On financial storms, part 2

Click here for Part 1 of this post.

Just like East Asia in 1997, Latvia has very high current account deficit and a lot of credits in foreign currency (euro in Latvia now, dollars in East Asia in 1997). This lead to a devastating financial crisis in several Asian countries 1997. In this post, I will describe two reasons why (I think that) such crisis is unlikely in Latvia.

First, Bank of Latvia is well-prepared to defend to present exchange rate of 1euro=0.7 lats. In 1997 Thailand, the crisis started by exchange rate of Thai baht plunging from 25 baht/dollar to 56 baht/dollar. This put extreme pressure on people and businesses which had borrowed in dollars. Many of them went bankrupt because their baht incomes were worth much less dollars but the amounts of dollar loans were still the same.

As of July 2007, Bank of Latvia has the foreign currency reserves worth 5.1 bln US dollars. This is comparable with the amount of lats in circulation and Bank of Latvia should be able to maintain the present exchange rate even if people rush to exchange lats for euros.

Speculative attacks on currencies use borrowed money. If speculators want to crash the exchange rate of Thai baht, they borrow money in bahts and exchange it for dollars, until there is no party willing to exchange dollars for bahts. Then, the exchange rate falls. Eventually, some of borrowed money is exchanged back at a lower exchange rate to repay the loans. The rest is speculators' profit.

The problem with doing that in Latvia is borrowing a sufficiently large amount of lats. In more developed financial markets, one can easily borrow large amounts for speculative transactions. Latvia, however, has very little in terms of financial markets. The banking system is oriented towards everyday transactions and borrowing the lat equivalent of 5.1 bln US dollars for speculative purposes is between very hard and impossible.

The second distinction between Latvia now and East Asia in 1997 is the nature of foreign currency inflows. If foreign money is withdrawn from a country in a panic, that can trigger a financial crisis. Some investments are harder to withdraw than others. As Martin Wolf said, "factories do not walk" (if an investor has purchased a factory, it is difficult to sell it in a panic and leave the country with money). Foreign investment into Latvia has been more in shopping centres than in factories. However, shopping centres are about as unlikely to walk as factories.

For the last years, most of foreign currency inflows have been through Latvian banks borrowing money from abroad. This is more worrisome but a fair amount of this borrowing has been from Scandinavian banks that own the respective Latvian banks. As a result, Scandinavian banks are interested in stable long-term future for the Latvian banks and are less likely to withdraw their loans suddenly.

The third distinction is that financial markets have been less stormy in recent years and have tolerated much larger imbalances then before. This can, however, change anytime. But, based on first two distinctions, I'm optimistic about Latvia.

That being said, the Latvian boom of last few years will probably subside. To use an analogy from Asia, Hong Kong avoided a financial crash in 1997. Yet, a colleague from there tells me that there was a marked difference between pre-1997 Hong Kong (optimistic, flush in money for any reasonable project) and post-1997 (people squabbling over much smaller amounts of funding). There were people who had been abroad for a while, went back around 1997 and were quite disappointed with life there post-1997. And it's worse in the industries which boomed in 1997. For example, the salaries for Hong Kong construction workers now are half of what they were in 1997.

On financial storms

There had been some comparisons between Latvia's economy now and that of East Asian countries (e.g. Thailand) before 1997 Asian financial crisis. In both cases, the country experienced very fast economic growth and had a big current account deficit (10% of GDP in 1996 Thailand, over 20% in Latvia now). As we now know, Thailand's boom ended with collapse of its currency, baht and a severe economic crisis in the following years. Similar things happened in several other Asian countries, shortly after Thailand.

What does this mean for Latvia? Discussions with Edward Hugh lead me to exploring what economists think about the causes of 1997 crisis in Thailand. In particular, it lead me to this paper by Paul Krugman, written a few years after 1997.

Interestingly, I can relate Krugman's theory to what has happened in Latvia over the last 10 years. Krugman develops a mathematical model of country's economy which leads to a conclusion that it can be in two stable states:

• high-trust state in which investment takes place and banks lend money freely;
  
• low-trust state in which domestic businesses are nearly bankcrupt and banks are unwilling to lend them money.

The low-trust state sounds very much like Latvia of mid-1990s in which credit was mostly unavailable. The high-trust state is Latvia of today. In 1997, a sequence of unfortunate events lead Thailand's financial system to collapse from the high-trust state into the low-trust state. The consequences were felt for a long time: in 2005, the average income in Thailand was less than in 1997.

