpnwZSx6g8_GECmCw_bKFRP11ZFIEWgQFU4BO3ffNqyVndnH1bFNaCfJCA5lEz87_pryXjnlQehMi2TwMTWcbc3BqjyvNhrHCOtILETRR1lDdrKL1SRvEk/s400/hungary+exports+two.png" /></a><br /><br /><br /><strong>Domestic Demand Drifts On Downwards</strong><br /><br />Construction activity was down by 5.1% in July as compared to July 2008. In the first seven months of 2009, output was down by 2.4%. In comparison June, production fell by 12.2% in July according to indices adjusted for seasonality and working days. This large drop is really only a reflect of the pre VAT introduction surge registered in June.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsgSN1uMnXQf3snjk0h-MOZ4idKyJTHcEi-44dBIoGM9a5VMF6sE1ulW6YdZdpV-q_O_GG4ZWrdKMI1yuzuyica3LSoNPmbsPAh_9mMX6H7Kw4HPiPA-TsOVl6EYYywKjmHRbVxzmBTM4/s1600-h/hungary+construction+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 211px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383536194142123922" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsgSN1uMnXQf3snjk0h-MOZ4idKyJTHcEi-44dBIoGM9a5VMF6sE1ulW6YdZdpV-q_O_GG4ZWrdKMI1yuzuyica3LSoNPmbsPAh_9mMX6H7Kw4HPiPA-TsOVl6EYYywKjmHRbVxzmBTM4/s400/hungary+construction+index.png" /></a><br /><br />The two construction sectors are moving in opposite directions at the moment. Within the 5.1% aggregate increase, building construction was down by almost a quarter, while civil engineering works expanded by 19.6%. From the start of the year the construction of new buildings is down by 12.7% while civil engineering works are up by 12.3%.<br /><br />From the September 2006 peak construction activity as a whole is now down by 27.58%. September 2009 will mark the start of the third year of contraction.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6gXpaFQpQ8e4PDSZ-1JmXGZasj1DF0BC1Vhl7Nzdflmn07oZ4ixzac3VjjSxxLNA7VZ-H3kxJFcxA4FhnE7quxce9wM_QRqTVF0P00jmLZTIajZbf_zHqx8ugQpSUVcUVAaxy9Maaf8w/s1600-h/Hungary+construction+P2P.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 212px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383536405141047298" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg6gXpaFQpQ8e4PDSZ-1JmXGZasj1DF0BC1Vhl7Nzdflmn07oZ4ixzac3VjjSxxLNA7VZ-H3kxJFcxA4FhnE7quxce9wM_QRqTVF0P00jmLZTIajZbf_zHqx8ugQpSUVcUVAaxy9Maaf8w/s400/Hungary+construction+P2P.png" /></a><br /><br />Hungary's retail sales fell by 2.2% in June compared to June 2008, although sales did increase by 0.5% compared to the previous month. Of course, we need to remember in this case that the 5% VAT hike was introduced on 1 July, so it is perhaps surprising that the increase wasn't bigger.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhBAWRjj1Hkh6UZzZ355mykgmUF-gprcZ5E5ngyiRSzG30Reu-ls2iIVCaVZ87Mbm5KZyEFxgn8OLGoxLy2Qnf3305tJQxLU1wXeDYzl0kB_73vGK-iloJoKqEXsqba5mF2A1Kj1wBlBU/s1600-h/hungary+retail+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 231px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383537607271538946" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjhBAWRjj1Hkh6UZzZ355mykgmUF-gprcZ5E5ngyiRSzG30Reu-ls2iIVCaVZ87Mbm5KZyEFxgn8OLGoxLy2Qnf3305tJQxLU1wXeDYzl0kB_73vGK-iloJoKqEXsqba5mF2A1Kj1wBlBU/s400/hungary+retail+one.png" /></a><br /><br />Thus the month on month increase is very misleading, since it was evidently driven by the government decision to raise value-added tax on the first of July - in an attempt to compensate for revenue losses which will be produced by forthcoming reductions in personal income and payroll taxes . So the increase in sales was in fact due to an attempt to avoid the 5% rise in VAT, and we should be ready for a sharp drop in July. Prime Minister Gordon Bajnai is in the process of implementing spending cuts worth 1.3 trillion forint ($6.9 billion) over a period two years in an attempt to keep the budget deficit in check.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhHM584YpdDOTdo81SApKKWc83UNmmEPIYriJcYf3gLVGDMW7C3J9BCnrW9mKPfpnfBJ77XG5JxqHmmj-e0qaDoxhSZ6PPQXzjUKSUsFavnREw7bYleTApzwjE_JVaCvHg5JiiVwFHqbwE/s1600-h/hungary+retail+two.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 229px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383537907127943634" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhHM584YpdDOTdo81SApKKWc83UNmmEPIYriJcYf3gLVGDMW7C3J9BCnrW9mKPfpnfBJ77XG5JxqHmmj-e0qaDoxhSZ6PPQXzjUKSUsFavnREw7bYleTApzwjE_JVaCvHg5JiiVwFHqbwE/s400/hungary+retail+two.png" /></a><br /><br /><br /><strong>While The Central Bank Is Caught In A Policy Trap</strong><br /><br />Hungary’s central bank cut its benchmark interest rate to the lowest level in 17 months at the end of August to try to help jolt the countryt out of its worst recession in almost two decades. The Magyar Nemzeti Bank lowered the two-week deposit rate to 8 percent from 8.5 percent. Monetary policy makers voted for the 50 basis-point cut with an “overwhelming” majority over a reduction to 7.75 percent according to central bank President Andras Simor. In fact the minutesd showed that the bank cut interest rates by a seven to one majority, with one member voting for a 75 base point cut.<br /><br />In fact many analysts now see further easing in the pipline, but in taking this stance they need to think about two points.<br /><br />i) The Hungarian government is still incredibly complacent about the inflation problem, and currently forecasts that inflation will only slow by the end of next year to something just below the central bank's current medium-term target which is itself very complacent.<br /><br />"We expect inflation to slow from [an annual average of] 4.5% this year to 4.1% in 2010. As for 2010, the December inflation figure may start with a digit 2," Finance Ministry State Secretary Tamas Katona told journalists last week.<br /><br />In its latest report on inflation, published in August, the National Bank of Hungary projected that inflation will likely dip below the 3% mark from the third quarter of 2010 onward. The central bank's annual inflation forecast is 2.5% on average for the second half of next year.<br /><br />But if Hungary wants to avoid a substantial devaluation then the internal devaluation needs to operate, and to a significant degree, which makes these current forecasts simply laughable. You wouldn't have thought, given all the complacency that the economy was contracting at around an annual 7% rate.<br /><br />ii) the key problem for the central bank is the value of the forint - given the level of household exposure to Forex loans. My opinion is that the recent recovery in the currency value has been almost entirely driven by yield differentials, and by self-fulfilling expectations (traders expect the currency to rise), rather than by any change in the underlying economic fundamentals, which as we have seen, has not taken place.<br /><br />But with consumption sinking, government spending falling and exports insufficiently competitive to drive the necessary surplus, the whole thing is now becoming rather a mess, with no clear economic policy objective in the short term (except, of course, cutting the bfiscal deficit and maintaining a strong exchange rate), while in the long term the emphasis is rightly on increasing exports. But no one has any idea of how exactly to correct prices sufficiently with the CHF mortgages stuck in the middle, and it remains to be seen how the markets will ultimately respond to these rate reductions as and when the wind of risk sentiment changes, as it will.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigRwng26LVesoj7xYQQ-IqJOLpZ4GZnF6VH309aKHzFJOVvdwzzeX2zhh6Y-oRp0dDJXgCyEbCcm0BwcK34D6e5b_yPLC-msjMzNS1pF4D7XlaKW0VLTVG3jfggpUCl72sT_mLG9NO-4g/s1600-h/Hungary+interest+rates.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 248px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383538131362307778" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEigRwng26LVesoj7xYQQ-IqJOLpZ4GZnF6VH309aKHzFJOVvdwzzeX2zhh6Y-oRp0dDJXgCyEbCcm0BwcK34D6e5b_yPLC-msjMzNS1pF4D7XlaKW0VLTVG3jfggpUCl72sT_mLG9NO-4g/s400/Hungary+interest+rates.png" /></a><br /><br />Basically the problem is the value of the forint. My opinion is that the recent recovery in the currency value (see chart below) has been almost entirely driven by yield differentials, and by self-fulfilling expectations (traders expect the currency to rise), rather than by any change in the underlying economic fundamentals, which as we have seen, has not taken place.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEglymMzdoGYIgKMBik70TmoTQrjcO_T2cqALG1iUteLjefC9aAX5VDUw5Eb0fU0VXJx0RFIjk-22h8Ihjz59PnEe_HUDOR3DjapwIGMEb3PfQBSaoinnYeD5whTWFV0FeBRqcG1_lz83M4/s1600-h/five+year+forint+chart.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 241px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383538415132361474" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEglymMzdoGYIgKMBik70TmoTQrjcO_T2cqALG1iUteLjefC9aAX5VDUw5Eb0fU0VXJx0RFIjk-22h8Ihjz59PnEe_HUDOR3DjapwIGMEb3PfQBSaoinnYeD5whTWFV0FeBRqcG1_lz83M4/s400/five+year+forint+chart.png" /></a><br /><br />The problem the central bank and the Finance Ministry have to address is the ongoing issue of the mountain of Swiss Franc denominated mortgages.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEio6VsVZAP-vhd51NAarJVt3zARNitGABW9Eyx09JGhEvBDI2Uq1TR-3EKMGiF2V0npco8NUwwz96_TNq3KKzNHUAvzuO9p84axOiZmisIZna2Ms9LXEIuAmiFwwxFeZ_k1baLwMSFZD08/s1600-h/forex+mortgages.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 236px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383538726334263634" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEio6VsVZAP-vhd51NAarJVt3zARNitGABW9Eyx09JGhEvBDI2Uq1TR-3EKMGiF2V0npco8NUwwz96_TNq3KKzNHUAvzuO9p84axOiZmisIZna2Ms9LXEIuAmiFwwxFeZ_k1baLwMSFZD08/s400/forex+mortgages.png" /></a><br /><br />These have stopped increasing in recent times, but still constitute a serious obstacle to any devaluation of the HUF, due to the non performing loans issue this would create for the banking sector. Not only has money been borrowed against homes for to fund house purchases, it has also been loaned for consumption, so indeed the fact that even these loans are stagnating hardly bodes well in any way for domestic demand.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjW2ZX32Rt5o6D6Q72RGlZ573BpbOdYoQYr-HttYADkxi8ibzblU74Doo9KK-uHlTdIVGpOBnxjMB90Wn-DS3ID4otajEfC8TncYqI-iWcIKu9xKcHRlNdBj1ynOhPWEG7b4lb-wgt79eQ/s1600-h/Hungarian+Refis.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 252px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383539011507488898" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjW2ZX32Rt5o6D6Q72RGlZ573BpbOdYoQYr-HttYADkxi8ibzblU74Doo9KK-uHlTdIVGpOBnxjMB90Wn-DS3ID4otajEfC8TncYqI-iWcIKu9xKcHRlNdBj1ynOhPWEG7b4lb-wgt79eQ/s400/Hungarian+Refis.png" /></a><br /><br />The result of all this botched policy is that Hungary’s EU harmonised unemployment rate rose to the its highest level in at least a decade in May and has been stick there ever since - and with the rise of unemployment, of course the percentage of impaired loans in the banking sector will also continue to grow. The rate rose to a seasonally adjusted 10.3 percent, the highest since at least 1996 and was still there in July (the latest month for which we have Eurostat data).<br /><br />And the situation is more likely to deteriorate than improve, with the central bank forecasting lay-offs of around 180,000 across 2009-2010, nearly 5% of the total number of employed, and now even the number of employees in the public sector is starting to fall back.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjTDKlBhgVweLbGoaEjPpIHUv7is2dtLrCdrnSiQp53-QlVHVnSmCtUm0mKh_T93HzvrEi-YKVywhM2kJrKYEypUBvYPa-WeLdIbVLlnu6QZ8QiBBXZCQdMYn40DZ5ELmj3_aUkzQR88vk/s1600-h/hungary+unemployment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 202px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5383539236649633058" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjTDKlBhgVweLbGoaEjPpIHUv7is2dtLrCdrnSiQp53-QlVHVnSmCtUm0mKh_T93HzvrEi-YKVywhM2kJrKYEypUBvYPa-WeLdIbVLlnu6QZ8QiBBXZCQdMYn40DZ5ELmj3_aUkzQR88vk/s400/hungary+unemployment.png" /></a>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-41778697250475340022009-09-15T15:22:00.001+02:002009-09-15T15:22:22.118+02:00Bank Rossii Eases Further As Russia's Economy Contracts At A Record RateRussia’s central bank this week lowered its main interest rates for the seventh time since April 24 - lowering the refinancing rate a further quarter percentage point. The decision came hard on the heels of the announcement that the Russian economy suffered a record economic contraction in the second three months of the year and refelect the growing recognition that the country now faces a painfully slow recovery. Just how painful things might become will form the subject matter of this report.<br /><br /><strong>Risks Rising On All Fronts<br /></strong><br />Bank Rossii cut the refinancing rate to 10.5 percent from 10.75 percent (following a quarter point reduction on August 10), and lowered the repurchase rate charged on central bank loans to 9.5 percent from 9.75 percent, effective from tomorrow. The bank has now cut the rates six times since April 24. Nonetheless Russia’s benchmark refinancing rate is still the second-highest in Europe, after the 12% on offer in Serbia and Iceland - meaning ruble denominated assets remain an attractive carry pair with either Euro or USD, and that with inflation stuck around the 12% mark the problems for central bank monetary policy are legion.<br /><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3M3kVyLjnGr0vTlh5uYbzEg60nTWA-Rq2UDK-BORFTi9M7qyEP0g3ecJ7qVCWV3rfyw4elF76GKKCnFpXM4opme5VLG2dpIZNppfO_ijif3UGbY0rp3nD4IR-YT5tC6IOuLlZOCioAEhM/s1600-h/russia+interest+rates.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 231px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5381306991987709234" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3M3kVyLjnGr0vTlh5uYbzEg60nTWA-Rq2UDK-BORFTi9M7qyEP0g3ecJ7qVCWV3rfyw4elF76GKKCnFpXM4opme5VLG2dpIZNppfO_ijif3UGbY0rp3nD4IR-YT5tC6IOuLlZOCioAEhM/s400/russia+interest+rates.png" /></a><br /><br />In the report that follows I will argue how the steady and systematic long term mismanagement of Russia's monetary policy has now created a veritable Procrustean bed of problems for Russia's economy and society. Failure to address the underlying inflation problem between 2005 and 2008 meant that large structural distrortions were accumulated in the economy, including a massive problem of commodity export dependence, a problem which effectively turned the country into a veritable disaster waiting to happen if ever there should be a protracted lull in the secular rise in energy prices. That lull has now arrived, and it is not at all clear just for how long we will all need to get to learn to live with it. <p></p><p>In a more or less reasoned analysis Capital Economics suggest that oil prices could fall back to somewhere around $50 a barrel in 2010. If this forecast proves anywhere near correct, the Russian economy is going to be subject to major downside risks, due to the difficulties posed by:<br /><br />i) financing the fiscal deficit<br />ii) rising unemployment<br />iii) growing bad loans in the banking system<br />iv) refinancing external debt<br />v) the continuing high level of consumer price inflation and the difficulties this poses for monetary policy at the central bank<br /><br />Added to all this, the economy will clearly not rebound as easily as many seem to foresee, adding to the risk element on all fronts. The Russian Economy Ministry seem to be getting ahead of themselves at the moment, since following a period when they have tried to get the bad news all out up front, just last week they decided to raise their 2010 forecast to a growth of 1.6 percent - up from the previous 1 percent forecast. This growth, if realised, would follow an anticipated shrinkage of some 8.5 percent this year, based on the September 9 estimate of Economy Minister Elvira Nabiullina that output may grow 3.9 percent to 4.5 percent in the second half of this year compared with the first six months - such strong optimism I find hard to accept, unless the turnround in global economic activity turns out to be much stronger than the one we are currently seeing.<br /><br /><strong>Is The Worst Really Behind Us?</strong><br /><br />Gross domestic product contracted an annual 10.9 percent in the second quarter, according to the Federal Statistics Service. The headline number represented a worsening in the year on year performance following a 9.8 percent contraction in the first quarter. Evidently the Russian economy has been extremely hard hit by the worst global financial crisis since the Great Depression as demand for Russia’s oil, natural gas and metals (around 80% of total ex-CIS exports), and industrial production plunged as companies depleted stocks and struggled to raise funds during the credit crunch.