OREANDA-NEWS. On November 28, 2008 Hansabank Markets have made revisions of our forecast for the Baltic economies, taking into account the changes in the global economy and in the Baltic countries themselves, reported the press-centre of Hansabank.

The global economy is heading towards a recession. However, it is not yet clear how deep it will be and how long it will last, as it is not clear whether the coordinated action of global economic powers will have a lasting effect on markets or not. In addition, we do not know what the consequences of the recent troubles are.

Hence it is quite difficult to formulate a forecast now for every country. It might easily happen that current expectations prove to be too optimistic, and that global economic developments may turn out to be worse than currently expected.

The Baltic economies were heading towards recession without the recent troubles in the global financial market, and the worsened economic situation and outlook in the financial world have made our forecast significantly gloomier, as all three countries are subject to global economic developments.

It would be very difficult to show improving growth rates in the Baltic economies at a time where the global economy and particularly their main trading partners are in a recession; however, whether recovery will come at the same time as in partner countries and how strong it will be depends on the local economies.

Weak global demand will negatively affect the export possibilities of Baltic companies. The only factor, which may help, is that production costs here are still significantly lower than in most of the export destination countries in the EU. There is also ample room from gaining productivity growth (the productivity gap is big between Baltic countries and their main trading partners). There is still some room for gaining from Russian economic developments, but since risks in Russia have increased more than in developed countries, this might be too risky option for many companies.

Lower prices, particularly energy prices, will help local infl ation to recede. That should smooth the burden of local economic distress on consumers and encourage earlier recovery of consumption (or at least keep the decline smaller). It also should help the Baltic economies to remain competitive in global markets, as many businesses are rather energy consuming.

The strongest negative effect is expected from the financial markets, where the Baltic countries are now considered to be among the most risky. This has made foreign financing significantly more difficult and expensive as risk margins have grown strongly. Hence, the lowering of policy rates has had no effect on the cost of new borrowing in the Baltic countries. Still, the falling money market rates have already eased the situation of those who have already taken loans, as the majority of loans have fl exible interest rates, which are bound to Euribor rates.

The Baltic economies have to rely more on domestic finances, which, however, are more expensive and less available (due to lower saving rate) than cheap foreign loan money, which poured into the economies in 2004-2007. This means that investing has become more expensive, and thus the urgently needed change in the economic structure cannot be fast.

Although the Baltic countries can expect generous money fl ows from different EU funds (estimated ca 3-4% of GDP every year in the 2007-13 budgetary period), those funds will not save the Baltic countries from a prolonged period of economic stress, as it can hardly be expected that the use of those funds will not be without troubles. Also, they will not cover the needs of the private sector.

Taking into account all the abovementioned factors, we have cut our growth expectations for the Baltic countries and expect negative GDP growth in Estonia and Latvia in 2008 (the countries have already entered formal recession as they had two consecutive quarters of negative quarterly growth), while Lithuania will still note positive annual growth figures in 2009 (though well below previous expectations).

The year 2009 is expected to be the most difficult for all three countries: we forecast a fall of around 2% in Estonia, 4% in Latvia and only minor growth in Lithuania. 2010 should bring slow recovery in Estonia and Latvia, with 2% and 1% growth respectively, but the Lithuanian economy is about to suffer from the closure of the Ignalina nuclear power station and followed that sharp increase in electricity prices.

Economic growth is mostly affected by very weak domestic demand – household and investments – as unemployment will increase, wage growth will stall and investments fall. Although external demand will be weak and we have cut exports growth expectations, we also see that the three countries will be able to at least partly use their production advantages. The very weak domestic demand will also mean a sharply smaller imports fl ow, and hence we expect a rapid decline of trade and current account deficits. It is likely that the Estonian and Latvian current and capital account deficits will fall below 5% of GDP by the end of 2009.

Weak domestic demand is already containing inflation rates, and we expect inflation to retreat rather rapidly. Estonia will see single-digit annual growth rates already in the 4th quarter of 2008, and Latvia and Lithuania are expected to follow soon.

The falling inflation has made it possible to again talk about euro adoption. We are of the opinion that Estonia and Latvia could fulfil the Maastricht inflation criterion in 2010. However, there is an increasing threat in all three Baltic States that falling budget revenues and high reluctance of governments to make substantial cuts in spending growth may result in budget deficits exceeding 3% of GDP, which is another Maastricht criterion.

We expect governments to act in a responsible way, avoiding excessive increases of expenditures which are not of primary importance; it is highly needed to increase the efficiency of public services, and governments should avoid increasing taxes or other financial burdens for companies and households.