Tuesday, July 24, 2007

Latvia, Estonia, real estate...

Latvia is what Estonia was 2 years ago. I heard that from an Estonian friend who travels to Latvia for work frequently and has had many opportunities to compare the two countries.

Some Estonian politicians try to deny it. When United Nations released its Human Development Index for 1999, Estonia was classified as a "highly developed country" for the first time but Latvia was still in the "medium development" category. That produced some gloating from Estonian politicians (including Toomas Hendrik Ilves?). They proclaimed that this is a sign of fundamental differences between Estonia on one side and Latvia and Lithuania on the other side.

Two years later, in 2001 UN report, Estonia, Latvia and Lithuania were all in "high development" category. And, since then, Latvia's ranking has been the same as Estonia's, with two year delay. (Both countries have been moving up from the bottom of "high development" category towards its middle.)

"Latvia is what Estonia was 2 years ago" is something that one can observe both in statiscal data and rankings and in everyday life. And, now I'm discovering that this pattern also shows up in real estate.

When Soviet Union fall apart, both Estonia and Latvia were quite poor. New construction nearly stopped in both countries. People simply could not afford a new apartment, because of low incomes and lack of bank credit. In Riga, there was not even enough money to finish the construction that was started during the Soviet period and some apartment buildings were standing half-built for 5-7 years.

Meanwhile, the incomes started growing and credit became available. Aparment prices surged up and, in 2002, new construction started picking up again in Estonia (chart on page 14 of this report). Two years later, in 2004, Latvia followed. Since then, the number of new apartments has been growing rapidly in both countries.

Now, I am wondering if "Latvia repeats Estonia" applies to downturns as well. As detailed on Estonian housing bubble blog (in Russian), the housing prices started falling in Estonia at the beginning of this year. The new construction had satured the market of apartments, for people who can afford to buy a place at the present prices. The prices for some Soviet-era apartments have declined by 10% or so. Speculative investors who had earlier signed contracts for not-yet-built apartments now prefer breaking the contract and losing their deposits instead of completing the purchase and getting an apartment which they can't sell. And Estonian banks are making plans for the case if the prices decline by 20% or more.

Since May, the housing prices have been falling in Latvia as well, but by smaller amounts (about 4% so far). A real estate dealer interviewed by Diena newspaper says: "Compared to Estonia, we don't have a panic in Latvia. Sellers rarely allow serious price reductions."

Well, there is that usual delay between events in Estonia and Latvia. Which might be much less than 2 years this time. Developing...


Edward Hugh said...

Hi Again,

I'm reading the inflation news today. It isn't good, but that isn't surprising. This article was interesting.

Apart from the BICEPS paper we have already come across, they mention this paper by Carsten Valgren. I think that it is interesting and very relevant. It draws attention to the difficulties that the Latvian monetary authorities will have in correcting for the structural imbalances. Really the National Bank of Hungary are experiencing similar difficulties since they cannot reduce rates agressively enough to counter the rapid decline in domestic demand due to the impact this would have on the Forint, and hence on those with Swiss franc mortgages. Here is some of the "blurb" from Valgren:

The choice major countries have made in the classical trilemma: ie, Free movements of capital and floating exchange rates – has left room for independent monetary policy. But will it continue to be so? This is not as obvious as it may seem. Legally central banks have monopolies on the issuance of money in a territory. However, as international capital flows are freed, as assets are becoming easier to use as collateral for creating new money and as money is inherently intangible, monetary transactions with important implications for the real economy in a territory can increasingly take place beyond the control of the central bank. This implies that central banks are losing control over monetary conditions in a broad sense. Historically, this has of course always been happening from time to time. In monetarily unstable economies, hyperinflation has lead to capital flight and the development of hard currency” economies based on foreign fiat money or gold. The new thing – this paper will argue – is that we are increasingly starting to see the loss of monetary control in economies with stable non-inflationary monetary policies. This is especially the case in small open advanced – or semi-advanced – economies. And it is happening in fixed exchange rate regimes and floating regimes alike.

Latvian abroad said...

I agree. And, if it's a time lag of 15 months between wage increases and inflation, it can get even worse. 15 months ago, the wage growth was still 20%/year and now it's 35%/year.

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