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7Gc-zU26ay1PNw-kB0Pk2_AYZJgRuE1yzbg8eX-Bhb9Lq_pB68gaXaZLiPInfGgRKkDbGe98I_4Ljgs7MWgiTac2j0EfGhbKWX9RmVAUep0IaZRqxyqQekm-N_yQ8l3YIPBcx3PUvRe1P/s1600-h/GDP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5368676977584648370" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7Gc-zU26ay1PNw-kB0Pk2_AYZJgRuE1yzbg8eX-Bhb9Lq_pB68gaXaZLiPInfGgRKkDbGe98I_4Ljgs7MWgiTac2j0EfGhbKWX9RmVAUep0IaZRqxyqQekm-N_yQ8l3YIPBcx3PUvRe1P/s400/GDP.png" /></a><br /><br />Manufacturing contracted an annual 18.7 percent in the quarter compared with a 23.5 percent drop in the first quarter, while construction was down 20.5 percent in the period following a 20.9 percent annual decline in the first three months. Retail sales fell an annual 11.3 percent, more than twice the pace of decline in the first quarter when they shrank by 4.9 percent. Capital investment slumped by an annual 23.1 percent in May, the most since December 1998. The Russian government forecasts that GDP may fall by as much as 8.5 percent for all of 2009, following growth of 5.6 percent in 2008 and 8.1 percent in 2007. <p></p><br /><p><strong>Looking Into The Third Quarter<br /></strong><br /><br />However the contraction evidently eased in the second three months of the year, and while the Russian Statistics Office do not publish seasonally adjusted estimates of quarterly movements in GDP, Neil Shearing at Capital Economics estimates the economy effectively moved sideways, with roughly zero percent growth (plus or minus a tiny fraction on either side). Moving forward into the thirds quarter, the best measure we have of the current activity level is the GDP Indicator compiled for VTB Capital by Markit Economics on the basis of their Composite PMI. </p><p>Interestingly, the Indicator moved back intopositive territory in August, posting above the neutral level of 50.0 for the first time since last September. That said, the latest reading of 52.2 suggested only a moderate rate of expansion in activity, and remained well below the long-run series average, while both the contry's services and manufacturing sectors posted equally modest month-on-month gains in activity. So we could say the economy continued to move more or less sideways on the month with the quarterly rate still standing at the slightly negative minus 0.2%.<br /><br /></p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiy3WuaaTjJG74LXv19ZLxjZGA9vQyz3pOzBAF-IbfqT-xb5VxRIvcmueolVFzd9xzdEPGtTm-IjD-FJTp6rk_fDRlgtBF6dYo7U9RMagYco48G00pv0Sv-lySvl88phWLkF5BNCwDsoP27/s1600-h/GDP+indicator+3.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 246px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379504449093906418" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiy3WuaaTjJG74LXv19ZLxjZGA9vQyz3pOzBAF-IbfqT-xb5VxRIvcmueolVFzd9xzdEPGtTm-IjD-FJTp6rk_fDRlgtBF6dYo7U9RMagYco48G00pv0Sv-lySvl88phWLkF5BNCwDsoP27/s400/GDP+indicator+3.png" /></a><br /><br />Now while the GDP indicator continued to show quite a strong year on year contraction in August of minus 3.9%, this was well down on May’s revised record rate of minus 9.9%. So while the Indicator has now spent nine months in negative territory - a longer sequence than the earlier seven-month record run from September 1998 to March 1999 - as companies produce direct for new demand, and government stimulus spending has its effect, the rate of contraction has eased notably. But it is worth noting that the current average rate of decline - minus 6.4% - is much sharper than that seen in the 1998 downturn, while we should be asking ourselves, absent a clear rebound in energy prices, just how sustainable the current improvement is.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-EvJf1BVkQm9jzrQV-H9bsF_5uOWRl-jTNyHzNIAPQ58SKHeGfAhB29utVf7gxOpu9qGuHJszgrCTh5gJulW3wREHx5E8uyzHMn6HNjk4k5_GeAoq4b4nwadI6jMkER5u7HSEEDv17e1K/s1600-h/GDP+indicator+2.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 245px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379504386039800530" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-EvJf1BVkQm9jzrQV-H9bsF_5uOWRl-jTNyHzNIAPQ58SKHeGfAhB29utVf7gxOpu9qGuHJszgrCTh5gJulW3wREHx5E8uyzHMn6HNjk4k5_GeAoq4b4nwadI6jMkER5u7HSEEDv17e1K/s400/GDP+indicator+2.png" /></a><br /><br />Over the second quarter as a whole, the Indicator averaged a revised annual minus 9.2%, far worse than the annual minus 6.2% posted in Q1. The first two quarters of 2009 have seen steeper contractions than in any previous quarter since the current time series began in June 1998. However,the Indicator does show a slower rate of annual decline for Q3 since the average so far, is minus 5.2% over July-August.<br /><br /><strong>Industrial Output Trending Up<br /></strong><br />Russian industrial production rose for a second consecutive month in July, and the year-on-year decline eased after the central bank cut rates and the government ramped up spending. Output rose 4.7 percent from June, after a 4.5 percent rise the previous month, and on an annual basis declined 10.8 percent compared with 12.1 percent in June, according to the Federal Statistics Service.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhI5vMpBkmnc9tzCgWCeyhIupX36EMvDHGI_isUpxhT9wrXO6akNY6qOEa8MvvDtFBnlOtF-qK1-SXX1q340xnJE2Bq4pgJUi_Z8e1Hi_8NYnvxXoE37qRKm94E4s3xk24rgXTC1wC6muT9/s1600-h/russia+IP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 235px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379504672715064194" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhI5vMpBkmnc9tzCgWCeyhIupX36EMvDHGI_isUpxhT9wrXO6akNY6qOEa8MvvDtFBnlOtF-qK1-SXX1q340xnJE2Bq4pgJUi_Z8e1Hi_8NYnvxXoE37qRKm94E4s3xk24rgXTC1wC6muT9/s400/russia+IP.png" /></a><br /><br />VTB’s Russian Manufacturing Purchasing Managers’ Index also advanced in August to 49.6 from 48.4 July.<br /><br /><blockquote>“Modest production growth was supported by a second successive monthly increase in new orders, which reflected stronger market activity, particularly at home,” the report said. At the same time, “excess resources remained a key feature,”with “employment, backlogs and inventories all continuing to fall.”</blockquote><p><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8zyGpzwqO21QNhaZaGGfIwPw2C9tPML2tKHwH972git9KXlwbzNn3G0Q1PzWa-fYOrr5KgovMlGc-DfgssHyajUcZNmMrqgfz3JywR3yHkWOFI8BfL99bos8C8RUGg9jLF9DuxkSBc4jQ/s1600-h/russia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 244px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379505952232016098" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8zyGpzwqO21QNhaZaGGfIwPw2C9tPML2tKHwH972git9KXlwbzNn3G0Q1PzWa-fYOrr5KgovMlGc-DfgssHyajUcZNmMrqgfz3JywR3yHkWOFI8BfL99bos8C8RUGg9jLF9DuxkSBc4jQ/s400/russia.png" /></a><br /><br />In addition Russia’s services sector returned to growth during August. Both the level of activity and amount of new business rose for the first time since last September, resulting in an overall improvement in the business climate. Employment continued to fall, but the rate of job shedding was at its slowest in ten months. Costpressures intensified again, but remained subdued whencompared against the long-run trend for the survey.<br /><br />The August services PMI rose by 3.7 points, reaching 52.2, ending a ten-month sequence of decline in the service sector. That said, the survey organisers were at pains to point out that the latest figure still pointed to a relatively muted rate of expansion compared to the survey’s long-run trend.<br /><br /><br /></p><p></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLiAtsLDcICfTCwXteB8F3QZ9vHQPeLny9UxZkWoNlSPg5MySoJoREd2S58cOu39Ie1c9h7NgdNEFxXfaLxlIUUEq7hNrg38RIVghWDvB8GFfGc3sfJYdptSMoRKiSrGUhErLc_Ecrygqk/s1600-h/russia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 244px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379505831773146866" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLiAtsLDcICfTCwXteB8F3QZ9vHQPeLny9UxZkWoNlSPg5MySoJoREd2S58cOu39Ie1c9h7NgdNEFxXfaLxlIUUEq7hNrg38RIVghWDvB8GFfGc3sfJYdptSMoRKiSrGUhErLc_Ecrygqk/s400/russia.png" /></a><br /><br /><strong>As Unemployment Rises, And Incomes Fall, Domestic Demand Shrinks<br /></strong><br />Russia's unemployment rate has been declining recently after reaching its highest level in more than 8 years (8.8%) in April. The unemployment rate continued to decrease in August in all Russia’s 47 regions, according to the latest statement from the Russian Ministry of Health and Social Development. Still, the current 8.2% rate is still very high by Russian standards.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-0T3yBRRR71HaiFsQiCc09HWr1-Qo9WSi17B3zYEMAcbWvBrUmBUfO8QLzWjr5X-Goy7TH_zwjERauvDWm1VZ6YKdILsSw5-pBeKF_posIaVNwHFbrjaAolidv9MyD8RXtAvQVdC2XNvJ/s1600-h/russia+unemployment.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 202px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5381314845921769298" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh-0T3yBRRR71HaiFsQiCc09HWr1-Qo9WSi17B3zYEMAcbWvBrUmBUfO8QLzWjr5X-Goy7TH_zwjERauvDWm1VZ6YKdILsSw5-pBeKF_posIaVNwHFbrjaAolidv9MyD8RXtAvQVdC2XNvJ/s400/russia+unemployment.png" /></a><br /><br />Household income which had begun to strengthen following last winters dramatic fall, began to weaken in late spring and was down 5.4% year on year in August, providing additional evidence that the stimulus spending isn't working out exactly as intended.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidw07C0SnqeBpv8gSHgndW5F8-i-M-uJbyN6YC-nweqKZSj2iYzXR6KvBlCqoxgACZBNvkWjE5peJM2gmrSGvvs-jG0eczX86igeJAr1KWsJZuTMumZx_axZDP67rjVAlNO9gkcijCk9zu/s1600-h/disposable+income.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 244px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5381314705027646066" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEidw07C0SnqeBpv8gSHgndW5F8-i-M-uJbyN6YC-nweqKZSj2iYzXR6KvBlCqoxgACZBNvkWjE5peJM2gmrSGvvs-jG0eczX86igeJAr1KWsJZuTMumZx_axZDP67rjVAlNO9gkcijCk9zu/s400/disposable+income.png" /></a><br /><br />And so, not surprisingly Russian retail sales dropped the most in almost ten years in July, sliding for a sixth consecutive month, as households cut back spending in response to falling income and limited consumer borrowing possibilities. Sales slid 8.2 percent from a year earlier after declining 6.5 percent in June, according to the Federal Statistics Service.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjq1V0X5-MEbdSo8iBVMcy144UxGYMuiPHtZ5YE0Go843RY1fW9ui2hkUlKnMbYaybBHLvLrlSJaI9f2ILystFBKpZ_5zKHJamsSR0D8FOt_TIO1EWQxq2b0Am7lMQ6aBtPFkKVCBDf-1_7/s1600-h/russia+retail+sales.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 243px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379505647996283922" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjq1V0X5-MEbdSo8iBVMcy144UxGYMuiPHtZ5YE0Go843RY1fW9ui2hkUlKnMbYaybBHLvLrlSJaI9f2ILystFBKpZ_5zKHJamsSR0D8FOt_TIO1EWQxq2b0Am7lMQ6aBtPFkKVCBDf-1_7/s400/russia+retail+sales.png" /></a><br /><strong>Inflation Still The Big Bugbear<br /></strong><br />The best think that can be said about Russian monetary policy instruments is that they are hopelessly ineffictive. Even though August consumer-price growth was probably much lower than July’s 12 percent pace it is still extremely hard to understand how incompetence can have reached such a level that an economy which has been contracting at more than 10 per cent a year can still have double digit consumer proce inflation. There is no other word for it, this is a mess.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyQW1Vq0BFHN9543ybYT90TMZwvLd1U1vpdmsFa1eBJhdXEwF-kdw6aag6TyRMBiYV7CMJjI5Ovi5PfyF7koF3TFf1JDxCUNnI98xq3wj9NFcrZ-EY_aM8QRgnqprRZK4fvokAbfiJ15mN/s1600-h/russia+inflation.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 241px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379548564890177986" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgyQW1Vq0BFHN9543ybYT90TMZwvLd1U1vpdmsFa1eBJhdXEwF-kdw6aag6TyRMBiYV7CMJjI5Ovi5PfyF7koF3TFf1JDxCUNnI98xq3wj9NFcrZ-EY_aM8QRgnqprRZK4fvokAbfiJ15mN/s400/russia+inflation.png" /></a><br /><br />Producer prices at least have been falling, and slid again in July for the eighth consecutive month as industrial production slumped and companies competed by discounting products amid waning demand, according to the press release from the State Statistics Service. The price of goods leaving factories and mines was in fact down a record 12.3 percent compared with July 2008 after sliding an annual 9.4 percent in June. The pressure on wages and incomes is thus easy to see. What is not so easy to see is why domestic prices take so long in responding to these signals and the Economic Development Ministry still expects inflation to range from 12 percent to 12.5 percent in 2009 from last year’s 13.3 percent. Stunning!<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBWOML9jS1dRW2nx8psQpKGtKGegbM0qROU-RwOzrrttnXW4OyH9eVbKppzSpHzTJj9kl5Q9DmHR187RNPkMJQAl067UVNaMWKXKQEr8QtMTWMrLgWonKM2WRxar7McVAAIkT3f1g8vj_k/s1600-h/producer.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379504526672039490" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBWOML9jS1dRW2nx8psQpKGtKGegbM0qROU-RwOzrrttnXW4OyH9eVbKppzSpHzTJj9kl5Q9DmHR187RNPkMJQAl067UVNaMWKXKQEr8QtMTWMrLgWonKM2WRxar7McVAAIkT3f1g8vj_k/s400/producer.png" /></a><br />Now suprisingly one of the biggest problems Russia faces as a result of this very disorderly contraction is a sharp fall in capital investment, which is dropping steadily almost with no relief. Down 18.9% year on year in July.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjtTi9MQdykStDXO8ohxbBcu_Fk17M54Y_TuwdJO7y6Ctzu1cNUfRozHszB9MDru2xpMLKhqELfUEXAt9R5IZzUnrcFJ4TNS-E2Avg_RM4Zw7uSPvCspDrc5PROsYVLZ59CQAl1BK39NQ-k/s1600-h/fixed+capital.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 217px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5381314776306373330" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjtTi9MQdykStDXO8ohxbBcu_Fk17M54Y_TuwdJO7y6Ctzu1cNUfRozHszB9MDru2xpMLKhqELfUEXAt9R5IZzUnrcFJ4TNS-E2Avg_RM4Zw7uSPvCspDrc5PROsYVLZ59CQAl1BK39NQ-k/s400/fixed+capital.png" /></a><br /><br />So, as the Federal government pounds in stimulus after stimulus, while oil prices however in the $70 dollar a barrel range, the country now risks returning to a period of entrenched budget deficits that may threaten its credit rating and lead directly to further ruble devaluation. The country faces “still-substantial risks to public finances due to the severe economic contraction” and financial risks linked to “stress” in the financial industry and liabilities of state-run companies, according to Standard & Poor’s analyst Frank Gill. </p><p>According to Gill, if the government fails to rein in the budget shortfall, the credit rating may be cut from its current BBB rating. Russia's budget deficit widened in the first eight months of 2009 to the equivalent of 5.9 percent of GDP, according to Finance Minister Alexei Kudrin following a shortfall of 4.3 percent in the first seven months. The expectation now is that the deficit may come in at around 8.9% of GDP on the whole year.<br /><br />On the other hand the government stimulus plans involve an average outgoing of between 850 billion rubles ($26.8 billion) and 900 billion rubles a month this year following a 1.5 trillion ruble jumpstart in December. In its attempt to plug the gap the government is drawing on its $85.7 billion Reserve Fund and $90.7 billion National Wellbeing fund, which were built on windfall oil revenue, tin order to pay for an “anti-crisis” program that estimated to be worth about 2.5 trillion rubles ($79 billion) you include the tax breaks, central bank lending and all the other multifarious measures.<br /><br />With the Reserve Fund expected to be drained by the end of next year, Russia will need turn to international debt markets for the first time since 1998, and is seeking to raise $17.8 billion from investors next year, according to Alexander Kudrin. This will mean the country’s debt to GDP ration - which is still very, very low by international comparisons - will more than double by 2012, growing from 6.5 percent of GDP in 2008 to 16.4 percent by 2012 according to Finance Ministry estimates. </p><p><br /><strong>How To Get Out Of the Mess</strong><br /><br />Well, one way not to solve the problem would be a ruble devaluation according to European Bank for Reconstruction and Development Chief Economist Erik Berglof. Even while recognising that the country has a very difficult couple of years in front of it, Berglof argues “this (devaluation) is the wrong way to think about the recovery in Russia”.<br /><br />As he says, Russia’s failure to wean itself off its reliance on commodity exports has condemned the country struggling to find economic growth in the face of a large drop in demand for its key export products. “If you want to have a flexible exchange rate, you need to get out of this dependence on commodities,” Berglof said. “It’s a major concern that in the last 10 years Russia has become actually more dependent on commodities. Unfortunately, not much progress has been made.”<br /><br />Well, this is eaxctly the point, and is why I have been arguing over the last two year about how all those wage increases which the Russian administration seemed to rejoice in (since they bought short term popularity) simply fuelled domestic inflation and in the process did untold damage to domestic competitiveness. However it is evident Russia's industries cannot now simply be transformed overnight, and this is where I find a weakness in Berglofs argument, since some remedy is needed to straghten out the distortions and get of commodity export dependence. But what? If it isn't devaluation, then surely we will need to see very substantial wage deflation in order to attract the now much needed inward foreign investment.