The positive message from Krugman's paper is that crises of this form are not inevitable. They don't automatically happen once the current account deficit exceeds some magic number. Rather, current account deficit (and also large debt in foreign-currency, another similarity between Thailand'97 and Latvia'2007) are signs that the economy is vulnerable and might be less able to withstand a sequence of unfortunate events ("financial storm") pushing it into a downward spiral.

I've tried to think if such a financial storm could occur in Latvia now. I think no. There are some substantial differences between Thailand and Latvia. I will write on those in another post tomorrow but the most important one is that Bank of Latvia has the reserves to maintain the current exchange rate between the Latvian lat and EUR. (Thailand's crisis started with Baht plunging from 25 baht/dollar to 56 baht/dollar.)

Found on the web

One day in Latvia. On August 31, 50 professional photographers and many more volunteers will take photos all around Latvia, to create a snapshot of everyday life in Latvia.

The first such event took place 20 years ago, on August 31, 1987. 30,000 pictures were taken. Here is a selection of those. Back then, nobody had any idea what surgeon Valdis Zatlers will be doing 20 years later...

Latvian housing market: the current state

An increasing number of people are coming to this blog via google, searching for "Latvian housing crisis" or something like that.

I would not call it a crisis (not yet, though it could become one in the future) but here is the current situation. After rising more than 60% in year until April 2007, the Latvian housing prices have dropped 8% since then. The number of "For rent" ads has been steadily increasing, as sellers choose to wait and rent out the apartments instead.

Diena newspaper has two blogs: one by a journalist who is trying to sell his apartment and another by a person who is trying to rent a place. Both of them are having difficulties. If we believe the blog comments, the rental apartments get rented out quickly, often for a price roughly equal to a mortgage payment when buying a similar place at the current prices. So, there are people who could make the mortgage payments... but they chose to wait with buying or (most likely) don't qualify for mortgage under the new stricter bank requirements.

Banks have been a big part of both rise and fall in the housing prices. Since April, the amount of money issued in new mortgages has declined. By now, managers of all 4 biggest Nordic owned banks have admitted that they are deliberately cutting back on new loans, because of the concerns about severe overheating in the Latvian economy. Hansabanka (owned by Swedbank) who is by far the biggest lender in Latvia has cut back the most.

There are claims that the smaller locally owned banks are expanding their lending and giving loans to people who are turned down by big banks. I have no data on that but the press releases from Latvian association of banks show decline in total lending by all banks combined. So, even if smaller banks are increasing their lending, the increase is not big enough to compensate for cutbanks by Hansabanka etc. And if this happens to be a mirror image of what happened before the prices peaked. It was the local banks who had the stricter standards then, while Hansabanka&Co were increasing their market share with easier loans.

I've been wondering for a while if cheaper credits from abroad would somehow find their way into Latvian credit market, defeating the cutbacks by Hansabanka&Co. This has not happened on a large scale yet and, given the overall situation in world financial markets, is becoming less and less likely.

Chocolate bear

Since I've had so many heavy real estate/economy posts recently... here is something less serious:

This is a 36kg chocolate bear, produced by Laima, the main Latvian chocolate producer.

The story behind it started last April when a brown bear swam on a piece of ice from Latvia to the Estonian island of Ruhnu, 37km away from Latvia. The bear was on the island for 4 months and it managed to avoid multiple attempts to catch it, until disappearing (swimming back to Latvia?) in August.

One year later, Laima produced the chocolate bear and gave it as a gift to the people living on the Ruhnu island. They have not eaten it yet... instead, they arranged for an artist to produce a plaster copy of the chocolate bear, for a permanent display on the island. When the plaster copy is ready in mid-September, they will finally eat the chocolate bear.

Away for the next week

Blogging to restart on August 20 or 21.

Latvians in Ireland and UK: the numbers, part 2

One week ago, I wrote about the statistics how many Latvians have left for Ireland and UK. This is the continuation, on how these numbers have changed between 2004 and now. The first graph shows the number of Latvians who have moved Ireland for first time, according to Irish authorities:
To make the comparison between the years fair, I have divided the number of people who arrived in each year by the number of months for which we have data. (For 2004, that would be 8 months after Latvia joined EU in May 2004. For 2005 and 2006, 12 months. For 2007, 6 months because we don't have data for the rest of the year yet.)

The immigration from Latvia to Ireland is clearly decreasing. Slowly in 2006 and then more quickly in 2007. The numbers from UK show a similar trend.

