Monday, March 10, 2008

Latvia is in recession

Today, Latvian Statistics office revised its estimate for economic growth in Q4 2007 downward to 8%. It sounds still good but only until you look at it in the right way....

The right way is to break down the growth by quarters of 2007, as Edward Hugh did in this post. Doing that with the revised estimate gives:
  • Q1 2007 (compared to Q4 2006): +2.4%
  • Q2 2007 (compared to Q1 2007): +2.7%
  • Q3 2007 (compared to Q2 2007): +2.8%
  • Q4 2007 (compared to Q3 2007): 0.0%.
Our prime minister is still predicting 6% growth (down from his earlier 7.6%) for 2008 but I think it's a major overestimate.

Latvia is in an extremely sharp economic slowdown. It's not yet felt here in everyday life, but, soon, it will be.

In another bad news story, Latvian Statistics estimates that inflation is at 16.7%/year now. Most of last month's inflation is, however, taxes on tobacco and higher heating costs. So, the local inflationary spiral may be just simply bad, not horribly bad.

22 comments:

stefan said...

Well, if you look at it that way, Estonia has been in recession in Q3 every year for some 10 years. Comparisons yoy is the only reasonable way of looking at it. Seasonal adjustments are also difficult to do.

Latvian abroad said...

stefan,

I meant seasonally-adjusted quarter-on-quarter 0.0% in my post.
Year-on-year is the best but, at rapid turning-points (which is, what I suspect, we have) it's slower to notice the change.

I wish 0.0% was a statistical fluctuation but it fits with the other economic statistics (like retail sales) too well...

Edward Hugh said...

Hi Stefan,

I take your point, but Latvia's GDP doesn't seem to fluctuate strongly between quarters in the way Estonia's does. I have just put an extended post on Latvia Economy Watch going through the constant price data for the last few quarters with a toothcomb. I actually came up with a 0.23% contraction q-o-q. Obviously there could be seasonal and working day adjustments to work in here, but I have looked through the numbers from 2000, and I can't find a single case of contraction between Q3 and Q4 over this period except in 2007.

Seasonal corrections given the very strong movement up and down in GDP over short periods of time in the last few years raise their own statistical issues about establishing trend.

So I am with LA here, and I have my linesman's red flag firmly raised.

Incidentally LA, methodologically looking at q o q data to guesstimate is legitimate I think, as long as we remember that growth is a cumulative process, so you can't just add and subtract, and you have to make an educated guess. You have come up with 0% and I have come up with minus 0.23, well within some sort of reasonable margin of error I think.

The economy is grinding to a halt. I think any attempt to offer a whole year 2008 number at this point is completely premature. Obviously 6% is ridiculous. The thing is crashing, and it isn't on an elastic band, so it isn't going to snap back in the same way. Getting any sort of positive growth this year will be an achievement, and OMG that latest inflation number.

stefan said...

Hi latvian abroad and edward hugh

To be clear, I completely agree on your conclusions. We are at a turning point where I expect a massive liquidity squeeze in Latvia, pulling both GDP growth and inflation down.

Latio/Arco real estate surveys indicate a 25% drop of Riga standard apartments during a year.

A leading manager of Skonto Buve talks about a standstill.

Retail sales drop yoy in January.

Car sales have turned negative.

Industrial production negative early 2008.

Finally, I like to look at the LVL in circulation numbers:

LVL in circulation, yoy growth:
Jan +22,7%
Feb +19,6%
Mar +19,1%
Apr +18,5%
May +15,9%
Jun +13,8%
Jul +11,2%
Aug +10,0%
Sep +4,7%
Oct - 0,1%
Nov -2,3%
Dec -2,3%
Jan - 8,5%

With a 15,8% inflation in January, the real value of LVL in circulation was down 21% yoy in January.

Foreign loan financing is drying up, and CPI inflation should come down - lead by rents and other capital returns affected by over investment.

Edward Hugh said...

Hi again Stefan,

Thanks for the clarification and the data. Out of interest I just unpdated my original post and put a chart for quarterly Latvian GDP at constant prices since 2000 on Latvia Economy Watch. There is very little in the way of seasonal variance, and what there is seems to come in Q1 (the weather I presume).

"Foreign loan financing is drying up, and CPI inflation should come down - lead by rents and other capital returns affected by over investment."