<br /><br />Of course not everyone agrees with Berglof, and the Russian Association of Regional Banks, whose 450 members include the Russian units of Barclays and Citigroup, has called for a devaluation of as much as 30 percent. Billionaire Vladimir Potanin, realist and owner of 25 percent of OAO GMK Norilsk Nickel, said in recent interview with the Russian Newspaper Vedomosti that the “interests of the economy” will lead the currency to depreciate in the “mid term,” allowing exporters to cut costs and modernize production.<br /><br />Nonetheless energy, including oil and natural gas, accounted for 69.1 percent of exports to countries outside the former Soviet Union and the Baltic states during the first seven months of this year, according to the Federal Customs Service, while metals were responsible for another 12%. So the commodities dependency is massive, and this situation can't be turned round easily.</p><p><strong>Getting Carried Away By Global Liquidity?<br /></strong><br />Bank Rossi are also not 100% convinced by Berglof's reasoning, as witnessed by the fact that they facilitated a 35 percent depreciation in the ruble during the second half of last year (see chart below), and as the collapse in raw material prices and the dramatic change in local credit conditions first pushed Russia's economy into recession the ruble’s trading range was widened to between 26 and 41 against the dollar-euro basket.<br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5wxFMQT6ppidaVsVEgc4sx5CVVyty5bJmLHXp3jWSp_xqJdV30fWELdeuGPxzT8em8QlZ6Cplk3Lwyu2hAHVqa0WoiG5G_9DJRCNqHj7Sea-4-NlVUbQspAGipLe2ddplOQgMcpVn03Cp/s1600-h/rouble+one.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5381413592262744658" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5wxFMQT6ppidaVsVEgc4sx5CVVyty5bJmLHXp3jWSp_xqJdV30fWELdeuGPxzT8em8QlZ6Cplk3Lwyu2hAHVqa0WoiG5G_9DJRCNqHj7Sea-4-NlVUbQspAGipLe2ddplOQgMcpVn03Cp/s400/rouble+one.png" /></a><br /><br /><br />However the central bank is now locked on the horns of a massive dilemma, since as risk appetite returns, with it comes the enthusiasm for buying the so called "high yield" currencies - like the South African Rand, the Russian ruble and the Hungarian forint. Instruments denominated in all these currencies offer investors substantial returns at the present time thanks to offering some of the highest interest rates among globally traded currencies.<br /><br />Indeed buying Russian rubles was one of the key recommendations made by Angus Halkett, currency strategist at Deutsche Bank in London, in a research report published back in April, and the market seems to have followed his advice The so-called carry trade works by investors borrowing in currencies with low interest rates and good prospects of continuing depreciation (the USD at the moment, for example) in order to buy higher-yielding assets, in countries with high domestic interest rates and continuing prospects for ongoing appreciation.<br /><br />In general, engaging in one or other form of the thousand-and-one-varieties carry trade is pretty standard practice during times when returns for real economic activity are low, and central banks hold down rates and supply liquidity. Indeed we may include here the kind of carry practiced by banks in borrowing from the central banks only to then lend - for a small, but very low risk, interest rate commission - to their national government, who at this stage in the business cycle will normally be running a fiscal deficit. So more than funding recovery, the watchword at the moment is very much "carry on carrying".<br /><br />But for those on the receiving end, the consequences of so much carry are far from innocuous, since the process simply funds all sorts of economic distortions, and far from allowing normal market corrections to occur, it simply amplifies the problem. And this is exactly what is starting to happen now in Russia. The ruble had its biggest weekly advance in more than three months last week as risk sentiment rose, following industrial output data from China, which is now the world’s second-largest energy user, which simply showed output increased at a faster pace than forecast.<br /><br />As a result the ruble tends to rise as risk sentiment does, and in particular as economic data exceeds consensus expectations, and the currency has now been on an upward trend since mid-August (see chart below), gaining 0.7 percent to 30.6629 per dollar last Friday alone. This was the highest close since July 27. Over the week as a whole the ruble appreciated 3.1 percent, the most since the week ending May 22. So things are now becoming very detached from the so called "fundamentals" (whatever those might be in the topsy turvy world in which we now live), since it simply is not plausible that the currency should be rising in this way in a country with 12 percent consumer price inflation and which badly needs to move away from commodity export dependency. The only conclusion which could be drawn is that the Russian economy now needs massive structural reforms, and on any imaginable scenario in the world in which I live these are simply not going to be implemented.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2QJJperP5MmSR4v3MHRLH23P5bPvIAvoBAxeM3GfYEHedmrD70E_U8a6ZEawvWcFp60L5lDJA-_OD2LtepM-d4Y-FZl09l4GCTG3koUV5qDybdSRtZ5zOyo9qbhCa6RRt1E1pFmJ1NYIf/s1600-h/rouble+2.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5381413495551242706" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2QJJperP5MmSR4v3MHRLH23P5bPvIAvoBAxeM3GfYEHedmrD70E_U8a6ZEawvWcFp60L5lDJA-_OD2LtepM-d4Y-FZl09l4GCTG3koUV5qDybdSRtZ5zOyo9qbhCa6RRt1E1pFmJ1NYIf/s400/rouble+2.png" /></a><br /><strong>Bad Loans About To Surge?</strong></p><p><br />We also need to consider what is going on in the banking system. According to the lastest report from Standard and Poor's Russian banks currently face “increasing system-wide risks” as loan quality deteriorates and borrowers struggle to keeps their heads above water during the record economic contraction.<br /><br />S&P last week downgraded Bank Vozrozhdenie’s credit rating to B+ from BB- and Alfa Bank, Russia’s biggest private lender, was cut to B+ from BB- as a signal to the industry. As the ratings agency indicated, the inability of Russian companies to continue to make their debt payments will more than likely further stifle lending as banks channel funds into building up their reserves. </p><blockquote>“The ratings on Bank Vozrozhdenie broadly reflect the increasing system wide risks in Russia due to the economic recession and deteriorating operating environment,” the S&P analysts said. “The downgrade primarily reflects deteriorating asset quality for Bank Vozrozhdenie, and the entire Russian banking industry, owing to the continuing economic slowdown.”</blockquote>OAO Sberbank, VTB Group and other lenders are also facing a surge in “troubled assets” that may total $213 billion, according to an earlier Standard & Poor’s report in June - with as much as 38 percent of all assets held by Russian banks possibly becoming problematic by the end of 2011. Russia's banks had already set aside 1.5 trillion rubles ($48.9 billion) in July to cover overdue debt, a monthly increase of 7.6 percent compared to a rise of 6.9 percent in June, according to the last statement from Bank Rossii (Sept. 1).<br /><br />Sberbank’s provisions for the rising debt reached 388.1 billion rubles, or 7.1 percent of total lending, as of June 30, according to the bank itself. The share of bad loans in the second quarter jumped to 6.4 percent from 3.5 percent in the first quarter, while year-to-date lending by the bank was only up 0.4 percent.<br /><br />At Bank Vozrozhdenie, S&P's estimate that about 15.7 percent of loans are “under stress,” S&P. The bank, which focuses on lending to small and medium- sized businesses, saw non-performing loans rise to 7.3 percent at the end of the second quarter, compared with 3.4 percent in the first three months of the year.<br /><br />Overdue bank loans in the system as a whole reached 5.5 percent of total lending in July, compared with 5 percent a month earlier, with overdue corporate loans jumping to 5.3 percent in July from 4.8 percent in June. The bank corporate loan books fell by 0.2 percent in July, while lending to households was down 0.4 percent for the sixth consecutive monthly decline.<br /><br /><br /><strong>Russian Outlook</strong><br /><br />In this report we have identified how steady and systematic long term mismanagement of Russia's monetary policy how now created a veritable Procrustean bed of problems for Russia's economy and society. Failure to address the underlying inflation problem between 2005 and 2008 meant that large structural distrortions were accumulated in the economy, including a massive problem of commodity export dependence, a problem which effectively turned the country into a veritable disaster waiting to happen if ever there should be a protracted lull in the secular rise in energy prices. That lull has now arrived, and it is not at all clear just for how long we will all need to get to learn to live with it. <p></p><p>In a more or less reasoned analysis Capital Economics suggest that oil prices could fall back to somewhere around $50 a barrel in 2010. If this forecast proves anywhere near correct, the Russian economy is going to be subject to major downside risks, due to the difficulties posed by:<br /><br />i) financing the fiscal deficit<br />ii) rising unemployment<br />iii) growing bad loans in the banking system<br />iv) refinancing external debt<br />v) the continuing high level of consumer price inflation and the difficulties this poses for monetary policy at the central bank<br /><br />Added to all this, the economy will clearly not rebound as easily as many seem to foresee. The Russian Economy Ministry seem to be getting ahead of themselves here, since only last week they raised their 2010 forecast to 1.6 percent growth from 1 percent. This would follow an anticipated shrinkage of some 8.5 percent this year. Economy Minister Elvira Nabiullina said on Sept. 9 output may grow 3.9 percent to 4.5 percent in the second half of this year compared with the first six months - and this I find hard to accept, unless the turnround in global economic activity turns out to be much stronger than the one we are currently seeing. The consequence of this is that it will still be some years before Russian GDP even gets back to the 2008 level, as Capital Economic's Neil Shearing recently argued (see chart below).<br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8nBkDFliCTKhfOhZ3avuHiRaO_JuyRdI9KW-B1vAY1cWOpIAqfZpnn0JVXRyP3xH4j0ieSd6f2yAHwp-hb-QYMdsp1nNNcQn0vvxiWf_030MOOFtD9moyYLzt8z8YeJ5-VGE8piKsHhpm/s1600-h/shearing.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 253px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379504801167262802" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8nBkDFliCTKhfOhZ3avuHiRaO_JuyRdI9KW-B1vAY1cWOpIAqfZpnn0JVXRyP3xH4j0ieSd6f2yAHwp-hb-QYMdsp1nNNcQn0vvxiWf_030MOOFtD9moyYLzt8z8YeJ5-VGE8piKsHhpm/s400/shearing.png" /></a><br /><br />I also agree with Neil that while financing the Russian deficit is unlikely to add to the inflation issues (given the substantial output gap under which the economy currently labours) underlying inflation is bound to remain well above any reasonable comfort zone, and this will complicate policy decisions enormously.<br /><br />Financing the fiscal deficit - which looks set to top 9% of GDP this year and despite some planned fiscal consolidation is unlikely to fall much below 5% of GDP in2011 - is not a major problem for the government, although the issue of which currency to issue the inevitable bonds in will be, since the likelihood of devaluation at some point remains large - Neil Shearing expects the currency to fall by 10% against its dollar/euro basket over the next six months or so, breaching in the process the current lower bound of the trading range, and this it seems to me is a perfectly reasonable expectation.<br /><br />Of course, talk at this point of a return to the sort of chaos we saw in 1998 is certainly premature, especially with debt to GDP only just breaking the double digit frontier. But serious issues do lie ahead in 2010, not least of them how to recapitalise Russia's badly wounded domestic banking system, and how to refinance all the outstanding forex denominated corporate debt. Of course, if we are living a fairytale version of Alica in Dynamic Global Recovery land, then demand for Russia's commodity exports will surge again in 2010 and 2011. But what is we aren't, and demand remains muted, or more financial problems break out on Europe's perfifery? Perhaps the prudent investor will be able to spare the time to give just a little thought to the likelihood of this second, and definitely less apetising scenario.</p>Unknownnoreply@blogger.com3tag:blogger.com,1999:blog-1443720106009957151.post-6110364664263908202009-09-11T20:00:00.001+02:002009-09-14T11:32:40.783+02:00There Is Another Shoe To Drop In The Global Economic and Financial Crisis - And The Focus Will Be On Europe's Perifery<blockquote>'As far as I am concerned, this is ... the most complex crisis we've ever seen due to the number of factors in play'<br />Spanish Economy Minister Pedro Solbes speaking to the Spanish radio station Punto Radio September 2008<br /><br />“‘The global imbalances have to add up to zero and so, if the US is going to be less the consumer importer of last resort, then other countries are going to need to be in different positions as well."<br />Director of the US president’s National Economic Council Larry Summers, speaking over lunch with the FT’s Chrystia Freeland.</blockquote><br /><br />Basically what we now have before us - as Pedro Solbes pointed out before being uncerimoniously defenestrated from the inner circle of the Spanish government - is an extremely complex situation and problem set. The background has evidentally been an unprecedented global financial and economic crisis, but this crisis has affected countries unequally, and it is noteworthy just how many people in what could be called the "weaker" countries have often sought refuge in the global nature of the crisis, rather than asking themselves just what it is exactly about their own particular economy that makes them "weaker", and more vulnerable, and why the crisis has struck more severely "here" rather than "there". Thus there is a great danger that people take refuge in the fact that the crisis is global in order to avoid thinking about the actual reality that faces them. This danger becomes even more of an issue as some countries begin timidly to return to growth, leaving others stuck in the mire - and possibly in danger of bringing the whole pack of cards tumbling down on top of them again. One such danger is evident in China (for which see the numerous warnings from Andy Xie) but others are for me somewhat nearer home, on Europe's periphery. A number of countries in Eastern Europe immediately come to mind - not only the Baltics, but also Russia, Ukraine, Bulgaria, Romania, Hungary, Serbia and Croatia. And in Southern Europe Spain and Greece stand out as in particular need of what Jean Claude Trichet would undoubtedly call "extreme vigilance".<br /><br />If we leave out Russia (which is arguably a rather special case due to its dependence on energy revenue), then the simple fact of the matter is that what all of these countries had in common during the bubble years was that they were all running large (unrealistically large) current account deficits, which were produced to fuel strong credit driven housing and consumption booms. The crisis has struck all these countries like a shot of lightening for the simple reason that under present conditions such current account deficits are now no longer sustainable.<br /><br /><br />Now, the only way forward for such countries, as Paul Krugman points out (<a href="http://www.newsweek.com/id/190340">citing Reinhardt and Rogoff</a>) is to export their way back to growth, and to demonstrate how this might work Krugman produced a simple chart in his Lionel Robbins lectures, which although rather rough and ready does serve the purpose adequately well.<br /><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBCCbezv3-t3TytAmGA_5ATwCFa6zt8XiDyOOcdDrMkcEmENFe76hYHUcb_8ra8PA0F80l5QujA9BJMoJo5D-Ntzyse_Qe86ZEvQWozv6sUf0q5m6pvP8D7VzFvnAVy1TNxPlNlBDqE8vH/s1600-h/krugman+trade+surplus.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 254px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5378620488584067634" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgBCCbezv3-t3TytAmGA_5ATwCFa6zt8XiDyOOcdDrMkcEmENFe76hYHUcb_8ra8PA0F80l5QujA9BJMoJo5D-Ntzyse_Qe86ZEvQWozv6sUf0q5m6pvP8D7VzFvnAVy1TNxPlNlBDqE8vH/s400/krugman+trade+surplus.png" /></a><br /><br />So the central point I wish to make is that all these countries now need to run current account and trade surpluses to generate headline economic growth and to start paying down the external debt they accumulated during the heady years of the boom. Countries are no different to households in this sense. And the wider the current account deficit at the height of the boom, the bigger the correction needed. Without the much needed correction these countries simply will not recover, and we will see the famous "L" shaped recovery. If people think otherwise they are simply deluding themselves.