The second graph compares the trends in various countries. To keep it simple, I compared two years, 2005 and 2007. Here are the immigration rates (the number of people arriving in Ireland, divided by the population):
The red lines show the rates for 2005, the blue for 2007. For all three Baltic states, the numbers have significantly decreased. It appears that the present economic boom is making people substantially less interested in leaving their country.

Accidentially, the Latvian business magazine LD had the cover story "Latvians start returning from Ireland" last week. (The link is to the picture of the magazine, the story itself is only in the print edition.)

More on US visas

As I wrote before, USA passed a new law that may result in visa-free travel for Latvians to United States by 2009. Maybe. Or not. Depending on some fine print and other things.

Latvia and five other Eastern European countries are not happy about that and have officially declared their disappointment. The news story about that has an interesting quote from a (Polish) employee of the US embassy in Poland. He/she recommends people to schedule their visa interviews for Friday. Consular officials are in a better mood on Fridays, because of upcoming holidays and deny visas to less people. (Here is the original Polish source for the quote.)

US claims that visas are being denied because the embassy officials are unsure whether people will return to Poland afterwards. Well, in Latvia, I have witnessed a number of denials to people who did not have any intention of staying in US illegally.

Added to the blogroll

Window on Eurasia, by Paul Goble, one of best Eastern Europe experts in United States.

I grew up reading translations of Goble's opinion columns in Diena newspaper. I was really glad to discover that he now has a weblog and posts almost daily!

Some posts I particularly recommend:
- Russia’s Second Post-Soviet Generation Very Different from First - the first generation is people who came of age in 1990s, the second in 2000s and the values of the two generations differ quite a bit. After reading this, I wonder if the same trends can be seen in Latvia as well.
- Ethnic Russian regions nurture seccessionist ambitions and Regional Identity Trumps Ethnicity, RF Patriotism in Siberia- about the possibility that some parts of Russia may secede in the future.
- How the Chuvash ‘Discovered’ America – And Other Notions from New Russian Textbooks - some very strange ideas have made their way into Russian schools.

Direct flights between Latvia and North America?

LETA agency reports that Air Baltic, Latvia's national airline, is shopping around for Boeing 757 airplanes. Meanwhile, Riga airport is extending its runway so that they could receive intercontinental flights.

I've flown from North America to Latvia and back a lot in last 10 years. Typically, it involves flying from Riga to some major North European airport (London, Franfurt, Copenhagen), then, from there to North America. And there might be another change of planes in North America, if the final destination airport does not have direct connections to North Europe. Some of those trips have been quite exhausting for me.

A direct flight from Riga to, say, New York would make things much easier. There was one in early 1990s, thanks to Latvian American businessman Georgs Mikelsons, the founder and CEO of American Trans Air. When Latvia became independent, American Trans Air started a New York-Riga flight (with a stopover in Belfast, Northern Ireland). The flight did not quite fit together with the rest of ATA's flight network, though, and was discontinued a few years later.

Another flight was started in 2005, by Uzbekistan Airways, which chose Riga as a stopover point for their Tashkent-New York flights. I do get a bit nervous about their safety standards, though. (I don't know anything specifically about Uzbekistan Airways but a number of airlines from Russia and CIS have problems in that aspect.) In contrast, I feel perfectly safe flying Air Baltic.

The growth of Riga airport in last years has been extremely impressive. The number of passengers has more than tripled in 4 years and there has been a lot of new flights to new destinations. And direct flights between Latvia and North America no longer look impossible.

UPDATE (31/08): In comments, a reader says:

Hello, my wife flew Uzbek Airlines from New York to Riga and back last year. It was a great experience from start to finish. Due to us having two young boys, it's so much easier to fly non-stop than to have layovers. I've never heard anything about Uzbek Airlines having quality problems.

I'm glad to hear that. If I need to travel from Riga to New York, I might try Uzbek Airlines.

UPDATE 2: I am told that Latvians from Latvia are a bit cautious about the Uzbek Airlines flight (in the same way that I was when I wrote this post), while Latvian Americans fly it in large numbers. And their experiences with flying Uzbek Airlines are good.

