From the FT this morning:
Jobs without borders: Nordic nations want Baltic immigrants
By Robert Anderson
Published: October 24 2007 19:59 | Last updated: October 24 2007 19:59
Ginta Yermava remembers bursting into tears when she spread the cash from her first Swedish pay on her bed in the flat she shares with three other Latvian cleaners. “In one week I earned as much as I did in one month as a teacher in Latvia,” she says.
The company Ms Yermava works for, Rent Hos Dig (“clean at your place”), is able to undercut rival cleaning companies by more than half by bringing Latvian women to Stockholm for six-month stints.
Throughout the Nordic region, migrant workers such as Ms Yermava are filling vacancies and providing services. The inflow from the new European Union member states, particularly Poland and the Baltic states, is the largest since the 1970s, when governments shut the door to southern European migrant workers.
Some 75,000 migrants are working legally in Norway – making up 3 per cent of the labour force. Denmark, the second most popular destination, granted 20,000 new work permits last year. Employers – from big companies to the individuals who are Ms Yermava’s customers – welcome them. That is because, across the region, there are labour shortages caused by robust economic growth, ageing populations and labour market rigidities.
That has severe consequences for many companies. “Almost in every sector we have problems now, especially in finding skilled manual workers and engineers,” says Jussi Järventaus, managing director of the Federation of Finnish Enterprises. In Sweden, “large new investments are not being made as firms find it difficult to attract workers to work there quickly enough”, says Stefan Fölster, chief economist of Svenskt Näringsliv, that country’s enterprise confederation.
The labour shortages mean any slowing in economic growth will make it more difficult to finance the region’s generous welfare systems. Workers in the care and health sectors are also needed to look after the fast-ageing populations. Tobias Billstrom, Sweden’s migration minister, says hospitals in southern Sweden would have to close over the summer if it were not for migrant workers.
In Finland, where the demographic problem looms earliest, the number of employed workers to each welfare benefit recipient will drop from 1.7 now to 1.0 by 2030, according to the Organisation for Economic Co-operation and Development. Labour migrants – by filling vacancies, keeping wages competitive, paying taxes and spending their salaries, while drawing few state benefits – could boost economic growth and stave off the need to make fundamental reforms to welfare systems.
“We have been able to keep the wheels running at high speed because we have taken workers from elsewhere in Europe,” says Sigrun Vageng, executive director of NHO, the Norwegian enterprise confederation.
Denmark – whose minority government has relied on the backing of the nationalist People’s party – has tried to tighten asylum procedures while relaxing labour permit rules to allow highly qualified people from outside the EU to seek work. But it restricts jobseekers from the new EU member states and imposes tough skill and salary requirements on those from outside the EU.
Nevertheless, this month the centre-right government announced plans both to launch a publicity campaign to attract migrant workers and to reform the work permit system to make it easier for them to enter. With a snap general election called on Wednesday, if it wins a majority it may move further in this direction. Every Nordic government is now rethinking its migration policies to try to attract more legal workers, targeted at the right sectors.
There are already sizeable flows of workers within the region, with oil-rich Norway drawing some 20,000 migrant Nordic workers. There is also significant migration as well as commuting between southern Sweden and Copenhagen, made easier by the new Oresund bridge. But the real battle is on for cheaper workers from the new member states and highly skilled experts from all over the world.
Unlike the rest of the EU, Sweden and Finland have imposed no restrictions on workers from the new member states. Norway (not an EU member) and Denmark have controls, although in effect they allow migrants to enter to find work but make it difficult for them to claim social benefits.
The Nordic region is not the first choice for migrants from the new EU members, because of its high costs and taxes. Moreover, wages in their home countries are rising so fast – at more than 30 per cent in the last year in Latvia – that migration may soon slow. Highly skilled workers find that salaries at the top end are not competitive in the Nordic region, because income differentials are less than in the rest of western Europe. In fact, all the Nordic nations are losing young workers to countries such as the UK, where real remuneration can be higher. Swedes joke that London is fast becoming the biggest Swedish city after Stockholm because of the number of young workers who have moved there.