<br /><br />The situation in the US and the UK is, of course, not that different structurally from that which is to be found in some parts of Eastern and Southern Europe, but it is less extreme, in that the Current Account deficit peaked at between 5% & 6% of GDP. This is still large, and correcting it is going to be one of the very good reasons that the global economiy ISN'T going to return to any kind of strong growth anytime soon, given the strategic importance of the economies concerned.<br /><br />The UK and the US do, however, have one large and significant advantage over the worst affected countries in South and East of Europe, and this lies in the fact they can issue debt in their own currency, and they can allow that currency to devalue, and that in fact is the road that both these countries are now going down. But remember, the result of this is that US and UK consumers will now play little part in facilitating headline growth in the global economy, since they themselves will now be net savers. But most of the worst affected East European economies are either locked-into currency pegs with the euro (the Baltics and Bulgaria), or cannot devalue very far due to the strong dependence on forex loans (Romania and Hungary) or both. Nor can these countries realistically expect to issue debt in their own currencies. So they are in effect in a very parlous situation, on financial life support from the EU and the IMF, while unable to make sufficient adjustments sufficiently quickly to stop unemployment rising out of hand, and non performing loans piling up in the banking sector.<br /><br />Which brings us to Southern Europe. Italy is a case apart - since it is "simply" suffering from a kind of ageing-related terminal slow death "Venice style", and thus has a different problem set - in particular, while the Italian government is heavily in debt, Italian households are strong net savers, and thus any eventual default would be largely a "home team" issue. Portugal, Greece and Spain, on the other hand, were all running large CA deficits between 2000 and 2008, and these are deficits are now being forceably closed. But of course, and here comes the rub, these countries don't have their own currency - they have to issue debt in euros, and they can't simply fuel inflation (like they did in the past) since they can't print money, only the ECB can do that, and the ECB is a multi-national not a national institution.<br /><br />Now people over at the ECB are well aware of this problem, and the bank is facilitating all the liquidity these countries need in the short term, but it is so very important important to understand this only aids liquidity, it does not resolve the solvency-related issues (which the individulal countries have to sort out for themselves) and in fact the short term palliative only adds to long term accumulated debt problem if the breathing space offered is not taken advantage of. And, here comes the problem, since all the available evidence suggests that the correction the ECB would like to be funding is either not taking place, or is taking place too slowly to be of much use. That is, the ECB has the funding capacity, but it does not have the necessary political clout.<br /><br />Take Spain for example - Spain's external debt is continuing to rising even as I write, while at the same time GDP is falling, and will continue to fall untill we get back to export competitiveness. Worse, nominal GDP (that is current price GDP) is now falling faster than real (inflation-adjusted) GDP, so the value of the debt remains - in money terms - where it is, while GDP shrinks in relation to this absolute reference point - both in real terms, and even more so in nominal terms. I have been following this problem in Japan for the best part of a decade now, and the solution is evidently not an easy one, since - if you take the core core price index - Japan never really came out of deflation after 1998, and land prices are now back at the levels of somewhere in the early 1980s. Needless to say, if this repeats itself in Spain, the mess will not be a pretty one, and the problem for the ENTIRE global financial system will be substantial, due to the counterparty risk element.<br /><br />So we are really caught on the horns of a dilema here, Spain and other EU periphery countries have to deflate (willingly or unwillingly, they need to carry out what has now come to be known as "internal devaluation") but so long as they fail to do this and to attract sufficient investment for new export industries to turn the economic dynamic around AND as long the rest of the global economy doesn't recover strongly enough with some countries starting to shoulder significant deficits again, then we are all only going to plumb the bottom. Worse, unemployment will continue to mount, and bad debts pressurise the banking system, which is where the next shoe might then not only drop, but be forced right off the foot first.<br /><br />The only way in which it would be possible for these countries to attract the necessary investment to be able to start to create employment employment again would be to restore competitiveness, and over the time horizon we should be thinking about this is impossible for them to do via productivity improvements alone: hence the pressing urgency for the "internal devaluation" solution.<br /><br />And let's not be fooling ourselves here - the main reason those famous government bond "spreads" have all tightened so impressively recently has been the willingness of the ECB to discount the national government bonds which are first purchased by local financial entities and then passed on for discounting at the ECB - a practice one of my Spanish friends calls the "truco del almendruco" (that is, you sell the 10,000 euro new car for 9,995 euros thus changing the key headline digit, giving everyone the impression there has been a large and significant discount, and, oh yes, first of all you need to dump <a href="http://macro-man.blogspot.com/2009/06/wheelie-big-deal.html">a wheelbarrow load of cash</a> on the banks - in this case on <a href="http://macro-man.blogspot.com/2009/06/drawer.html">a one year financing basis</a>).<br /><br /><blockquote>"Between October 2008 and April 2009 MFIs’ net purchases of debt securities issued by the euro area general government sector totalled €217 billion in the context of rapidly declining short-term interest rates. This entirely reversed the net sales of €191 billion observed between December 2005 and September 2008 in the context of rising short-term interest rates."<br /><a href="http://www.ecb.int/pub/pdf/mobu/mb200906en.pdf">ECB Monthly Bulletin, June 2009</a></blockquote><p>So what I am saying is that the ECB is effectively conducting expansionary fiscal policy in the Eurozone countries - by buying a large part of the new government debt, a state of affairs which is in fact equivalent to conducting Quantitative Easing via the back door, while the EU/IMF tandem is offering similar support to the key countries in the East. Anatole Kaletsky <a href="http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article6597813.ece">made a similar point in the Times back in June</a>, when the ECB announced its €442 billion of new cash into the euro money markets in what was the biggest long-term lending operation in the history of central banking and roughly equivalent to half the Fed’s entire monetary expansion in the past 18 months.<br /><br /><blockquote>The Fed has “monetised” roughly $1 trillion of US Government debt since 2007, if we combine its Treasury and agency bond buying. Meanwhile, the ECB has lent $1.5 trillion to the euro-area banks. But what have the euroland banks done with this new money? They have lent most of it straight to their governments. Indeed, the governments in Ireland, Greece, Portugal, Spain and Austria would long-since have gone bust had it not been for the willingness of the commercial banks in these struggling economies to buy unlimited quantities of government bonds with money borrowed from the ECB. And these bond purchases have, in turn, been used as collateral for more ECB borrowings, which could be used to buy more government bonds.<br /><br />In effect, therefore, the ECB has been lending money by the shed-load to governments, with commercial banks acting merely as a fig leaf for what would otherwise be seen as a blatant monetisation of the most insolvent European countries’ public debt.</blockquote><br /><br />Now Anatole only has it half right here, the objective is not to finance dubious government debt in semi-bankrupt countries (Italy, for example), but to enbale those countries who had been running extraordinarily large current account deficits (Spain, Greece and Portugal) to close the deficits gradually (ie without precipitating a dramatic implosion in their economies) by facilitating government borrowing to fill the gap left by domestic and corporate deleveraging. The situation I am trying to describe is perhaps best illustrated by the following chart on Financial Balances prepared by PNB Paribas Chief European Economist Dominic Bryant for a recent research report on Spain.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjREcHT1QiH32K6OA5yNjIwx4JU3L_gQU9xUazPbX9ei0843N4BrS74GtGTHt1DW9gj4KJLiHXYtcm6Sj8-j8KDz17bP0NEygSWbKah4ERrd_FnX7sR-U9FnaIRL_q8RC4-M-JRJHbDuOY/s1600-h/financial+balances.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 251px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5378772318765243746" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjREcHT1QiH32K6OA5yNjIwx4JU3L_gQU9xUazPbX9ei0843N4BrS74GtGTHt1DW9gj4KJLiHXYtcm6Sj8-j8KDz17bP0NEygSWbKah4ERrd_FnX7sR-U9FnaIRL_q8RC4-M-JRJHbDuOY/s400/financial+balances.png" /></a><br /><br />As households and companies desperately try to save, to put some sort of order back into their balance sheets, government steps in (Krugman's push button "G") to help ease the transition. Such a policy is, of course, all well and good and totally justified (since there is effectively no alternative), so long as the structural transition which such support is meant to facilitate is actually carried through. And this is a big if, especially since most of the evidence we have seen to date suggests it isn't. <br /><br />And then there is the Irish case, and the proposal to create a "bad bank" (NAMA). According to Minister of Finance Brian Lenihan the Irish State plan to buy up toxic property loans with a current face value of €60 billion and investment property loans with a book value of €30 billion, all in exchange for Government bonds. And how will the Irish government finance a possible €90 billion (or two thirds of 2008 GDP) in bonds? We the government plans to pay the banks in bonds which they can then redeem for cash over at the ECB. Obviosuly there is little other way, with such a high proportion of GDP, but has anyone started to think what will happen if the Spanish exchequer is faced with an equivalent proportional sum to clean up bad loans in Spanish banks. Spain, remember is the only major country where there was a property bubble where the banks have not had a substantial capital injection.<br /><br />And in my humble opinion the ECB will only be willing and able to continue with this kind of policy for a limited period of time, since they will not be in a position to keep accumulating Irish, Austrian and Southern European bonds ad infinitum, and the sovereign governments won't be able to keep increasing their debt load for ever. Just look, for example at the kind of dynamic Spanish public finances have entered in 2009 (see the acceleration in the cash basis deficit shown for 2009 in the chart below - the evolution is almost exponential, and it still hasn't stopped the haemorrage of jobs out of the economy).<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjb5WJe4Si-UvzQNt-BROREeauvPwD6BwXOvmUVzMFXkpKqpnIlj9Bk8UG2iTajr8XyVf4lfC_Uda8D5-PdbXwViEGd2jXKcrL2phyphenhypheneYwmdBE3ELirDYNilySlUAEN2T2eODApLq19jnj0/s1600-h/Primary+deficit.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 307px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjb5WJe4Si-UvzQNt-BROREeauvPwD6BwXOvmUVzMFXkpKqpnIlj9Bk8UG2iTajr8XyVf4lfC_Uda8D5-PdbXwViEGd2jXKcrL2phyphenhypheneYwmdBE3ELirDYNilySlUAEN2T2eODApLq19jnj0/s400/Primary+deficit.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5378774620222129154" /></a><br /><br />We also need to think about the risk the ECB is running of accumulating substantial capital losses if there is a sovereign debt problem (which there most likely will be at some point if the correction is not carried out) in one of the member states as the size of the ECB position simply grows by the day, and ultimately the German and French taxpayers will have to pay the losses being steadily accumulated, something I feel they will be very reluctant if those in the worst case scenario countries continue to harp on about a global economic and financial crisis whilst effectively doing nothing to put their own house in order.<br /><br />Precisely this point was raised a while back <a href="http://blogs.ft.com/maverecon/2009/03/fiscal-dimensions-of-central-banking-the-fiscal-vacuum-at-the-heart-of-the-eurosystem-and-the-fiscal-abuse-by-and-of-the-fed/">by Willem Buiter on his Mavercon Blog</a>:<br /><br /><br /><blockquote>The first vacuum is that there is no single fiscal authority, facility or arrangement which can re-capitalise the ECB/Eurosystem when the Eurosystem makes capital losses that threaten its capacity to implement its price stability and financial stability mandates.<br /><br />The second related vacuum is that there is no single fiscal authority, facility or arrangement which can re-capitalise systemically important border-crossing financial institutions in the EU or the Euro Area, or provide them with other forms of financial support.<br /><br />When the Bank of England develops an unsustainable hole in its balance sheet, Mervyn King knows he only needs to call one person: Alistair Darling, the UK Chancellor of the Exchequer. If the Fed were to become dangerously decapitalised, Ben Bernanke also needs to call just one person: Tim Geithner , the US Secretary of the Treasury. It is possible that no-one in the US Treasury will pick up the phone, as none of the senior political appointments below Geithner are in place yet, but Geithner clearly would be the man to call.<br /><br />Whom does Jean-Claude Trichet call if the Eurosystem experiences a mission-threatening and mandate-threatening capital loss? Does he have to make 16 phone calls, one to each of the ministers of finance of the 16 Euro Area member states? Or 27 phone calls, one to each of the ministers of finance of the 27 EU member states whose NCBs are the shareholders of the ECB? I don’t know the answer, and I doubt whether Mr. Trichet does.</blockquote><br /><br />Maybe one day all those phones will be ringing, only for the caller to hear that old Elvis automated operator resonse - "no such number, no such zone".<br /><br /><strong>The G20 Needs A Real Rethink And A New Plan</strong><br /><br />So, coming back to where we started, growth in Germany and France. Such growth is unlikely to be anything like as strong as most commentators and analysts seem to be expecting. France will most likely do rather better than Germany, given that the German economy can't really move forward till other key economies move, due to export dependence. The German economy may well even ultimately contract over 2009 as a whole by more than the Spanish economy, and I expect Germany's problems (like Japan's) to continue well into 2010, simply because both these countries are now very high median age societies which are completely dependent on exports to grow - which means that now that the UK, US, Eastern and Southern Europe are no longer running current account deficits, Germany and Japan are very hard pressed to get the level of trade surplus they so badly need for achieving sustainable headling GDP growth, which brings us back to Krugman's joke about which planet is going to do the importing?<br /><br />Structurally the previous drivers of growth will now fail to work, since as Krugman suggests, all the former CA deficit countries now need to export and run trade surpluses to grow and straighten out their financial imbalances , and it is not clear which countries can buy all the added output, especially when countries in general are still reducing imports, and certainly not about to open up deficits which would soak up all those new surpluses.<br /><br />Essentially, I would close by emphasising that I am not a complete catastrophist, since I think there is a mid term solution out there - and that the answer lies in steadily unwinding the global demographic and wealth imbalances, through the economic development of a number of key emerging economies - in a way which would perhaps be similar to the implementation of the Marshall Plan which is what really brought the first great global depression to an end.