Yep. The big danger now is that this inflation inverts - which given the sort of money supply figures you are quoting it virtually has to - and we then get a bout of very sharp deflation.

The pace of the deceleration in Latvia is staggering. What only adds to the tragedy is that most of the professional observers simply look on and try to convince themselves that what is in fact happening, actually isn't.

My big worry if we hit deflation is that we will see another exodus of young people looking for work elsewhere.

stefan said...

Latvia has become a pure "Hot Money Economy". Swedish banks, Russian capital (and Icelandic capital) has pumped it up.

Since the hot money tide has turned, it is difficult to see how Latvia will cope in the near term. Ok, maybe the Russian part of the "financing" is resilient, but the Nordic is not, I would guess. With real estate 25% down, many credits should already be strained.

But as mentioned, the big problem is not a financing drain, but a brain drain.

sam said...

So, you guys, how long will the euro/lat peg hold? 6 months? 9? A year? C'mon, cough it up....

sam said...
This comment has been removed by the author.
stefan said...

sam
The peg would break only if a commercial bank goes broke, and the central bank decides to bail it out with fresh money. The second part of this should be quite unlikely.

On a macro level, we will see the liquidity squeeze take care of the inflation problem, I think.

Latvian abroad said...

sam,

I agree with Stefan. And the Latvian banks are still making big profits. Undoutably, their balances will deteriorate but it should take a while to go from their present state to bankcrupcy.

SO, I think the peg is safe for this year, at the very least. Unless something totally unforeseen happens. (I don't have any candidate for "something totally unforeseen" but, given the speed of recent events, I feel I have to add that caveat.)

hk said...

if real estate is down by 25% as mentioned above, how can the banks make money? I presume their mortgage loans will start to default at some point? and who will finance C/A deficit

stefan said...

hk
Collateral values are clearly already critically low for many bank loans. But in reality these loans are financed by the cash-flows of people whose wages rose 30% last year. Therefore, you will not see any foreclosures in Latvia, as long as you do not see unemployment, I guess.

The current account will be forced down by the upcoming liquidity squeeze, I think. Take away the construction boom and luxury imports, and imports should come down quite substantially.

But long term, of course Latvia is being filled up with capital, and this is reflected as a deficit i the current account and a surplus in the capital accounts. Just as for any emerging economy. Let us not forget the tax haven character of Latvia, as well as its convenient position for attracting Russian capital.

Latvian abroad said...

Also, the price increase in real estate was very quick (60%/year increase for 2 years before the peak). So, 25% decline means reverting to prices half-year before the peak (October 2006 or so). The mortgages taken out before that still have collateral.

So, it's **slightly** less dramatic than it sounds. There are is, however, a substantial number of people who are already in trouble (with interest rates higher than they expected and salary rises less than what they expected).

hk said...

I agree it's highly likely bank's needs would be put infront of those of regular people. Here's an update on the banks involved
http://www.ft.com/cms/s/0/41d0c82c-e98b-11dc-8365-0000779fd2ac.html?nclick_check=1

LA I have a candidate for 'something totally unforseen", whenever Euro gets too strong there's always a 'crises' to slow the appreciation. Concerns usually center around instability of the union and potential break up of the single currency. This time Eastern Europe might be sacrificed

Edward Hugh said...

Hi Sam,

"So, you guys, how long will the euro/lat peg hold? 6 months? 9? A year? C'mon, cough it up...."

Well for my part there is nothing to cough up, since I simply don't know. Rather than bank profits I'd be following export performance, and as LA notes this is holding up at the moment.

Since we can now expect little or now push from domestic demand in the coming years Latvia is going to become an exports driven economy. But with a fixed currency and rampant inflation it looks difficult - or even impossible - to maintain price competitiveness. This is going to be the key, but there are so many things we don't know yet.

Will - for example - the present inflation invert into outright pricer deflation at some point? The speed of the contraction makes me think it may well do, but wew have to get through to that point to really see.

Also, and this isn't just an incidental detail, my guess is that most of Latvia's real export competitors are now having serious issues with inflation themselves. Not as serious as Latvia, but important, and growing.

Even somewhere as distant as China just hit 8.7% (and rising) CPI, and those who have been following my demographic argument will note that they have been having a one child per family policy for 30 odd years now, so their whole population structure is a mess.

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James said...

I wish 0.0% was a statistical fluctuation but it fits with the other economic statistics (like retail sales) too well...

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