Consequently, every Nordic country has recently announced its intention to revamp policies to attract foreign workers. The Swedish government proposed in August to allow companies to seek workers from anywhere without first consulting state agencies and trade unions on whether there was a need. Migrants with special skills would also be allowed to enter on three-month visas to seek work and would be granted 24-month visas once they found a job, with a chance to win an indefinite stay after four years.
Compared with the UK, for example, there is less fear of an immigration wave and more concern that the region’s high taxes will deter migrants. “My worst nightmare is not that we have 300,000 wanting to come in but that we will make all these changes and we still will not be able to attract enough people,” says Mr Billstrom.
“We are opening up,” says Kim Graugaard, deputy director general of Dansk Industri, the Danish industry confederation. “But it’s one thing to open your borders and another thing to attract people to cross them.”
Norway is also beginning to rethink its policy towards workers from outside the EU. Although it has taken in more than half the labour migrants who have gone to the region from the EU’s new member states, last year it handed out only 2,000 of a possible 5,000 permits to workers from outside the EU.
Finland, traditionally a country of emigration rather than immigration, wants to attract workers from the former Soviet Union, where it thinks it stands the best chance. Finland already has some 47,000 Russian-speaking immigrants – about one-third of the total – who have been attracted by the similar climate and the short distance home. “In immigration we are looking eastwards,” says Tarja Cronberg, labour minister.
Yet luring migrant workers could also pose a challenge to the traditional Scandinavian policies of providing refuge for asylum seekers and regulating labour markets. Leftwing parties, which have traditionally dominated the region but are now out of power except in Norway, fear that opening the door to migrant workers could end up closing it for refugees.
Sweden and Norway in particular have a proud asylum record but often refugees have failed to find jobs and have added to the costs of financing the welfare system. Consequently, nationalist parties in Denmark, Norway and Sweden have put pressure on governments to restrict refugee flows.
Some fear the new focus on labour migration could worsen the marginalisation of unemployed refugees and increase popular resentment against them. “We think it is important to have a generous asylum system,” says Erland Olauson, first vice-president of the Swedish trade union confederation. “If you mix it [with labour migration] and there are problems, people will say – like in Denmark – ‘Don’t bring them in, leave them outside’.”
Sweden’s government sees no conflict in having generous asylum and labour migration policies. Indeed, it argues that the two should be complementary. “When Swedes are critical of immigration, they refer to the issue of people not working,” says Mr Billstrom. “Labour migration could drive the integration process of those people who are already here.”
Unions are worried, however, by the threat labour migration poses to wage levels and employment rules. This threat was demonstrated in 2004 when a Latvian company brought in its workers to build a school in the Stockholm suburb of Vaxholm and refused to sign a collective wage agreement.
The company abandoned the contract after unions picketed the site. The enterprise confederation took the case to the European Court of Justice, which this year ruled in a preliminary judgment that under Sweden’s accession treaty with the EU the company should have signed the agreement. “When workers come they should be treated like all the others,” says Mr Olauson. “We don’t accept an apartheid labour market.”
Norway’s Labour government has taken the toughest stand against low-wage migration, with tight checks on employers, subcontractors and recruitment agencies. Even the centre-right Swedish government defended the unions in the Vaxholm case.
Reconciling the need for imported workers with Scandinavia’s labour arrangements is likely to remain the biggest difficulty. Hindering migration flows could undermine welfare financing but too relaxed a regime could hurt popular backing for inward migration.
Wednesday, October 24, 2007
Baltic Blues
From the Economist last week:
Europe's fastest-growing economies hit choppy waters
DEVALUATION would be horribly painful and solve nothing. That is Latvia's defence, as its inflation rate and current-account deficit soar, and speculators hover over its pegged exchange rate. On paper, the small Baltic economy looks nastily exposed, as, to a lesser extent, do its neighbours Lithuania and Estonia (see chart). All three have overheating economies and fixed exchange rates: a risky mix. Some fear the region could be eastern Europe's Achilles heel.