<br /><br />The problem is that I think we are still some years away from being able to get any sort of agreement on such a programme - as everyone will have noted the G20 isn't really talking about this yet, although I think they eventually will. In the meantime we all have to stagger forward. And it is the risk of further "events" occuring in countries like Latvia and Spain that make all this staggering onwards and downwards ever so dangerous. In all the key countries involved - the Baltics, Bulgaria, Romania and Hungary in the East, and Portugal, Greece and Spain in the South - government support is simply not sufficient to arrest the contraction in Krugman terminology simply hitting the "G" button will not work, and these economies are steadily "imploding" in on themselves, with the result, as I keep stressing, that unemployment inexorably rises, and bad debts simply mount up in the banking system, and if nothing is done to change course the outcome is surely a foregone conclusion.</p><p>The principal difference between the East and the South is that in the East governments no longer have the capacity to continue to sustain large deficits, while in the South they continue to be able to do so, though even here they cannot hold out indefinitely. Sometime in late 2010 or early 2011 all of this will, with a horrid and almost deterministic inevitability, all come to a head.<br /><br />And this is why, I personally take the view that the global financial and economic crisis is far from over. There is another stage yet to come, and the focus of the problem will be Southern and Eastern Europe.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-42807768501324691042009-09-09T13:29:00.001+02:002009-09-10T11:36:29.484+02:00Latvia's Agony Continues In The Second Quarter - With Little Relief In Sight<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSTE15WXHpwAPTOI8ZqaZSZiAu1TcpEvaimUHwm-FHqAm0ThC6BP33lLLaPpM5MTfjbXqPrn74RL8mfMuXfCbf5ofdcXLqtVWwFbZeY7j5kCzfbT8J_4XU1yE7Y1-vYM5ST7XEnArV9KrD/s1600-h/Latvia+exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 260px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379418347289951458" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSTE15WXHpwAPTOI8ZqaZSZiAu1TcpEvaimUHwm-FHqAm0ThC6BP33lLLaPpM5MTfjbXqPrn74RL8mfMuXfCbf5ofdcXLqtVWwFbZeY7j5kCzfbT8J_4XU1yE7Y1-vYM5ST7XEnArV9KrD/s400/Latvia+exports.png" /></a><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3Ymsz48J8IxNh4h4uJhvDjE48bVGLyEU5jtn703u5DqInlXXQBm0km9Jbyomm9pqAv8LSehvL79SnPfM51d68K88rjYbu5Og_5crNgqSSn4n9SKW9M5JvXPbg4djBpgkBPvcZViNXZoQO/s1600-h/quarterly+constant+price+imports+and+exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 257px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379390117671651714" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi3Ymsz48J8IxNh4h4uJhvDjE48bVGLyEU5jtn703u5DqInlXXQBm0km9Jbyomm9pqAv8LSehvL79SnPfM51d68K88rjYbu5Og_5crNgqSSn4n9SKW9M5JvXPbg4djBpgkBPvcZViNXZoQO/s400/quarterly+constant+price+imports+and+exports.png" /></a><br />Latvia’s economy shrank a revised 18.7 percent in the second quarter of 2009 over a year earlier in what was the second-steepest drop in the entire European Union (worsted only by Lithuania) according to detailed data released by the statistics office yesterday. The contraction, which is now the largest since quarterly records began in 1995, was revised down from a preliminary estimate of a 19.6 percent annual drop. And Latvia's problem can easily be seen in the above charts which show the most recent movement in exports, and quarterly data for constant price imports and exports. The Latvian economy grew driven by domestic consumption and increased borrowing during 2006 and most of 2007, but then the country ran out of extra sources of cash, and so imports slumped, followed by exports as the global economy entered crisis. Now its time to pay back, which means the lines we see in 2006 and 2007 will now need to be repeated, only this time with exports on the top and imports below. Of course, really doing this will only be possible once the global economy recovers. But the key question is, will Latvian export capacity be ready when that critical moment comes, or will Latvia's agony continue, stuck in a horrid "L" shaped "non-recovery"? The most recent data on foreign trade, which saw exports fall and the trade deficit once more widen suggest that the latter danger is far from being a mere theoretical one.<br /><br />And I am not the only one to be raising it, since according to the latest report out from Nordea Bank, Estonia, Latvia and Lithuania, may well suffer deeper economic contractions than previously estimated as government austerity measures simply serves to sap domestic demand while export growth remains muted.<br /><br />So well done Nordea! But please permit me to say that this discovery does come as a bit rich from analysts who have persistently remained in denial that the key to Latvia's recovery was a substantial reduction in the price level in order to facilitate exports (on my view better achieved by formal devaluation, but by the express desire of the elected political leaders of the Latvian people now being carried out via a convoluted and painful process known as "internal devlauation").<br /><br />Still, it is interesting to see mainstream analysts starting to question the current orthodoxy that fiscal prudency will (due to the impact on investor confidence) lead to recovery in Eastern Europe, while here in the West our leaders have just re-affirmed the need to maintain fiscal stimulus, given the fragility of even those earliest signs of recovery.<br /><br />Indeed the analyst consensus is becoming more and more pessimistic. Danske Bank say the following in their latest Emerging Markets report:<br /><br />"Worries over Latvia’s public finances continue. Despite aggressive cuts in public spending so far this year, total central government spending in August 2009 was, extraordinarily, exactly the same as in August 2008. This is partly due to spending cuts being offset by increased social spending, and partly to some ministries and agencies awarding their employees big pay increases in June this year before imposing cuts in July as part of the IMF/EU programme. It is still too early to say that everything is fine in the state of Latvia."<br /><br />In the following monthly report I will examine just what evidence there is for the idea that Latvia's economy has actually bottomed out.<br /><br /><strong>The Fall In GDP Continues</strong><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheVWfR8dpMomcM4QlZ67IMJaKNRP_wLrz6Xb2fusIiRShwGOcy2kks0RJAfpUqpGB8bbQTi2Bpf-0Qo3C3NfPLuc6jc_po4gPRNaoXrCfWqOlLfAK0TQcOjstwswrpXrIVo7mMwyCTvsvU/s1600-h/Latvia+GDP+YoY.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 198px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379185178635463522" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEheVWfR8dpMomcM4QlZ67IMJaKNRP_wLrz6Xb2fusIiRShwGOcy2kks0RJAfpUqpGB8bbQTi2Bpf-0Qo3C3NfPLuc6jc_po4gPRNaoXrCfWqOlLfAK0TQcOjstwswrpXrIVo7mMwyCTvsvU/s400/Latvia+GDP+YoY.png" /></a><br />Latvia’s economy shrank an annual 18.7 percent last quarter, following a drop in gross domestic product of 18 percent in the first quarter. The charge downwards was lead by a decrease in private final consumption which fell an annual 23.21% (year on year - see chart). Government final consumption dropped bya mere 6.9%, but expenditure on gross capital formation (which includes the critical investment item) crashed by 38.1% - with construction (which forms part) down 29.5% (see chart below). Goods exports (63.6% of total exports) was down by 19.1% and the export of services by 15.7%. The slump in imports was, of course) even worse with the volume of goods imports (78.8% of total imports) down 39.4%, and the volume of services imports by 38.2%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgX5_rZwnS75Cocm2-S7YcUYhqFZpjhcpfZApeHOWJdIAPPONTWecRkRIP6mPOzGd0MQWAc0dxrunCm0pUvTpPt34ry_gAdCm0VQwJn3X82fkdwnNh0OpDQUkpRLaUxxz7SzYJNYT3RW2uz/s1600-h/Latvia+quarterly+construction+output.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 246px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379390356858752354" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgX5_rZwnS75Cocm2-S7YcUYhqFZpjhcpfZApeHOWJdIAPPONTWecRkRIP6mPOzGd0MQWAc0dxrunCm0pUvTpPt34ry_gAdCm0VQwJn3X82fkdwnNh0OpDQUkpRLaUxxz7SzYJNYT3RW2uz/s400/Latvia+quarterly+construction+output.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuMbAPRmiSDFv5BKWqZ16wKQVWou5f9Ca1dVL0tE7JVrun1v4bI1KeQXx1iZ_KVWMsx0FR_Dqy5kmE1zYa6BYPQcU9kLk7ypC5yhd32d2p3prUCVqo2KztvwR0lfKa2yd6snfT_B7pcg_e/s1600-h/Latvia+Private+Consumption.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 236px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379390264464387826" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjuMbAPRmiSDFv5BKWqZ16wKQVWou5f9Ca1dVL0tE7JVrun1v4bI1KeQXx1iZ_KVWMsx0FR_Dqy5kmE1zYa6BYPQcU9kLk7ypC5yhd32d2p3prUCVqo2KztvwR0lfKa2yd6snfT_B7pcg_e/s400/Latvia+Private+Consumption.png" /></a><br /><br /><strong>But Slows On A Quarterly Basis</strong><br /><br />Quarter on quarter, however, the rate of contraction did slow slowed substantially, from an 11% rate in the first quarter to a 1.6% rate in the second quarter. But even though the rate of contraction is now much, much slower, the economy is still contracting, so I think it is not quite accurate to say we have hit bottom yet. And hitting bottom is not the same as recovering, since there is unlikely to be any rapid bounce back, and any "recovery" is likely to have an "L" shape with a slight upward slope.<br /><br />Meanwhile, and hardly surprisingly, during the month Latvia’s credit rating was lowered by Standard & Poor’s, with the long-term foreign currency rating being lowered to BB, two notches below investment grade, from BB+, with a negative outlook. According to S&P's:<br /><br />“The rating action reflects our view of the political and economic challenges as a result of rapidly contracting nominal and real incomes and the associated pressures on public finances, as the country struggles to improve its growth prospects while maintaining a fixed exchange rate regime.....The outlook for growth beyond that remains highly uncertain, not least due to highly leveraged household balance sheets.”<br /><br />S&P's estimate that Latvia’s general government debt, which stood at 19 percent of GDP last year, will grow to over 80 percent in 2011, an estime which is broadly in line with current EU Comission forecasts.<br /><br />The International Monetary Fund also agreed on August 27 to disburse the second installment (of around 200 million euros) of the 1.7 billion-euro credit line approved last December. The decision followed a long period of uncretainty. Latvia’s government is trying to cut spending/or raise revenue by 500 million lati ($1 billion) a year between now and 2012, in a bid to get the budget deficit below 3 percent of GDP as part of an attempt to meet euro adoption criteria.<br /><br />The IMF said in their statement that the program had been adjusted to reflect:<br /><br /><br /><blockquote>- a significant increase in the program’s fiscal deficit ceiling in 2009 (up to<br />13 percent of GDP, compared with 5 percent in the original program) to avoid<br />measures that would harm the most vulnerable, and<br /><br />- an allowance of 1<br />percent of GDP in additional resources for social safety nets. </blockquote><p><br /><br />The statement which Moody's following the IMF decision asserting that Latvia’s Baa3 government bond rating - the lowest investment grade, - was being kept at stable was hardly surprising, although the justification they gave - that the bond issuance was supported by “significant, extraordinary fiscal assistance” from international lenders - surely was significant, and very much to the point. The EU Commission and the IMF are now guaranteeing and in order to do this have effectively assumed sovereign responsibility fo the country (see Appendix below).</p><p>Moody's were also a little more optimistic than S&Ps on government debt, since they estimated it would only rise to about 60 percent of gross domestic product in 2010 and fluctuate from about 60 percent to 65 percent over the medium term. I think this is too optimistic, basically for the sort of reasons S&Ps are giving. On the other hand they did also state that a currency devaluation, while not being their central scenario, "was a clear risk, along with additional problems in the banking sector".<br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgKzNdDtuOJOByQNyQqzHVSz-hKa6Apqt6M2ZKqZvMg726kmByPZZbbUggqzA6QGWboQHPGyUmkkVVhhSni_abMX-9MswgY_VN9u-1lcu4Frr2oFA0JmsCbahHWPqi-aaaxDdAKBmRbzyQ-/s1600-h/Latvia+GDP+QoQ.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 242px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379185690590142930" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgKzNdDtuOJOByQNyQqzHVSz-hKa6Apqt6M2ZKqZvMg726kmByPZZbbUggqzA6QGWboQHPGyUmkkVVhhSni_abMX-9MswgY_VN9u-1lcu4Frr2oFA0JmsCbahHWPqi-aaaxDdAKBmRbzyQ-/s400/Latvia+GDP+QoQ.png" /></a><br /><br /><strong>Little Sign Of Any Recovery In Main Indicators</strong><br /><br />If we now come to the future, we have to note there is little hard evidence at this point for any real recovery - nor should we expect to see any. Industrial output is still falling, and was down 1.4 percent in July over June, and 17.7% year-on-year (over July 2008). This compared with a 18.5% annual fall in the previous month.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_3ESm76O8Ce0m2sJNCLjzuJpkSs07HuQ1NHBGV6La2PFnBQmP-5iCgE0h185OA4yRc0j5mTuuKZl-JQulc7rXOMiK1IFlVCkx8rZ4ZzPtkXEVoQDEFmFcZebb5hgauRHbNE_8LvGNPKIf/s1600-h/Latvia+IP+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 224px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379186107561862210" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_3ESm76O8Ce0m2sJNCLjzuJpkSs07HuQ1NHBGV6La2PFnBQmP-5iCgE0h185OA4yRc0j5mTuuKZl-JQulc7rXOMiK1IFlVCkx8rZ4ZzPtkXEVoQDEFmFcZebb5hgauRHbNE_8LvGNPKIf/s400/Latvia+IP+index.png" /></a><br /><br />Latvia's industrial output started falling in February 2008, and has now fallen 22.4% from it peak.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMn0f_W8Sf8pXV4OSlNmfmi-X5quhSAHcLNhDh9A2qEijXIHGTIDon9tg4q4j1HFIooRddJV-OA9FVx_nqz9CyEtWx9Czyjng47taETLeoseyYiw43vTVp-qnvcnhWVi_Ah-6xYgYJ48iJ/s1600-h/Latvia+IP+P2P.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 225px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379186346851398850" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgMn0f_W8Sf8pXV4OSlNmfmi-X5quhSAHcLNhDh9A2qEijXIHGTIDon9tg4q4j1HFIooRddJV-OA9FVx_nqz9CyEtWx9Czyjng47taETLeoseyYiw43vTVp-qnvcnhWVi_Ah-6xYgYJ48iJ/s400/Latvia+IP+P2P.png" /></a><br /><br />Retail sales were down 1% in July over June, and 29.5% over July 2008.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhyTRgl4x1h170AmwUHmtBPMFjR_dIhMaTXCZvCfTiiZqTE79bEXxORhyphenhyphenxWztDX-v3KYgn8od2rvtgrPpNTL-DwCKIHKNIN8Pv8_3eHmqTmVpLupQB_s4IE2lXo8rPz7cVrxWQ8IN5CGasr/s1600-h/latvia+retail+index.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 225px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379186574711323362" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhyTRgl4x1h170AmwUHmtBPMFjR_dIhMaTXCZvCfTiiZqTE79bEXxORhyphenhyphenxWztDX-v3KYgn8od2rvtgrPpNTL-DwCKIHKNIN8Pv8_3eHmqTmVpLupQB_s4IE2lXo8rPz7cVrxWQ8IN5CGasr/s400/latvia+retail+index.png" /></a><br /><br />Retail sales have now been falling since April 2008, and are now 31.18% below their peak.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-u-2FJCVxJmBRO_kcxyN8f8M71gUzqKoJ03FdR4ibIOJnvxz9AUbqyY-v1hUhC9dU5CvVS1jJgSTeaKz5GLC6mTvJFqX5_sx0wPlN6vUPVG2mFY3tvNncfLuJjxMX7nKcDeSw5xD_1y_G/s1600-h/Latvian+retail+sales+P2P.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 223px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379186792991427570" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi-u-2FJCVxJmBRO_kcxyN8f8M71gUzqKoJ03FdR4ibIOJnvxz9AUbqyY-v1hUhC9dU5CvVS1jJgSTeaKz5GLC6mTvJFqX5_sx0wPlN6vUPVG2mFY3tvNncfLuJjxMX7nKcDeSw5xD_1y_G/s400/Latvian+retail+sales+P2P.png" /></a><br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDYOyVgKNeJnoqnvuMKAGRylKnu5TNWvsZmQB-nmlrZZRva07NevRiweq6gKN79EBJbDPil-5aJ8ajh0mxAdpf9tts5e9dgMXZ2IctJOcxoh1Kkf5rb8ofaqeTgoEtjSqPZoG5DnlPcPWv/s1600-h/Latvia+exports.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 258px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379190423134478258" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgDYOyVgKNeJnoqnvuMKAGRylKnu5TNWvsZmQB-nmlrZZRva07NevRiweq6gKN79EBJbDPil-5aJ8ajh0mxAdpf9tts5e9dgMXZ2IctJOcxoh1Kkf5rb8ofaqeTgoEtjSqPZoG5DnlPcPWv/s400/Latvia+exports.png" /></a><br /><br /><strong>The Trade Defict Widens in July As Exports Drop Back</strong><br /><br />Latvia's July trade deficit was 95.2 million Lati up from 67 million Lati in June. This was the first increase since December 2008. Latvian foreign trade turnover came in at 613.3 mln lats in July, down by 3.8% or 24.5 mln lats in current price terms than a month earlier and and down by 41.1% over July last year.<br /><br />In the January – July 2009 period foreign trade turnover was 4517.6 mln lats – down by 36.1% or 2547.5 mln lats over the same period in 2008.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXRHEpwOew6lFll8LOLKJZqSH0fWyaquSjhR5FB3cpxYmbFVbTrO2SahXD9Gs0sBs0tMEMWyheYVRf2nz0J8oOLNrubRdrR4r5VI7qWeAaIlewSZctTUL_4ojYfc8qL77NK48EXQ7A_yw2/s1600-h/Latvia+trade+deficit.