Friday, September 26, 2008

Baltic Economies Start Adjustment Process

As I noticed in the previous post, the Swedish banks which dominate banking in the Baltic economies have started to tighten lending standards, which will slow down credit expansion and therefore also monetary expansion. The monetary statistics from the Bank of Latvia confirm that this have already happened. In the year to July 2007, M2 rose by more than 30%. By contrast, M2 growth in the year to July 2008 was less than 6%. The story is similar in Estonia, where M2 growth fell from 23% in the year to August 2007 to 8% in the year to August 2008.In Lithuania, the deceleration in M2 growth was a lot less dramatic, from 22% in the year to August 2007 to 14% in the year to August 2008.

Note that in both Latvia and Estonia, real money supply growth have turned negative. With the heightened anxiety about the Baltic economies and the tougher lending standards this apply, monetary growth will probably decelerate even more dramatically later.

This is actually good news as the previous levels of money supply growth were clearly unsustainable and unsound. Largely as a result of this, consumer price inflation has started to fall from the peaks reached earlier in the year, particularly in Latvia. Between May and August 2008, when as a comparison euro area price inflation rose from 3.7% to 3.8%, it fell from 17.7% to 15.6% in Latvia, from 11.4% to 11.1% in Estonia and from 12.3% to 12.2% in Lithuania.

These levels are still of course far too high, but at least in Latvia and Estonia, they reflect mostly previous monetary inflation, and if you had looked at seasonally adjusted monthly numbers, it would have likely showed significantly lower numbers, particularly in Latvia.

Also as a result of this, the previously very high current account deficits are starting to fall back in Latvia and Estonia. In Latvia, the current account deficit fell from 24.9% of GDP in Q2 2007 to 15.6% in Q2 2008. In Estonia, the current account deficit in Q1 2008 (latest available) fell to EEK 7.9 billion from 13.0 billion in Q1 2007.

Lithuania by contrast is a different story, as its deficit rose from LTL 4.3 billion in Q2 2007 to LTL 4.8 billion in Q2 2008. That Lithuania had a different trend from Latvia and Estonia clearly reflect that they had a much more modest deceleration in monetary inflation (that is also the reason why their deceleration in price inflation were more modest).

That Lithuania has had a more modest deceleration in monetary inflation is also reflected by GDP growth numbers. In Lithuania, quarterly growth numbers are in fact still positive, although much lower than before. The yearly growth rate is a still good 5.5%, compared to 0.2% in Latvia and -1.4%.

But while this means that Lithuania is now experiencing less pain than Latvia and Estonia, this also means that Lithuania hasn't started the kind of adjustment process to more sustainable inflation rates and external deficits that Latvia and Estonia has started. As the current situation is unsustainable in the long run, this means that Latvia and Estonia will get over with the painful but inevitable adjustment process much quicker than Lithuania.


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