Latvia is in the worst situation. Year-on-year inflation in September was a whopping 11.4%; the current-account deficit over a fifth of GDP. Bank lending, much of it in foreign currencies, has soared, creating a property bubble in the capital, Riga. Overheating has hurt competitiveness. To some the national currency, the lat, looks like the likeliest casualty.
Latvia's position was not helped when Jürgen Stark, a board member of the European Central Bank, said earlier this month that ex-communist countries wanting to join the euro zone faced “substantial challenges”, banker-speak for “forget it”; Lorenzo Bini Smaghi, another ECB board member, publicly questioned the ability of these countries to keep inflation under control while maintaining fixed exchange rates, a stance that means adopting what is de facto the euro zone's monetary policy.
Yet a devaluation is far from inevitable. The Latvian banking system is largely foreign-owned. If overstretched borrowers start to default, that will hurt shareholders abroad, mainly in Sweden, not the stability of the whole financial system. If scared banks rein in lending and construction companies go bust, that would help produce a much-needed soft(ish) landing. Indeed, that may already be under way. Furthermore, speculating against thinly traded currencies is tricky. It may also be pointless: the Latvian central bank has enough reserves to redeem every lat in circulation, and more besides. And as Jon Harrison of Dresdner Kleinwort, a bank, points out, Latvia has little foreign debt and a strong credit rating. It could borrow in euros to ease a local credit squeeze.
The problem for Latvia is the lack of monetary-policy levers. The currency peg means it cannot raise interest rates. Even when banks cut back on their lending, other financial entities, such as leasing companies, can fill the gap. That leaves only fiscal policy; yet the government, an uninspired coalition stronger on business practice than economic theory, has shied away from the big surplus that might slow the economy and reassure outsiders. The 2008 budget foresees a surplus of only 1%, rising to 1.5% in 2010. Outsiders think 3% would be a good start.
A forced devaluation in Latvia would be ruinous for the middle class—at least for those who stayed to experience it. Tens of thousands of Latvians have gone to work abroad already. Any gain in nominal competitiveness might well be counterbalanced by an even tighter labour market.
Estonia and Lithuania would be at risk if Latvia did devalue. But elsewhere, a crunch in the Baltics would be more spectacular than significant. The combined GDP of the three Baltic economies is barely 1% of the euro zone's. Their plight might worsen wobbles in Kazakhstan, say, but most other ex-communist countries would weather the storm. The main change would be in the mood music. When liquidity was plentiful, lending in eastern Europe looked like a source of easy profit. Now the region's bottlenecked economies and lacklustre governments stand more harshly exposed.
Europe's fastest-growing economies hit choppy waters
DEVALUATION would be horribly painful and solve nothing. That is Latvia's defence, as its inflation rate and current-account deficit soar, and speculators hover over its pegged exchange rate. On paper, the small Baltic economy looks nastily exposed, as, to a lesser extent, do its neighbours Lithuania and Estonia (see chart). All three have overheating economies and fixed exchange rates: a risky mix. Some fear the region could be eastern Europe's Achilles heel.
Latvia is in the worst situation. Year-on-year inflation in September was a whopping 11.4%; the current-account deficit over a fifth of GDP. Bank lending, much of it in foreign currencies, has soared, creating a property bubble in the capital, Riga. Overheating has hurt competitiveness. To some the national currency, the lat, looks like the likeliest casualty.
Latvia's position was not helped when Jürgen Stark, a board member of the European Central Bank, said earlier this month that ex-communist countries wanting to join the euro zone faced “substantial challenges”, banker-speak for “forget it”; Lorenzo Bini Smaghi, another ECB board member, publicly questioned the ability of these countries to keep inflation under control while maintaining fixed exchange rates, a stance that means adopting what is de facto the euro zone's monetary policy.