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 261px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379418601221165810" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXRHEpwOew6lFll8LOLKJZqSH0fWyaquSjhR5FB3cpxYmbFVbTrO2SahXD9Gs0sBs0tMEMWyheYVRf2nz0J8oOLNrubRdrR4r5VI7qWeAaIlewSZctTUL_4ojYfc8qL77NK48EXQ7A_yw2/s400/Latvia+trade+deficit.png" /></a><br /><br />In July exports were down by 32.6% over July 2008 and imports down 46%. Over January to July exports were down by 27.2% or 705.4 mln lats, while imports were down by 41.2% or 1842.1 mln lats over the same period a year ago.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4kohwe9QF2xF-VYBuPozOZgFlxLjL2NnJQ9hSnpU56fvVZOwkvMa74HCKCMFzB8ghbIOmAlQze5yjWMF6jFAu0UON2Ur_5uWjdvdjcsYRYOJztlJ72FcXRHyQXmKfFOKRG0oYtgKjY0u7/s1600-h/latvia+exports+Y-o-Y.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 260px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379418512274249394" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4kohwe9QF2xF-VYBuPozOZgFlxLjL2NnJQ9hSnpU56fvVZOwkvMa74HCKCMFzB8ghbIOmAlQze5yjWMF6jFAu0UON2Ur_5uWjdvdjcsYRYOJztlJ72FcXRHyQXmKfFOKRG0oYtgKjY0u7/s400/latvia+exports+Y-o-Y.png" /></a><br /><br /><br /></p><p><strong>Unemployment Continues To Rise, And As It Does Bad Loans Pile Up In the Banking Sector</strong><br /><br />Latvia's unemployment rate hit 17.4% in July according to Eurostat data, and again this was the second highest level in the European Union (after Spain). Naturally with unemployment rising to such levels the number of distressed loans continues to rise and bad debt provisions in the banking sector wnet up again - to 6.6 percent of the total credit portfolio in July from 6.1 percent the month before, according to credit supervisor FKTK.<br /><br />The FKTK also said in a statement that bank losses by the end of the first seven months had hit 400 million lats ($817.6 million), up from 346.8 million lats at the end of the first half.<br /><br />Lending was again down, and the total credit portfolio fell by 0.7 percent in July. The level of debts with delayed payments of more than 90 days rose to 13 percent of the credit portfolio from 12 percent at the end of June.<br /><br /><br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaWNTsy9Zi4H_Kr3lWAbr7E7wKkC5m5CbLeZVJ4eX5S_y1_70-GYfYSlKD0dIVPbvrs_ujjnwyO882jpOJTqkf5dd6k4uwmdBG_YlHINupipXrkamsyixiJVVQMIZh_LtZd2mcTr8kJxGk/s1600-h/latvia+unemployment+rate.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 220px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379192063158364818" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaWNTsy9Zi4H_Kr3lWAbr7E7wKkC5m5CbLeZVJ4eX5S_y1_70-GYfYSlKD0dIVPbvrs_ujjnwyO882jpOJTqkf5dd6k4uwmdBG_YlHINupipXrkamsyixiJVVQMIZh_LtZd2mcTr8kJxGk/s400/latvia+unemployment+rate.png" /></a> </p><p><strong>What About The Internal Devaluation, Is It Working?<br /></strong><br />Well, prices have started falling, and the consumer price level was down in August by 1.0% compared to July. The average prices of goods fell by 1.3%, and of services by 0.4%. But if we compared to August 2008 we find that consumer prices (as measured on the Latvian national index) have incredibly still increased by 1.8% (down admitdely from the 2.5% rate of increase in July), which leads me to ask, given the pain that all of this is evidently causing, are prices still falling too little and too late to do any real good.<br /><br /><br /></p><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHUStqo-6RGrvM4FH0ftQgu-RtYjcHDxlKiSBZONd1NWn7woCyxANI_9gmZWRrS0z8uxxsRrsKoyaWBsv4nukhf7H9xFu92-_WhZI9bGnTEhc8zjUKx14KA8Lw0veTl2aPqJ9huln241KJ/s1600-h/HICP+general+and+core.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 225px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379197148136008802" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHUStqo-6RGrvM4FH0ftQgu-RtYjcHDxlKiSBZONd1NWn7woCyxANI_9gmZWRrS0z8uxxsRrsKoyaWBsv4nukhf7H9xFu92-_WhZI9bGnTEhc8zjUKx14KA8Lw0veTl2aPqJ9huln241KJ/s400/HICP+general+and+core.png" /></a><br /><br />The central bank seems to think the process is working, since they point out on their website that the real effective exchange rate of the lat, which is one measure of the price competitiveness of Latvian goods versus those of the country's major trading partners, improved between April and July, marking the first four-month gain since the beginning of 2005. We need to remember howvere that the REER index showed prices developing far faster than trading partners all the way from 2006 through to April 2009 (see comparative chart with Finland below) so there really is a long long way back down to go. And if we look at the chart immmediately below, we will see that while the gap is closing Latvian prices are still in a worse position in August 2009 (as compared to other Eurozone countries) than they were in August 2008 - that is over the last year as a whole the position has even deteriorated.<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhX9eiD9E38-HmcKBJbppvqWx4YfmGPaB6cmmNJuH01AnZd1JexXepr4S_0TTUGm4OF97xfiLGX2-osQrer_8zCWZo8NeckvmSey_f2HTRdWvqyUGqCqVldUnkGZ9ubnpYrVff4pPJwCB4l/s1600-h/HICP+core+EZ16++and+Latvia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 224px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379197342875217906" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhX9eiD9E38-HmcKBJbppvqWx4YfmGPaB6cmmNJuH01AnZd1JexXepr4S_0TTUGm4OF97xfiLGX2-osQrer_8zCWZo8NeckvmSey_f2HTRdWvqyUGqCqVldUnkGZ9ubnpYrVff4pPJwCB4l/s400/HICP+core+EZ16++and+Latvia.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgb1gM2b9tDIMhc_E-lFPjQWw9lxofYseBsC-nL-0-qml7p6O7lbw2F5Slpq1UwKlY8J9KdX4T5QGgyv3QvAnkzCBNbnBluGfBkZz0pEaR4i0sBSwbxrIlIPsA7YEJJVx4yuzKkTaGLHpBk/s1600-h/Latvia+REER.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 225px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379198418930554482" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgb1gM2b9tDIMhc_E-lFPjQWw9lxofYseBsC-nL-0-qml7p6O7lbw2F5Slpq1UwKlY8J9KdX4T5QGgyv3QvAnkzCBNbnBluGfBkZz0pEaR4i0sBSwbxrIlIPsA7YEJJVx4yuzKkTaGLHpBk/s400/Latvia+REER.png" /></a><br />A similar picture can be found in producer (factory gate) prices, which have only recently moved into negative territory on an annual basis. To get a comparison, German producer prices were down 7.8% year on year in July, while<br /><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWnuC0zQWv1SeYvZomhRMXcxE72HaNe8_DqMShiyaK5k9MFAWWPq6KnCosmjGyOM5lcOYnEIOY8C89twCD5yrTA3uKvPSGDGRHH8Q7SoodseDQTEM3pIwiSTKBJjeVDgNvN-dqkcaJrnMV/s1600-h/Latvia+Producer+prices.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379197081173813890" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhWnuC0zQWv1SeYvZomhRMXcxE72HaNe8_DqMShiyaK5k9MFAWWPq6KnCosmjGyOM5lcOYnEIOY8C89twCD5yrTA3uKvPSGDGRHH8Q7SoodseDQTEM3pIwiSTKBJjeVDgNvN-dqkcaJrnMV/s400/Latvia+Producer+prices.png" /></a> </p><p>In fact, while export prices are dropping substantially, import prices are also falling (see chart), and thus the real rate of price correction is still quite small.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpXYJMHOiuwZF6YtWhvfy6svLr0txdXcaieNki9fkvDmJF9XjSjz4F39GoxSFyiT8pKhF9K6HInOLDdlF7YilSSsi65yQw4-ICDyQ8CHLs2E1i0yoyMtrbtatv9yFyGOuq-w09uGjS8MM9/s1600-h/Latvia+relative+export+and+import+prices.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 192px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379196894458611058" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjpXYJMHOiuwZF6YtWhvfy6svLr0txdXcaieNki9fkvDmJF9XjSjz4F39GoxSFyiT8pKhF9K6HInOLDdlF7YilSSsi65yQw4-ICDyQ8CHLs2E1i0yoyMtrbtatv9yFyGOuq-w09uGjS8MM9/s400/Latvia+relative+export+and+import+prices.png" /></a><br /><br />I therefore contend that this weeks statement from Unicredit Group Chief Economist Marco Annunziata to the effect that, “For the region as a whole and for Latvia, we have gone through the worst,” is way too premature. Conditions are not improving, and as Moody's suggested pressures in the banking system are still building up. It is an open empirical question at this point whether we have the worst behind us. Even over a longer term horizon it is hard to see the grounds for optimism, since there are certainly no "green sprouts" to be seen on the new babies front, with year on year three month moving average being stuck around the 8% drop level. This depression is going to cast a long shadow over the future of the Latvian people, let's hope for everyone's sake that all those responsible (the government, the IMF, and the EU Commission) are fully aware of their hsitoric responsibilities here.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3VEkErjnfeB6fpQgvKWpKEv_5yV7tYF3J19buafjOBcuYdGZoepMof0yD8jQD0LtgB0yeI-iD0wbVHUT7TYtyi8VSdHX-7vhrczrkiYmf5nrxY6Dq3M3AR_EDWmctKYNlqfD7oXAxOPr2/s1600-h/latvia+births.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 220px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5379202481731776754" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh3VEkErjnfeB6fpQgvKWpKEv_5yV7tYF3J19buafjOBcuYdGZoepMof0yD8jQD0LtgB0yeI-iD0wbVHUT7TYtyi8VSdHX-7vhrczrkiYmf5nrxY6Dq3M3AR_EDWmctKYNlqfD7oXAxOPr2/s400/latvia+births.png" /></a><br /><br /><br /><strong>Appendix: IMF and EU Conditions from the respective Letters of Intent.</strong><br /><br /><br /><br />According <a href="http://www.zerohedge.com/sites/default/files/Latvia.pdf">to the letter of intent</a> signed by the Latvian Government, The Central Bank and the IMF, a number of new reporting obligations were agreed to. These include:<br /><br />* Consolidated central (basic and special budgets), local and general government operations based on the IMF fiscal template<br />* Detailed information on revenues from EU funds at the general government level, and EU-related spending by the central government, including transfers to local governments for EU-related spending<br />* Consolidated central and general government bank restructuring operations<br />* Privatization receipts received by the general government budget (in lats and foreign exchange, and payments in governments bonds)<br />* Information on debt stocks and flows, domestic and external (concessional and non concessional), by currency, and guarantees issued by the (i) consolidated central, local and general governments and (ii) public enterprises (including the Latvian guarantee agency and<br />the Rural guarantee fund), including amounts and beneficiaries<br />* Information on new contingent liabilities, domestic and external, of the consolidated central, local and general governments<br />* Data on general government arrears, including to suppliers<br />* Data on operations of extrabudgetary funds<br />* Data on the stock of the general government system external arrears<br />* Balance sheet of the BoL, including (at actual exchange rate) (i) data on components of program NIR; (ii) government balances at the BoL, broken into foreign exchange balances—distinguishing various program partner sub-accounts for program financing—and balances in lats.<br />* Balance sheet of the BoL (in program and actual exchange rates) (i) data on components of program NIR; (ii) government balances at the BoL, broken into foreign exchange balances—distinguishing various program partner sub-accounts for program financing—and balances in lats.<br />* Consolidated accounts of the commercial banks<br />* Monetary survey<br />* Currency operations, including government foreign receipts and payments and breakdown of interbank market operations by currencies (interventions)<br />* Aggregated data on free collateral—available, unpledged collateral held at the Bank of Latvia<br />* Daily data with banks’ current accounts, minimum reserve requirements, stock of repos and fx swaps<br />* Foreign exchange rate data<br />* Volume of foreign exchange lats trades<br />* Projections for external payments of the banking sector falling due in the next four quarters, interest and amortization (for medium and long-term loans)<br />* Projections for external payments of the corporate sector falling due in the next four quarters interest and amortization (for medium and long-term loans)<br />* The stock of external debt for both public and private sector</p><br /><br /><br />The Letter of Intent follows the earlier signing of a <a href="http://www.fm.gov.lv/preses_relizes/dok/Supplementary_MoU_13%2007%202009_ENG.pdf">Supplementary Memorandum of Understanding between the Latvian government and the European Union</a>. The terms of this understanding contained the following Monitoring and Reporting protocols.<br /><br /><br /><strong>Monitoring fiscal developments</strong><br /><br />• Monthly revenue and expenditure break-down of social budget, including data on social<br />benefits' hand-outs (unemployment, family, etc).<br />• Monthly state basic budget expenditure breakdown per type of expenditure for each<br />ministry or other relevant budget entity.<br />• Monthly revenue and expenditure break-down of local governments, including data on<br />GMI hand-outs and other benefits included in category "other social support".<br />• Monthly information on debt stocks and flows and guarantees given on new debt,<br />contracted by the (i) consolidated central, local and general governments and (ii) public<br />enterprises.<br />• Monthly data on new contingent liabilities of the consolidated central, local and general<br />governments.<br />• Monthly data on state budget loans and PPP projects.<br />• Monthly information on central government (i.e., ministries and agencies) and state<br />owned companies' staff and remuneration levels, institution-by-institution, showing last<br />months'/years' trends.<br />• Monthly data on general government arrears, including to suppliers.<br />• Bi-weekly Treasury cash-flow assessment of central government financing needs.<br /><br /><br /><strong>Monitoring financial developments</strong><br /><br />• Monthly statements of the operations on the special account.<br />• Monthly report on the amount of mortgage loans converted from EUR to LVL.<br />• Monthly report on outstanding loans split by currency and detailed to households<br />(housing, consumer, other) and non-financial corporations (by sector).<br />• Notify DG ECFIN whenever there is a consultation process with DG COMP related to<br />financial sector stabilization (i.e., Parex).<br />• Monthly report on banking sector stabilization measures.<br /><br /><strong>Monitoring structural reforms</strong><br /><br />• Monthly data on budget allocations to and appropriations of line ministries for financing<br />of EU Structural funds and Cohesion fund projects (including which programming<br />period they are related to).<br />• Monthly data on the amounts disbursed to final beneficiaries for project<br />implementation, by ministry and by EU Structural funds and Cohesion fund projects<br />(including which programming period they are related to).<br />• Monthly data on the amounts spent by state budget financed entities as final<br />beneficiaries on EU Structural funds and Cohesion fund project implementation, by<br />ministry and by EU fund (including which programming period they are related to).<br />• Monthly financial reports on reaching the Structural Funds and Cohesion Fund<br />expenditure targets by the Managing Authority.<br />• Quarterly qualitative assessment reports on reaching the Structural Funds and Cohesion<br />Fund expenditure targets by the Managing Authority.<br />• Quarterly assessment of policy options taken by the government regarding poverty,<br />health and pensions.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-1443720106009957151.post-53892418443693130332009-08-14T11:02:00.001+02:002009-08-18T15:06:44.175+02:00From Original Sin To The Eternal Triangle - Lessons From Central EuropeThe non-biblical concept of original sin, as <a href="http://fistfulofeuros.net/afoe/economics-and-demography/escaping-original-sin-in-hungary/">Claus Vistesen notes in this post</a>, when propounded in its standard Obstfeld & Krugman textbook version refers to the situation where many developing economies who are not able to borrow in their own currencies feel forced to denominate large parts of their sovereign and private sector debt in non-domestic currencies in order to attract capital from foreign investors - as evidenced most recently in the countries of Central and Eastern Europe. Well, piling insult upon injury, I'd like to take Claus's point a little further, and do so by drawing on another well tried and tested weapon from the Krugman armoury, the idea of the "eternal triangle".<br /><br />As is evident, the reality which lies behind the current crisis in the EU10 is complex, and has its origin in a variety of causes. But one key factor has undoubtedly been the decisions the various countries took when thinking about their monetary policy and currency regimes. The case of the legendary euro "peggers" - the three Baltic countries and Bulgaria - has been receiving plenty of media attention on late, and two of the remaining six (Slovenia and Slovakia) are now members of the Eurozone, but what of the other four, Romania, Hungary, Poland and The Czech Republic? What can be learnt from the experience of these countries in the present crisis.<br /><br />Well, one convenient way of thinking about what just happened could be to use Nobel Economist Paul Krugman’s Eternal Triangle” model (<a href="http://web.mit.edu/krugman/www/triangle.html">see his summary here</a>), which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.<br /><br />In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.<br /><br />The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.