THE BALTICS: On the up

castleThe Baltics were hit particularly hard by the global financial crisis, but they seem to be turning a corner, with Estonia leading the way, writes Angele Spiteri Paris. The global crisis was a double whammy for the Baltic states. As they were going through their own domestic difficulties, the rest of the world fell apart around them. But it seems as though some of these countries are clawing their way out of the quicksand and investors are slowly beginning to look more favourably on a few of these regions  –  Estonia in particular.

Most of the big Nordic banks invested heavily in the Baltics. According to Danske Bank research, the banking sector in the Baltic states is primarily foreign owned: 98% in Estonia, 91% in Lithuania and 63% in Latvia, and the ownership is mainly Scandinavian.

Gert Tiivas, managing director for East Capital Explorer, an independent investment company, says: “The Baltics have been on quite a rollercoaster ride in the last few years. When they first entered the EU in 2004 they were the fastest-growing countries in Europe which led to inevitable overheating.”

In the boom, people in the Baltic states saw quick and substantial improvements in their standards of living, but these were based on excessive levels of leverage and optimism, which led nowhere good.

Stefan Ingves, governor of the Sveriges Riskbank, the Swedish central bank, said in a statement: “As early as 2007, for instance, the rate of wage increase was 20-30% a year, bank lending to the corporate sector increased by 30-50% and lending to the private sector by 50-70%.”

But the biggest problem these countries had to deal with was that while they were seeing increasing unemployment and spikes in property prices, they were blindsided by the global financial crisis.

Tiivas, from East Capital, says: “ The result was obviously very harsh. Throughout the crisis, the Baltics were the worst performers in Europe even dropping as much as 15%. The press had written these countries off and if you paid attention to everything you read, the Baltics overall seemed pretty scary.”

But now things are looking up.

A report from Swedbank says: “The first signs of macroeconomic stabilisation have appeared, mainly in Estonia. Certain industrial sectors have begun to show signs of recovery and some light can be seen in what concerns the deep GDP fall of the past year.”

Swedbank is the largest bank across the Baltics, through its subsidiary Hansa Pank, with a combined market share of 31%.

According to Swedbank’s economic outlook in September last year, GDP is expected to fall 13.5% in Estonia, 18% in Latvia and 16% in Lithuania for 2009. The outlook for 2010 is more optimistic, with GDP expected to decrease 3% in Lithuania, 2% in Latvia and not decrease at all in Estonia.
Tiivas says: “I’m optimistic that we’re past the worst and I’m sure that sentiment has changed. The negative media coverage has now turned positive and that can affect investor sentiment.”

Estonia, by all accounts, seems to be the winning horse, if one were betting on the Baltics’ recovery.

Tiivas, of East Capital, says: “Coming out of both crises, investors began to notice that it is not reasonable to lump this group of countries together. There have always been marked differences between them, but the crisis magnified them.”

And Estonia is slowly rising above the rest.

Estonia’s economy grew by 2.6% in the fourth quarter of 2009 compared to the previous quarter. But the country’s central bank warned commentators not to jump the gun. In a recent statement, the Bank of Estonia said that recovery of the state’s economy is continuing but the effects of the crisis are not over yet and there is still a danger of relapses.

Tiivas says: “Estonia is in relatively good shape because it had reserves and did not have any budget deficit; it had something to fall back on.” But pulling itself out of difficult times was not easy.

The country went through what is known as an internal devaluation. This essentially means it implemented a reduction in labour costs across the board, through fiscal measures. This reduces real labour costs and therefore increases the competitiveness of exports, without affecting the budget and also reducing consumer demand within the country itself.

Tiivas says: “This was a very painful way of adjusting in the face of the crisis.”

But at least, difficult as it was, it seems to have paid off. Estonia is expected to meet all the euro convergence, or Maastricht, criteria by the spring assessment and to join the euro area in 2011.

Tiivas says: “If Estonia makes it into the eurozone, it will be a huge boost for investors.” He says the positive news about Estonia’s euro prospects has already had an effect on the markets: “Interest in these regions is coming back. The Baltics actually rallied in January this year, with Estonia being up around 40%. Although this was probably a result of fund managers reacting to reports around the country’s eurozone entry.”

According to Tiivas, the optimism about Estonia’s future has led to more interest in the region as a whole. “European investors are also more aware of the Baltics than they were a few months ago. This has obviously been helped by the rating agency reports of Estonia being on the way to meeting the
euro criteria.”

But in spite of increased interest in the Baltics, not all countries in the region are on such a positive path as Estonia. Lithuania is not in such a bad way but Latvia finds itself in a somewhat dire situation.

Other countries
Tiivas says: “Latvia has had a lot of trouble. When the crisis hit it had no reserves and also had to contend with a fragile political system. Furthermore, Parex, its biggest domestic bank, went bust. Latvia is still vulnerable.”

Lithuania falls somewhere between Latvia and Estonia, but the signs for the future are good. In February this year the country sold $2m (€1.5m) of bonds in overseas markets. This was its biggest sale of the securities, despite the drop in credit markets.

According to Tiivas: “Investment appetite for Lithuania has been doing well. Had the doomsayers had their way, the country would have been knocking on the IMF’s door a long time ago, but it hasn’t done so, which is a good thing.”

Unfortunately the same can’t be said for Latvia as there is currently not investment activity and confidence in the long-term outlook for the country is relatively low.

However, things may very well change. Tiivas says: “The beauty of the Baltics is their size. It is easier to change the path of the region because it’s so small. After all, its much easier to change the course of a small dingy than that of a huge cruise liner. So, the Baltics could very well surprise on the upside.” ©2010 funds europe

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