Yet a devaluation is far from inevitable. The Latvian banking system is largely foreign-owned. If overstretched borrowers start to default, that will hurt shareholders abroad, mainly in Sweden, not the stability of the whole financial system. If scared banks rein in lending and construction companies go bust, that would help produce a much-needed soft(ish) landing. Indeed, that may already be under way. Furthermore, speculating against thinly traded currencies is tricky. It may also be pointless: the Latvian central bank has enough reserves to redeem every lat in circulation, and more besides. And as Jon Harrison of Dresdner Kleinwort, a bank, points out, Latvia has little foreign debt and a strong credit rating. It could borrow in euros to ease a local credit squeeze.
The problem for Latvia is the lack of monetary-policy levers. The currency peg means it cannot raise interest rates. Even when banks cut back on their lending, other financial entities, such as leasing companies, can fill the gap. That leaves only fiscal policy; yet the government, an uninspired coalition stronger on business practice than economic theory, has shied away from the big surplus that might slow the economy and reassure outsiders. The 2008 budget foresees a surplus of only 1%, rising to 1.5% in 2010. Outsiders think 3% would be a good start.
A forced devaluation in Latvia would be ruinous for the middle class—at least for those who stayed to experience it. Tens of thousands of Latvians have gone to work abroad already. Any gain in nominal competitiveness might well be counterbalanced by an even tighter labour market.
Estonia and Lithuania would be at risk if Latvia did devalue. But elsewhere, a crunch in the Baltics would be more spectacular than significant. The combined GDP of the three Baltic economies is barely 1% of the euro zone's. Their plight might worsen wobbles in Kazakhstan, say, but most other ex-communist countries would weather the storm. The main change would be in the mood music. When liquidity was plentiful, lending in eastern Europe looked like a source of easy profit. Now the region's bottlenecked economies and lacklustre governments stand more harshly exposed.
Hungary Predicts 10-Month Budget Gap at 4.6% of GDP
Hungary's government, struggling to cut the European Union's widest budget deficit, said it expects the shortfall to reach 4.6 percent of gross domestic product at the end of the month.
The deficit will be 32 billion forint ($182 million) in October alone, driven by an early payment of November wages, Deputy Finance Minister Miklos Tatrai said at a press conference today. He maintained the projection of an annual deficit at 6.4 percent of GDP, after last year's gap of 9.2 percent of GDP.
Prime Minister Ferenc Gyurcsany has cut public jobs, raised taxes and slashed subsidies to reduce the deficit from a record last year. The EU has said Hungary may be able to meet its budget goal this year for the first time since 2001.
``Revenue is coming in as planned, with slightly more than expected from value-added tax and the corporate income tax, while spending has somewhat underperformed projections,'' Tatrai said today.
The forint traded at 250.57 per euro at 10:24 a.m. in Budapest, from 250.74 late yesterday.
Without the early payment of November wages and family support, made necessary because of the schedule of national holidays, the October budget would end in a 25 billion-forint surplus, he added.
The government wants to cut the shortfall to 4.1 percent of gross domestic product next year, according to the 2008 budget draft being debated by parliament. Hungary wants to lower the gap to less than 3 percent by 2009.
The government may next week decide to drop an earlier plan to tax banks' and insurance companies' unused reserves from next year, though no decision has been made yet, Tatrai said. The tax would add about 30 billion forint to revenue.
The deficit will be 32 billion forint ($182 million) in October alone, driven by an early payment of November wages, Deputy Finance Minister Miklos Tatrai said at a press conference today. He maintained the projection of an annual deficit at 6.4 percent of GDP, after last year's gap of 9.2 percent of GDP.
Prime Minister Ferenc Gyurcsany has cut public jobs, raised taxes and slashed subsidies to reduce the deficit from a record last year. The EU has said Hungary may be able to meet its budget goal this year for the first time since 2001.