<br /><br />A second problem which stems from this "initial decision" has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency decision, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it can no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.<br /><br />The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition to do so (which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion). The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.<br /><br />So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions - to such a degree that in both cases the IMF has had to be called in. At the same time both of them are still having to "grin and bear" higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability less dramatic, and both inflation and domestic interest rates are much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.<br /><br /><br /><strong>Appendix</strong><br /><br />Here for comparative purposes are charts illustrating the varying degrees of economic contraction, inflation, and interest rates. GDP contraction rates actually present a little problem at the moment, since one of the relevant countries - Poland - still has to report. However Michal Boni, chief adviser to the Prime Minister, told the newspaper Dziennik this week that the economy expanded at an annual rate of between 0.5% and 1% in Q1. So lets take the lower bound as good, it is still an expansion.<br /><br /><p><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjHpq-QbnEGoGyIEFhg5BDyI3KbB-YThIg6h1merK0rkAV65VglcWvhiBqZ9VuK6TnK61r-mx8xzg658Z09ZFppM1B37r8FZY4UrrYSDo3Goa2_G_Fesb8Whu3JpjMNyYZ_-uJUGhfh_3u3/s1600-h/gdp.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369520243749636306" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjHpq-QbnEGoGyIEFhg5BDyI3KbB-YThIg6h1merK0rkAV65VglcWvhiBqZ9VuK6TnK61r-mx8xzg658Z09ZFppM1B37r8FZY4UrrYSDo3Goa2_G_Fesb8Whu3JpjMNyYZ_-uJUGhfh_3u3/s400/gdp.png" /></a><br /><br />The economy in the Czech Republic contracted by an estimated 4.9% year on year in the second quarter.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSa65op1Vb4sgUuOC5UNgrEYUvkzOmf91E0zZqQry-Qbw-kDzYqHY-DNN95JxRfGICfdcT3sJ50-Zi7O0ixhOtJyRe_yH3bTf6PJ72qqiYjDPdi9jqVm9GP9vMDiqfwmgCkH0DNI17xUFe/s1600-h/gdp.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 232px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369516514917178322" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgSa65op1Vb4sgUuOC5UNgrEYUvkzOmf91E0zZqQry-Qbw-kDzYqHY-DNN95JxRfGICfdcT3sJ50-Zi7O0ixhOtJyRe_yH3bTf6PJ72qqiYjDPdi9jqVm9GP9vMDiqfwmgCkH0DNI17xUFe/s400/gdp.png" /></a> The Hungarian economy contracted by an estimated 7.4% year on year in Q2.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkapvbF7Y-VrCUNw5FPaxhNP01kjn-RavxP8eFl4nq6FjIaV1D3f_5T-Z-H2NoDkAVOM2QoHZ1m19NeujDLfNIM0XnZK01qK1KDxrqPdtlaYCTzihsOTFTou1H0sldtvuq2jSurUT75PWm/s1600-h/gdp+2.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 235px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369510800079158962" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgkapvbF7Y-VrCUNw5FPaxhNP01kjn-RavxP8eFl4nq6FjIaV1D3f_5T-Z-H2NoDkAVOM2QoHZ1m19NeujDLfNIM0XnZK01qK1KDxrqPdtlaYCTzihsOTFTou1H0sldtvuq2jSurUT75PWm/s400/gdp+2.png" /></a><br /><br />While the Romanian economy contracted by an estimated 8.8% year on year.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTB48aOMzcSVZ1a2ojlChgFP7WBQywKi983OTreW4HKuh09lAljq6BBm4HOjr55TYhVAftX9oxk3AWe51YHS1B-F3Jr8lGz3ExvQdcDlWzAHjAHAA02yVyX0zYrP-SNpPZbWpXQSNeZd3J/s1600-h/romania+GDP.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369513200130394306" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTB48aOMzcSVZ1a2ojlChgFP7WBQywKi983OTreW4HKuh09lAljq6BBm4HOjr55TYhVAftX9oxk3AWe51YHS1B-F3Jr8lGz3ExvQdcDlWzAHjAHAA02yVyX0zYrP-SNpPZbWpXQSNeZd3J/s400/romania+GDP.png" /></a><br /><strong>Inflation Rates</strong><br /></p><p>Poland's CPI rose by an annual 4.2% in July.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmMpuKy1uAQdBw_Fin2SOFF1WDbGD74Kve2HB8WeSnqeLhCnoqc6k1Cts-CXQY04ZEH2ibMcYr-7ms1s_tMTbuMWLQOxfirCN-M0s4FX9hyphenhyphenSOSQSBWfc-X85pKbIzP7E0ah8y1GugX796M/s1600-h/CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 186px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369520178830452706" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjmMpuKy1uAQdBw_Fin2SOFF1WDbGD74Kve2HB8WeSnqeLhCnoqc6k1Cts-CXQY04ZEH2ibMcYr-7ms1s_tMTbuMWLQOxfirCN-M0s4FX9hyphenhyphenSOSQSBWfc-X85pKbIzP7E0ah8y1GugX796M/s400/CPI.png" /></a><br />The CPI in the Czech Republic rose by an annual 0.3% in July.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYsyJZdvsGRuNuC_kN-6XxGsA9CsZTeR9xEai9j6axk5kwxMFUur-LaaHpuTmCEKkoczJfRnz1QmSbjLrGbwz6jkLtIvEdZ6uFkMnfbJRHzdKDOGkHs0cUra_5qt5TeolMTC8ITuuuUUId/s1600-h/CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 217px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369516440042775362" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYsyJZdvsGRuNuC_kN-6XxGsA9CsZTeR9xEai9j6axk5kwxMFUur-LaaHpuTmCEKkoczJfRnz1QmSbjLrGbwz6jkLtIvEdZ6uFkMnfbJRHzdKDOGkHs0cUra_5qt5TeolMTC8ITuuuUUId/s400/CPI.png" /></a><br /><br />Romania's CPI rose by an annual 5.1% in July.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEir0Fu_mwyrQKE5_2ZcS2WTq5DXMlLFJqfbCXa5f7mbSkfcShUCTY5D30pKxs7flWnRbd1vngymptydA0Br0_A4DXsIpy8AdLiYuWr6332zJgGkgpRsEY6evDaarCHz7S9_Kwara3taSxgC/s1600-h/CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 230px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369513059447983618" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEir0Fu_mwyrQKE5_2ZcS2WTq5DXMlLFJqfbCXa5f7mbSkfcShUCTY5D30pKxs7flWnRbd1vngymptydA0Br0_A4DXsIpy8AdLiYuWr6332zJgGkgpRsEY6evDaarCHz7S9_Kwara3taSxgC/s400/CPI.png" /></a><br />Polands CPI rose by an annual 5.1% in July.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwK8rxbmrV9P407jC9C3fKLSqBAcRBtMbz8NJpd0ANpcZYG05EbCQT035_GwwY459IyKvDDfGYReEIO-MajEz_M0eB4NWW4LpESqTlHWIcsGyS9ACx59VLqDuRmmPdqtVtfmou5eVoxGfB/s1600-h/hungary+CPI.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 229px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369510635155610482" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgwK8rxbmrV9P407jC9C3fKLSqBAcRBtMbz8NJpd0ANpcZYG05EbCQT035_GwwY459IyKvDDfGYReEIO-MajEz_M0eB4NWW4LpESqTlHWIcsGyS9ACx59VLqDuRmmPdqtVtfmou5eVoxGfB/s400/hungary+CPI.png" /></a><br /><strong>Interest Rates</strong><br /><br />The benchmark central bank interest rate in Poland is currently 3.5%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj55ILEAqgLfTYfmQSLzB6CB-MpjW6j50T4ze3b8WQiZcZu_eyMoMZgGnY6ehWh6FqvWMlzsz2sCA29Km4LQO-JDNXZor1poKdjNVayvRN78Xgmdo6brafT51qAVPcyJNwIfOLJt6bO4brW/s1600-h/interest+rates.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 244px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369520115353289810" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj55ILEAqgLfTYfmQSLzB6CB-MpjW6j50T4ze3b8WQiZcZu_eyMoMZgGnY6ehWh6FqvWMlzsz2sCA29Km4LQO-JDNXZor1poKdjNVayvRN78Xgmdo6brafT51qAVPcyJNwIfOLJt6bO4brW/s400/interest+rates.png" /></a> The benchmark central bank interest rate in the Czech Republic is currently 1.25%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcr8neCJRmS52jtx5TxH0FNft5BJjQP8F20bKoTqRFeoAFIQZI4cAccfSva-NwETR4Hz4VA9l8WWb5hSwImpOYmkOPsdM6arV6oxdjRZuWU0Pv2QxKEer9esVM_RYYnFdfMb0Zqp0Cap3r/s1600-h/interest+rates.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 227px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369516359161761794" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcr8neCJRmS52jtx5TxH0FNft5BJjQP8F20bKoTqRFeoAFIQZI4cAccfSva-NwETR4Hz4VA9l8WWb5hSwImpOYmkOPsdM6arV6oxdjRZuWU0Pv2QxKEer9esVM_RYYnFdfMb0Zqp0Cap3r/s400/interest+rates.png" /></a><br />The benchmark central bank interest rate in Romania is currently 8.5%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgakE5elZxZ7p7OybAaKDryFroH-tXRN5Wo-VOGQ9NbiuaR64Gwe9UjXiOVFQaWpziw1ywYItz51jBuXcY66FuH0jYOvWfyz_BIXpSPoWu2mQcWgQrMXLwFol1aR4XPBLb3PHZVvUlQlsU/s1600-h/Hungary+interest+rates.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 400px; height: 243px;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgakE5elZxZ7p7OybAaKDryFroH-tXRN5Wo-VOGQ9NbiuaR64Gwe9UjXiOVFQaWpziw1ywYItz51jBuXcY66FuH0jYOvWfyz_BIXpSPoWu2mQcWgQrMXLwFol1aR4XPBLb3PHZVvUlQlsU/s400/Hungary+interest+rates.png" border="0" alt=""id="BLOGGER_PHOTO_ID_5371287640518185298" /></a><br /><br />The benchmark central bank interest rate in Hungary is currently 8.5%.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgW07BDZOtlABX8sTKIAS-37EwRt9nLhYfThhuNZndqaUzF3Jn9TnpsjDZ6Of_45TFGr-pk8WURlhnXq0jNi2oaGVVfTwJFt9TMKAS02lJcrm09uHyIc7J7VWHeX1RasxwQbUMGAyodpGy_/s1600-h/Hungary+interest+rates.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 245px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5369510538558067954" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgW07BDZOtlABX8sTKIAS-37EwRt9nLhYfThhuNZndqaUzF3Jn9TnpsjDZ6Of_45TFGr-pk8WURlhnXq0jNi2oaGVVfTwJFt9TMKAS02lJcrm09uHyIc7J7VWHeX1RasxwQbUMGAyodpGy_/s400/Hungary+interest+rates.png" /></a> </p>Unknownnoreply@blogger.com1tag:blogger.com,1999:blog-1443720106009957151.post-23093681169479068832009-08-09T10:29:00.001+02:002009-08-09T10:35:46.193+02:00"Advances in Development Reverse Fertility Declines" - Science or Hocus Pocus?According to a once-upon-a-time post on the Economist's <a href="http://www.economist.com/blogs/certainideasofeurope/2007/07/a_fistful_of_reply.cfm#list-comments">Certain Ideas of Europe Blog</a> Edward Hugh “was very cross” about some of the journalism they were serving up over at that prestigious journal. Well, not to worry, since this time he is hopping mad. And the issue which lies behind his wrath is essentially the same one, how to interpret and understand the demographic processes which are currently so evidently affecting our societies. In what is simply the latest episode in a long and sorry saga (if you want documentation, please see the comments Claus Vistesen and I nailed to their "Wall" in the above linked post) this week's print issue contains <a href="http://www.economist.com/sciencetechnology/displaystory.cfm?story_id=14164483">a research review from their science and technology correspondent</a> who is evidently not backward in coming forward with headline grabbing claims. According to the said corresponedent the demographic transition (a process which has been ongoing for over two hundred years now) has finally and definitively gone into reverse gear:<br /><blockquote>"One of the paradoxes of human biology is that the rich world has fewer children than the poor world. In most species, improved circumstances are expected to increase reproductive effort, not reduce it, yet as economic development gets going, country after country has experienced what is known as the demographic transition: fertility (defined as the number of children borne by a woman over her lifetime) drops from around eight to near one and a half. That number is so small that even with the reduced child mortality which usually accompanies development it cannot possibly sustain the population.<br /><br />If Mikko Myrskyla of the University of Pennsylvania and his colleagues are correct, though, things might not be quite as bad as that. A study they have just published in Nature suggests that as development continues, the demographic transition goes into reverse."</blockquote><br /><br />Well quite a strong claim is being made here. The idea that a group of researchers have come up with a finding that shows the "rule....that people have fewer children as their countries get richer...no longer holds true" is certainly not one to be sniffed at. Such a strong claim needs some very heavy backing you would think, given all the research that has gone into the topic in recent years.<br /><br />In fact, the research makes no such direct claim, since Myrskylä et al simply find statistically significant evidence for a reversal in the relationship between the human development index (HDI)<br />and the total fertility rate (Tfr) at HDI levels around 0.85–0.9. The rest is only interpretation. As we will see, to move from a simple statististical correlation to formulating a hypothesis you need an explanatory framework, and you need to be able to make falsifiable predictions. The Nature letter from Myrskylä et al is far from being at this stage of development. They have simply found an interesting correlation, and the rest is in the eye of the observer.<br /><br /><blockquote>"Back in 1975, a graph plotting fertility rate against the Human Development Index fell as the Human Development Index rose. By 2005, though, the line had a kink in it. Above an HDI of 0.9 or so, it turned up, producing what is known in the jargon as a “J-shaped” curve (even though it is the mirror image of a letter J). As the chart shows, in many countries with really high levels of development (around 0.95) fertility rates are now approaching two children per woman. There are exceptions, notably Canada and Japan, but the trend is clear."</blockquote><br /><br />However, according to the Economist the trend is clear. But is it? Edward has been doing some digging.<br /><br />In fact the problem goes beyond the Economist, since the source behind the article is a letter published in Nature. Below <a href="http://www.nature.com/nature/journal/v460/n7256/full/nature08230.html">you can read that letter</a>.<br /><br /><blockquote>"During the twentieth century, the global population has gone through unprecedented increases in economic and social development that coincided with substantial declines in human fertility and population growth rates. The negative association of fertility with economic and social development has therefore become one of the most solidly established and generally accepted empirical regularities in the social sciences. As a result of this close connection between development and fertility decline, more than half of the global population now lives in regions with below-replacement fertility (less than 2.1 children per woman. In many highly developed countries, the trend towards low fertility has also been deemed irreversible. Rapid population ageing, and in some cases the prospect of significant population decline, have therefore become a central socioeconomic concern and policy challenge10. Here we show, using new cross-sectional and longitudinal analyses of the total fertility rate and the human development index (HDI), a fundamental change in the well-established negative relationship between fertility and development as the global population entered the twenty-first century. Although development continues to promote fertility decline at low and medium HDI levels, our analyses show that at advanced HDI levels, further development can reverse the declining trend in fertility. The previously negative development–fertility relationship has become J-shaped, with the HDI being positively associated with fertility among highly developed countries. This reversal of fertility decline as a result of continued economic and social development has the potential to slow the rates of population ageing, thereby ameliorating the social and economic problems that have been associated with the emergence and persistence of very low fertility."</blockquote><br /><br /><br />Here is the chart (reproduce from Nature data) which the Economist presents to illustrate the 'J curve' relationship.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPkWv6NplX20P52dtVOwUUUEkHQXVgdcOS5TDaUj66dzzLkPdY2_XP-NgZBzezZXKykSIc3CPVVTpjKD7RL_8x1oUzSpscs2lvNYsjpvsoQVn4HeRJbADQyOkSnFCMKa_xNZ5e0qGNNZBn/s1600-h/Nature+Chart.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 252px; DISPLAY: block; HEIGHT: 277px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367548469545674898" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhPkWv6NplX20P52dtVOwUUUEkHQXVgdcOS5TDaUj66dzzLkPdY2_XP-NgZBzezZXKykSIc3CPVVTpjKD7RL_8x1oUzSpscs2lvNYsjpvsoQVn4HeRJbADQyOkSnFCMKa_xNZ5e0qGNNZBn/s400/Nature+Chart.png" /></a><br /><br />Nice, isn't it? Nature even go to the lengths of a putting up a special "event" podcast featuring an interview with Hans Peter Kohler (<a href="http://www.nature.com/nature/podcast/">click here for link</a>) as if to underline the importance of the "finding") But does any of this have any compelling validity?<br /><br />Methinks not as much as the authors of the letter, or those who are covering it in the media, are trying to make out. There are many issues which are raised here, but I would just like to mention three.<br /><br />The first is the decision of the research team to work with a period based fertility measure which is known to be very unreliable for "tempo" reasons (the Total Fertility Rate- Tfr) as the basis for a longitudinal study. And let us remember, the authors only really claim to have found a correlation between HDI levels in the 0.85–0.9 range and movements in the Tfr, and there could be many explanations for this. Indeed the authors themselves even offer one of them in their supplementary information - "countries at development levels near the critical level HDI = 0.86 might have a more rapid postponement of childbearing than more advanced countries.. " - a possibility which, in fairness to the authors, they try to test for.