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Latvia `Hard Landing' May Cause Baltic, Balkan Economic Tremors

By Aaron Eglitis and Milda Seputyte

Nov. 12 (Bloomberg) -- Two years ago, investors hoped Latvia's economic performance would be replicated across post- communist eastern Europe. Now they're praying it won't.

The fastest-growing economy in the European Union is most at risk of a ``hard landing'' among 15 emerging-market nations, according to Standard & Poor's. Analysts at Goldman Sachs Group Inc. predict ``the adjustment is likely to be painful and to start soon.''

Latvia's expansion, fueled by consumer spending, cheap loans and surging wages, was once seen as the key to matching western living standards. Now, the pitfalls are more obvious than the benefits. Inflation has soared, property prices are falling and the current-account deficit has widened. Economists say Latvia's woes signal similar risks in neighboring Estonia and Lithuania and as far south as the Balkans.

``Latvia will have a significant slowdown, possibly a recession,'' said Istvan Zsoldos, an economist at Goldman in London. The adjustment may ``pressure investors to reduce exposure to the Baltic states as well as Romania and Bulgaria.''

The impact threatens to extend beyond the Baltic region at a time when global markets are reeling from a credit collapse.

``Any turbulence in the Baltic countries would likely have a contagion effect on other emerging-market economies that rely on debt financing,'' according to Goldman analysts.

Leading the Pack

Latvia's economy grew 11.1 percent last quarter, more than four times the pace of the euro region, pushing inflation to 13.2 percent and spurring an import surge that's swollen the current- account deficit to the widest in the EU. The current account is the broadest measure of trade because it includes transfer payments and investment income.

Zigurds Vaikulis, an economist at Parex Asset Management in Riga, predicted inflation may quicken to 15 percent in January.

Estonia and Lithuania, the other former Soviet republics on the Baltic coast, are following a similar pattern. Estonia's economy grew 7.6 percent in the second quarter, with inflation at 8.5 percent in October. Lithuania's third-quarter gross domestic product rose 10.8 percent and October inflation was 7.6 percent.

The Lithuanian Finance Ministry on Nov. 9 raised its inflation forecast for 2007 and 2008 to 6.5 percent.

``There is no place for optimism, only concern,'' said Violeta Klyviene, an economist at Orion Securities in Vilnius. ``The ongoing trends threaten to further spur inflation and to widen the current-account deficit.''

Goldman's analysts project Latvian GDP growth would have to fall to ``at least a negative 7-8 percent for a year'' in an extreme case to bring the current-account deficit to a sustainable level, ``before recovering to the trend growth of around 7 percent.''

Riga Real Estate

In the capital Riga, where property prices more than doubled last year, the values of Soviet-era apartments have tumbled 12 percent in the past five months, real-estate company Latio says.

The central bank said on Sept. 20 it would support the lats by selling euros after the currency fell to the lower end of its trading limit.

Standard & Poor's, Fitch Ratings and Moody's Investors' Service have said Baltic economies are at risk of overheating.

Stockholm-based Swedbank reported on Oct. 24 that third- quarter profit slipped 2 percent on losses from bad loans and expansion costs in the Baltics. An Oct. 11 downgrade by Deutsche Bank AG cited an ``anticipated sharp drop'' in Baltic economic and credit growth. Swedbank stock is down 37 percent since February.

Bulgaria Also Vulnerable

Lithuania, Estonia and Bulgaria are the most vulnerable because they use a currency board, which prevents central banks from using interest rates to control inflation and growth, said Lubomir Christoff, head of Bulgaria's Central Depository, on Oct. 12.

``Measures taken by politicians are, in our view, not sufficient, and even if politicians had the will, there are few tools at hand,'' Deutsche Bank analyst Jan Wolter says.

Wages, which have soared as much as 77 percent since the Baltic nations joined the EU in 2004, sparked a surge in credit while demand for imported electronics, cars and furniture pushed current-account deficits to records.

Romania and Slovenia, the only eastern nations to use the euro, are also at risk, officials and economists have said.

The International Monetary Fund's Albert Jaeger said on Oct. 2 that Romania's economy, which expanded 5.6 percent in the second quarter, is showing signs of overheating. The same day, Slovenian central bank Governor Marko Kranjec warned of a similar situation.

``The risk of a hard landing in the economy and financial distress is very significant and no investor should ignore these risks,'' said Lars Christensen, a senior economist in Copenhagen at Danske Bank A/S, in an e-mailed note.

To contact the reporter on this story: Aaron Eglitis in Riga at [email protected]

Last Updated: November 11, 2007 19:24 EST