Latvians in Ireland and UK: the numbers

Two weeks ago, I wrote about Latvians (and other Eastern Europeans) who have left Latvia to work in Ireland and UK. Here is what the numbers are. Both Ireland and UK maintain detailed statistics on the number of Eastern Europeans who have arrived there. In Ireland, the new residents have to obtain PPS numbers (Irish counterpart of Latvian personas kods or US Social Security Number) and the government tracks the number of those. Here are the data:

In UK, the Eastern Europeans who work there have to register through Worker Registration Scheme (WRS). Here are their numbers:
It's not quite 1.5 or 2 million of Poles in UK that some newspapers have reported. I mentioned that number in my previous post, but, when I look at it again, it turns out that 1.5-2 millions include Poles who have visited UK as tourists. The actual number of Polish workers in UK is 393,000 but that is still quite big.

And both in Ireland and UK, Poles outnumber the other Eastern Europeans. That is not surprising since Poland has much more people than any of the other countries. Here is what the numbers look as a percentage of population for the respective countries:
It's actually Lithuanians who have been the quickest to leave their country. 3.3% of Lithuania's population has ended up working in UK or Ireland. (Since UK only registers those foreigners who work there, the percentage of working-age Lithuanians who have left is probably 5-6%.) Latvia is second, with 2.5% of population gone. Slovakia is third and Poland is fourth. That surprised me a bit, because there are so many newspaper stories about Poles in UK and hardly any about Slovaks. Estonia is fifth. The emigration rates from Hungary, Czech Republic and Slovenia are much smaller.

Curiously, UK data say that more than half of arriving Eastern Europeans intend to work there for 3 months or less. So, some of people counted in those graphs may have actually gone back. I wonder if that actually happens or whether people are lying on their worker applications for some strange reason.

I will have another post with numbers from UK and Ireland in a few days, including a new trend that has not been noticed by the media yet...

Added to the blogroll

Lituanica. I've finally found an English language weblog about Lithuania!

Estonian Russians defending Estonia - in an unlikely place.

The political rhetoric between the Baltic States and Russia has been quite heated for more than a decade. And a significant part of Russian media has been depicting Estonia and Latvia as "fascist states" which oppress helpless ethnic Russian minorities. The rhetoric has gotten even more heated in the wake of Bronze Soldier incident of May 2007 in Estonia.

Now, ethnic Russians who live in Estonia are trying to tell the Russia that the stereotypes about Estonia are wrong... in a Nashi camp!

Six Nashi activists from Estonia went to the well-publisized camp of Nashi, the pro-Putin Russian youth organization (called "Putin's storm troopers" by its critics), had the Estonian flag flying over their tent and attempted to explain what Estonia is actually like. One of them said:

It's nonsense to view Estonia as a fascist state. We have come here to do something against "Estoniaphobia" that is spreading in Russia and among "Nashi" members.

It's not the first time when I read about Estonian Russians trying to tell Russian audiences that the things that Russian media say about the Baltic states are very, very far from the truth...

July real estate numbers

According to Latio real estate company, apartment prices in Riga declined by another 3.8% in July. Combined with declines in previous two months, this means the prices are 8% below the peak level in April.

On the other hand, the prices are still 4% above December 2006 level and 29% above July 2006. So, housing in Latvia remains quite expensive, compared to local incomes.

Another real estate company, Balsts, reports smaller declines of 1% compared to June and 5% compared to April. I'm still browsing the apartment ads in the case I return to Latvia soon and my impression is that Latio's estimates are the more accurate ones.

Latvians to be able to travel to US without visa... maybe, someday

On Friday, US Congress passed a security law that, among other things, expands the Visa Waiver program, which allows people from certain countries to visit United States without having to go to US embassy and obtain a US visa before their visit. Currently, there are 27 countries in the program (most of Western Europe and a few other countries, such as Australia, New Zealand, Japan).

Originally, Bush administration intended the expansion as a reward to Eastern European countries which supported US war in Iraq in 2003. Negotiations between Bush administration and US Congress took a while, with US Congress trying to set limits on how the program can be expanded and Bush administration trying to write the rules so that they would be the party which decides.

The new law says:

(1) the United States should modernize the visa waiver program by simultaneously--
(A) enhancing program security requirements; and
(B) extending visa-free travel privileges to nationals of foreign countries that are allies in the war on terrorism.

The law then defines the requirements for the new program. The most important benchmark is the percentage of visa applications from a country that are denied under the present system. If less than 10% of visa applications are denied, the country becomes eligible for visa-free travel. Alternatively, if more than 10% of applications are denied but the percentage of visitors to US who stay in US illegally instead of going back at the end of their visit is very small, the country may also be eligible. (US will define the numerical value of "very small" later.)