<br /><br />And you don't have to rely on me for the suggestion that the Tfr is hardly the most desireable measure for what they want to do, since the authors themselves point this very fact out in the supplementary information (and the only thing which surprises me is that nobody else who has reviewed the research seems to have twigged the implications of this). So the very title of the Letter is totally misleading, they have not found that "Advances in Development Reverse Fertility Declines" -since in the first place the direction of causality is not adequately determined (it might be that reverses in fertility decline advance development, as I try to show in a piece referenced below) and in any event the research only shows movements in the HDI correlate with movements in the Tfr (and not with "fertility").<br /><br /><blockquote>The recent literature on low fertility in developed countries has pointed to the important role of delayed childbearing, that is, the ongoing postponement of childbearing to increasingly later ages. In the context of this paper, delayed childbearing is potentially important because the postponement of childbearing can distort the total fertility rate as a measure of the quantum (or long-term level) of fertility. “Tempo effects”, or the reductions in the total fertility rate resulting from a postponement of childbearing, have been shown to partially explain the very low fertility rates observed in some European countries.</blockquote><br /><br />So this is the first issue. Due to the phenomenon of birth postponement, the Tfr is a hopelessly unreliable indicator, and what is often called "the birth recovery" is in fact a statistical issue produced by the fact that the Tfr first sinks to very low levels (the birth dearth) and then recovers as women reach the new (higher) childbearing age. Since all of this is simply so obvious, I am absolutely astounded that two such well known and highly respected demographers - Hans-Peter Kohler and Francesco Billari - have placed their name on a piece of research that could almost be described as a publicity stunt. I am even more astounded by the way Nature appear to have been hoodwinked.<br /><br />Basically, I don't think that there can be any doubt that if they used a more comprehensive measure of fertility - say completed cohort fertility - they wouldn't get the correlation they claim to have found, since CFRs never fell so low, and have not bounced back in the same way. This is essentially because this indicator removes the temporal component found in the TFR (older first birth ages among women in developed societies) and only focuses on quantity. True, they did carry out a robustness test using an adjusted Tfr, but the results are much weaker, and the sample far from satisfactory (at least for the claims being made), and the authors well know this (see below).<br /><br />In their longitudinal study the authors look at Tfrs for a number of countries over the period 1975 to 2005 and compare these to the lowest Tfr reading observed while a country's HDI was within the 0.85–0.9 window. For all countries considered, the HDI in 2005 was found to be higher than the HDI in the reference year. For 18 of the 26 countries that attained a HDI 0.9 by 2005, the Tfr in 2005 was found to be higher than the TFR in the reference year. As I say, this is hardly surprising, given the tempo impact on Tfrs. The "2005 18" are Norway, the Netherlands, the United States, Denmark, Germany, Spain, Belgium, Luxembourg, Finland, Israel, Italy, Sweden, France, Iceland, the United Kingdom, New Zealand, Greece and Ireland.<br /><br />Perhaps it is more surprising (and interesting) to learn that they found six countries where the HDI was over 0.9 but where the Tfrs didn't pick up: Japan, Austria, Australia, Switzerland, Canada and South Korea. Clearly the absence of "rebound" in even the Tfrs is something of a cause for preoccupation in these countries, and examining the background to what is happening in these countries could at the end of the day turn this research into something quite interesting. That is to say, if for their level of development we might have expected the tempo effect to be more or less over, why do some countries continue to have very low fertility levels?<br /><br />Basically, to shoot a hole straight through their hypothesis (falsify it that is, surely in science things should be falsifiable), I would say it is only necessary to find a significant number of countries in the first group where fertility as measured by a better indicator didn't rise. Unfortunately we don't have a really good time series for such an indicator, but Eurostat have published statistical estimates for Completed Cohort Fertility Rates (Cfrs) for EU countries up to the 1989 cohort. That is, estimates of what fertility is likely to be for women who were 30 in 2009. Looking at this data, the following countries would appear to offer no evidence whatever for a rebound in cohort fertility in what we know to dat: Norway, Netherlands, Denmark, Germany, Italy, Finland, Sweden, France, Iceland, the UK, Greece and Ireland. That is to say, as far as I am concerned, the whole hypothesis falls till at least subsequent data confirm it.<br /><br />I haven't been able to check foir the US (but the Cfr is probably up) Israel (also) or New Zealand. Belgium has little available data. So the only two European countries which you could say with some degree of security actually could confirm the hypothesis would be Luxembourg and Spain - but if you just look at the increases in Spain - from 1.34 to 1.35 - and think about the fact that 5 million new migrants arrived (mainly in childbearing ages) between 2000 and 2009, then the result is hardly dramatic, and if you look what just happened to the economy, it is more than likely that GDP per capita is plummeting, and and household income (which has a weighting of more than one third in the HDI) with it. Which brings me to the second question, the reference year. But before I move on to that, as I say above, the authors are perfectly well aware of the issue with using Tfrs.<br /><blockquote>In particular, one could speculate that tempo effects might be—at least partially—responsible for the observed change in the development–fertility association. For example, countries at development levels near the critical level HDIcrit = 0.86 might have a more rapid postponement of childbearing than more advanced countries. If this were the case, tempo effects would reduce the TFR more strongly at intermediate than at advanced HDI levels, and the positive association between HDI and TFR in Figures 1–2 could be partially explained by differences in the pace of fertility postponement, rather than by variation in levels among advanced countries.</blockquote><br /><br />The authors therefore carry out a robustness test which effectively amounts to a cross-sectional study (cross-sectional note, not longitudinal) of the relationship between the total fertility rate with and without adjustment for tempo effects, and the human development index in 1975 and 2005. Tempo adjusted TFRs are not available over the period in question so they simply took data for 2005 (for those countries for which it is available from the ’European Demographic Data Sheet 2008’ (published by the Vienna Institute of Demography, Vienna, Austria) and from McDonald P, Kippen R. The Intrinsic Total Fertility Rate: A New Approach to the Measurement of Fertility (Population Association of America Annual Meeting 2007, New York, 2007). What they can then show is that the HDI–TFR relationship at persists at advanced development stages persists even after adjusting the total fertility rate for tempo effects. But, as I say, this is cross sectional, not longitudional. What does this jargon mean? It means there is no clear causal relationship, since equally it could be better HDIs which is driving better fertility, and hence you can use the HDI to explain differences between countries if you wish, but not the evolution of fertility in individual countries. The 2005 result is show as a black line in the chart below, where you can see that as HDI goes up, Tfr also seems to be higher.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh35EuJj9xYZrTzsTYgTMkA6GRfLm1FapgQy3-DOFJftFm2JNJbfpc1tb-kr6PxZ8BFDubvofi-h2debvnD7HdEaVN4wN_5mp1lMRju2t4Uw9cvVU2oIiAzFjrhx3K2eex9IrrEkz85lIET/s1600-h/cross+section.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 371px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367570595746256130" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh35EuJj9xYZrTzsTYgTMkA6GRfLm1FapgQy3-DOFJftFm2JNJbfpc1tb-kr6PxZ8BFDubvofi-h2debvnD7HdEaVN4wN_5mp1lMRju2t4Uw9cvVU2oIiAzFjrhx3K2eex9IrrEkz85lIET/s400/cross+section.png" /></a><br /><br />Which is very much to the point, and brings me to my second issue, since in my blog post "Taking Solow Seriously - Does Neoclassical Steady State Growth Really Exist?" (<a href="http://edwardhughtoo.blogspot.com/2009/06/taking-solow-seriously-does.html">which you can find here</a>) - I demonstrate using a few simple charts that the evolution in GDP per capita (which accounts remember for one third of the HDI) may well be a function of underlying population dynamics, since three countries with stronger population growth and higher fertility (the US, the UK and France) evidently perform much better than three will low-to-negative population growth and very low fertility (Italy, Japan and Germany).<br /><br />Also, it should be remembered, as I mention, we need to think about base years. 2005 was the mid point of a massive and unsustainable asset and construction boom. I think there is little doubt that if we took 2010 or 2011, the results would be rather different.<br /><br />Finally, the piece in the Economist article that I personallyfind most interesting is the following:<br /><br />"Dr Myrskyla’s data, however, suggest the ultimate outcome of development may not be a collapsing population at all but, rather, the environmentalist’s nirvana of uncoerced zero population growth."<br /><br />I want to stress, I certainly think this stationary population idea is certainly one possibility in the more highly developed nations - but if we move to stationary populations, with higher and higher proportions of the population in the older age groups the result is - as we know - a rising median population age. It is the economic impact of the abrupt rise in median age that I personally am focused on, and how just this rise, and the resulting fall in living standards for many young people, might feedback in a negative way on fertility and thus produce ever more rising median ages. In recent days, some have been asking why people like myself are so focused on what is going on in Latvia, which is after all, a pretty small country. Well, I think here in the issues raised by the Nature letter we have just one more reason why that country is important, since in a sense it is conducting a "live" experiment.<br /><br />Finally, I want to say, none of the above should be read as suggesting that there isn't a great deal of interest and material to talk about in the study the authors have carried out. Nor would I hold them entirely responsible for the way in which others have used and abused their work. I just the reserach doesn't demonstrate what they want it to demonstrate, and that the study doesn't deserve the kind of high media profile it has been receiving, since it is going to mislead the general public more than it will enlighten them, given the important methodological issue which are still to be clarified.<br /><br />The heart of the problem is twofold. The excessive reliance on a rather problematic indicator (the Tfr) and the causality issue when it comes to GDP per capita and higher fertility (which way does the arrow point?). In fairness the authors do attempt to construct their own combined time series based on a mixture of tempo-adjusted Tfrs and Tfrs, a procedure which seems at the very least to be somewhat problematic if you want to reverse fifty years of academic consensus. And they do get the same sort of result, but the outcome is much weaker and is based on a much smaller sample of only 25 countries. But even this result is at the very least odd, since, as I argue above, cohort fertility hasn't really increased in most of thecountries concerned. So I think we really all need to see more details of how the authors actually constructed the time series to be able to form a better judgement.<br /><br />But all this being said, and whatever the original intentions of the authors, serious scientific debate does seem to have been turned here into something of a media circus. Wasn't it blogs that were supposed to do that?<br /><br /><strong>Appendix</strong><br /><br />Below I offer a series of charts showing estimated completed cohort fertility rates based on data compiled by Eurostat using the distribution of births by parity (first and second or higher order births) and mean age of mothers at respective parities to carry out the calculations. Evidently, the most recent data for hard data on completed cohort fertility comes for the 1960 - 1965 cohort. These charts should not be treated as hard data, but a rule-of-thumb type quick visual inspection suggests that it is hard to accept the case for a substantial fertility rebound in many European countries.<br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjsNckdP1pnfI7vt-EVhKClO9LU5azlVMKHv1KPaHavkruZfMcU-0Abm8VIsOQQl0u58QsI7VNcMEqUhyphenhyphenviEp34oPXGrY1VTeIKJlt4E-hz1nwImVjomNrTyyQ4zOEStkA4DLzHFjRcvHXL/s1600-h/Switzerland+and+Slovenia.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 203px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367674186431232946" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjsNckdP1pnfI7vt-EVhKClO9LU5azlVMKHv1KPaHavkruZfMcU-0Abm8VIsOQQl0u58QsI7VNcMEqUhyphenhyphenviEp34oPXGrY1VTeIKJlt4E-hz1nwImVjomNrTyyQ4zOEStkA4DLzHFjRcvHXL/s400/Switzerland+and+Slovenia.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg8DC5-L_RbWazWX_lFaW0ZGvhBphl9IhDZcXc2B-eDEkFGP8bak7iyLeTlPMjVxwdygfY5B1ChAalFu0dazvX60h5ZgtXdO4fX-C4pLOjipZTyNJn-cIyeAqBYrhMuV71DolPTbLGB5y-l/s1600-h/norway+and+denmark.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 203px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367674098388633858" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg8DC5-L_RbWazWX_lFaW0ZGvhBphl9IhDZcXc2B-eDEkFGP8bak7iyLeTlPMjVxwdygfY5B1ChAalFu0dazvX60h5ZgtXdO4fX-C4pLOjipZTyNJn-cIyeAqBYrhMuV71DolPTbLGB5y-l/s400/norway+and+denmark.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLHlFvxtmAp18r6Mi2gNARS90P3xLyJoIqFAGgpJc9LSnQYAhIli1Q2c4Kry5kQeTmRFQJbND7KFwV3wqDJcLGr_4oPCIf74bHSEYK7ggquNNPaL42j6KDoTXtG8usiYaOEXpXKf_QmXyY/s1600-h/netherlands+and+Italy.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 201px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367674038682289090" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiLHlFvxtmAp18r6Mi2gNARS90P3xLyJoIqFAGgpJc9LSnQYAhIli1Q2c4Kry5kQeTmRFQJbND7KFwV3wqDJcLGr_4oPCIf74bHSEYK7ggquNNPaL42j6KDoTXtG8usiYaOEXpXKf_QmXyY/s400/netherlands+and+Italy.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjL9LFGYdMyTbIysL_Iv6IhMwodJSWoWwoXVJq3yS-d5tJh3_rUF_5xrfe-_NHgDlpSHG5Hms4Ecr_8TtIbSPatXAL0tHWhEm4LWdxfWUvNc4pb-dzWLUWc_qNySW8jB9lcSxwt6BPKfVY9/s1600-h/luxembourg+and+spain.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 203px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367673971570134402" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjL9LFGYdMyTbIysL_Iv6IhMwodJSWoWwoXVJq3yS-d5tJh3_rUF_5xrfe-_NHgDlpSHG5Hms4Ecr_8TtIbSPatXAL0tHWhEm4LWdxfWUvNc4pb-dzWLUWc_qNySW8jB9lcSxwt6BPKfVY9/s400/luxembourg+and+spain.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbtBJGrnaZGksKW6d8JS5QTDeTFcUxOuFQZDozFj0sRRW8EJWWVaDqRSuXWPcWVgHZX_kMT76QFEGDX2aHIr4swyurcguuPybhB7ZcUZ_gHaC-gKzX1d_NimIg4ZVQyKMZqQVi0EWMM0gl/s1600-h/ireland+and+Greece.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 204px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367673903059991538" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjbtBJGrnaZGksKW6d8JS5QTDeTFcUxOuFQZDozFj0sRRW8EJWWVaDqRSuXWPcWVgHZX_kMT76QFEGDX2aHIr4swyurcguuPybhB7ZcUZ_gHaC-gKzX1d_NimIg4ZVQyKMZqQVi0EWMM0gl/s400/ireland+and+Greece.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAM1ptG7Zwsjayyv0XuSnVaAdWD3QDjvniWsBXedDYR2Ie5I4nwGwHAi9QUZsFm-Zq41aUL3wjYmqcFh4lghNZwqLp1AzE80laT1nG_gSKc-Kql8ej5Xx0T1IdA5HrFPQq8zoBeWXN3FmQ/s1600-h/Iceland+and+Sweden.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 201px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367673834237046354" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjAM1ptG7Zwsjayyv0XuSnVaAdWD3QDjvniWsBXedDYR2Ie5I4nwGwHAi9QUZsFm-Zq41aUL3wjYmqcFh4lghNZwqLp1AzE80laT1nG_gSKc-Kql8ej5Xx0T1IdA5HrFPQq8zoBeWXN3FmQ/s400/Iceland+and+Sweden.png" /></a><br /><br /><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM0NeKbwCAv47pPhDPIQPScLzc56V2ZaQScwFwp-itgKNuFsAhZosLfSrOJAZ2lwWxCyZsfZDzB_YdDeN3mZgxn0gBFl2WqxOi0I2hdrpNAA7aR9XjNacSe19FS98vDM9ZWozsnSdYxt3a/s1600-h/finland+and+germany.png"><img style="TEXT-ALIGN: center; MARGIN: 0px auto 10px; WIDTH: 400px; DISPLAY: block; HEIGHT: 202px; CURSOR: hand" id="BLOGGER_PHOTO_ID_5367673761512320754" border="0" alt="" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiM0NeKbwCAv47pPhDPIQPScLzc56V2ZaQScwFwp-itgKNuFsAhZosLfSrOJAZ2lwWxCyZsfZDzB_YdDeN3mZgxn0gBFl2WqxOi0I2hdrpNAA7aR9XjNacSe19FS98vDM9ZWozsnSdYxt3a/s400/finland+and+germany.png" /></a>Unknownnoreply@blogger.com0