It's less than Latvia has hoped for. Only two Eastern European nations qualify under the "10% rule": Czech Republic and Estonia. A few others have slightly more than 10% visa denials. Hungary has 12% and Latvia has 15%. Poland has more than 25% denial rate.

Well, Latvia probably will not become eligible for visa-free travel in the first year of the new program. Maybe in 2008, maybe in 2010. Maybe under the next US President. (Democratic presidential candidate Barack Obama has been quite supportive of visa-free travel for Eastern Europeans.) But it is a step forward.

Getting US visa can be a quite painful. While researching this blog post, I came across this story from Hungary. A researcher at Central European University went to US Embassy in Hungary and this what the rant that she heard from the US consul:

You work in an archive? Who wants to archive those dismal TV shows and cartoons? Anyway, it's beyond reasoning why they spend taxpayers' money on archiving programs that nobody is interested in. It's unbelievable that the CEU [Central European University] is spending money to preserve old photos, old nonsense, TV rubbish, spending money on sending people here and there, instead of helping Africans by sending aid.

It's a humiliating story and I have heard similar ones from friends in Latvia. It seems that the way how US embassy staff treat visa applicants depends on the personality of the visa official (or even what mood the official is on a given day) at least as much as the actual visa application.

I'll have to do at least one US visa application for a work trip before Latvians become eligible for visa-free travel. And I'm not looking forward to it.

UPDATE (4/8): According to Artis Pabriks (Latvia's minister of foreign affairs), it should take about one and half more years until Latvians can travel to US without visas. That would be the end of 2008 or early in 2009.

Added to the blogroll

Latvian Economy Watch, by Edward Hugh, Catalan/British economist who also has weblogs on economies of various other countries (Hungary, in particular) and contributes to A Fistful of Euros.

Latvian banker complains about the real estate bubble

In an interview to Baltic Business Service, Latvian banker Ainars Ozols (the chairman of the board of SEB Latvijas Unibanka) complains about some effects of the real estate boom in Latvia:

The real estate industry has spoiled the [business] people because they no longer have to think how to earn money. They can just buy a house and land and then resell for me. That's all the business. No need for innovative ideas, no need for effort. This is not normal for long-term development.

Ozols also said that he would like to be optimistic and that, in past, Latvian businesses have been able to adjust rapidly when needed (for example, after the 1998 Russian financial crisis which had substantial effect on Latvia).

Meanwhile, a real estate analyst from the "Arco" company predicts 8-12% drop in the prices of Soviet-era apartments in Riga but no drop in the prices of newly constructed ones. The full report from Arco is here. It's only in Latvian but it has a lot of interesting information. For example, I didn't realize that the number of newly built apartment is still only half of what it was in 1990, at the end of Soviet period! The "current construction boom" is less of a boom that people think....

Misbehaving tourists

This story has been all around the Latvian news for the last few days and now it starts showing up in English-language media as well:

Flashing when wearing a kilt is a bad idea

Well, flashing one's private parts in public is a bad idea, even if one is not wearing a kilt. And flashing them in another country, on the steps of that country's most important monument... that's much worse.

And that's what happened. A drunk Scottish tourist flashed passers-by near the Freedom Monument in Riga, Latvia.

Latvia has had a major influx of tourists in last few years. Hundreds of thousands of them every year. And there is a tiny number of them that would do something as outrageous as this. But, if it happens, it makes news in Latvia. And Latvian public is fairly sensitive to such misbehaviour, particularly if it involves the Freedom Monument...

British embassy did a "Responsible Tourism" campaign this spring but it appears that people who listen to "Responsible Tourism" campaigns are mostly the ones who would behave responsibly anyway...

Travel stories on Latvia

There have been several articles on travel to Latvia in American press this week:

• A Baltic primer (Estonia, Lithuania and Latvia -- and especially their lively capitals -- are flourishing in the post-Soviet era) - in San Francisco Chronicle
• Touring the Baltic - in Newsweek
• Riga: The Curtain Rises - in Washington Post

All the articles are fairly good. The article from Washington Post is the most detailed one. It touches history of Latvia, nightlife, achitecture, arts and culture. And it concludes by saying:

Edging away from the crowd, I took a moment to behold the attractive cityscape and began to imagine neon lights covering the baroque facades, and nightclubs overtaking the quiet cafes and restaurants. Perhaps I'm wrong; maybe Riga will hold on to its special Old World splendor. Authorities have already taken steps to rein in the revelry a bit.

But just in case, my recommendation: Go now.

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...