``Revenue is coming in as planned, with slightly more than expected from value-added tax and the corporate income tax, while spending has somewhat underperformed projections,'' Tatrai said today.
The forint traded at 250.57 per euro at 10:24 a.m. in Budapest, from 250.74 late yesterday.
Without the early payment of November wages and family support, made necessary because of the schedule of national holidays, the October budget would end in a 25 billion-forint surplus, he added.
The government wants to cut the shortfall to 4.1 percent of gross domestic product next year, according to the 2008 budget draft being debated by parliament. Hungary wants to lower the gap to less than 3 percent by 2009.
The government may next week decide to drop an earlier plan to tax banks' and insurance companies' unused reserves from next year, though no decision has been made yet, Tatrai said. The tax would add about 30 billion forint to revenue.
Local company makes gigantic bid for Telekom Slovenije
Local company makes gigantic bid for Telekom Slovenije
Wednesday, October 24, 2007 10:50:00 AM
According to press reports, citing leaked information from the Slovenian privatisation agency, the only local bidder, Engrotus, submitted the highest offer in the privatisation tender for a 49% package in Telekom Slovenije. The bid implies EUR 460 per share, which appears to be a staggeringly high price at first glimpse. Hungary's largest telecom group, Magyar Telekom, is also among the bidders.
2007.10.16 14:58
Hungary Magyar Telekom submits non-binding bid for Telekom Slovenije
The deadline for the final decision in the tender has not been set, but eexperts believe it could be end-December. Non-binding bids were welcome by 15 October.
According to the latest press reports, citing sources close to the privatisation agency, Engrotus, owned by the richest Slovenian businessman Mirko Tus, offered EUR 460 per share for the 49% stake in Telekom Slovenije. The runner-ups are Iceland's Skipti with EUR 350 and Germany's telco giant Deutsche Telekom with EUR 317 per share offers. There were some other bids in the area of EUR 300 per share and some offered even less than that. According to Croatia's Limun, the government of Slovenia still favours Deutsche Telekom and will not necessarily take the bid of Engrotus seriously.
The commission for the privatisation of Telekom Slovenije explained that Mirko Tus was the only bidder that failed to submit a financial plan for the purchase of the Slovenian national telecom company, Limun also reported. The Ministry of Economy has not say just yet what is the deadline for Tus to amend his bid.
Hungary's Magyar Telekom and Croatia's Telekom Hrvatski, both subsidiaries of Deutsche Telekom, reportedly offered EUR 317 per share for the 49% package, which surprised the privatisation agency, as well.
The Slovenian bidder's EUR 460 bid seems overly high at first signt, since it implies an 2008 EV/EBITDA ratio of over 9.5x for Telekom Slovenije. The EUR 317 per share offer made by Deutsche Telekom translates into a 7.5x 2008 EV/EBITDA ratio, which appears to be much more realistic, compared to the regional and global average of the telecom sector. We must keep in mind that the 49% package will most likely sell at a premium over the average stock exchange valuation.
Calculating at EUR/HUF of 251, the EUR 317 per share bid for the 49.13% stake we arrive at HUF 254 bn necessary resources, while Magyar Telekom's cash pool was not larger than HUF 95 bn at the end of the second quarter and it also had elbowroom in respect of indebtedness. Consequently, its dividend payment would probably not be jeopardised even if its were successful in its acquisition drive. At the same time we must highlight that the EUR 317 per share bid remains unconfirmed information and even it were a fact, it would still be no more than an indicative bid.
Wednesday, October 24, 2007 10:50:00 AM
According to press reports, citing leaked information from the Slovenian privatisation agency, the only local bidder, Engrotus, submitted the highest offer in the privatisation tender for a 49% package in Telekom Slovenije. The bid implies EUR 460 per share, which appears to be a staggeringly high price at first glimpse. Hungary's largest telecom group, Magyar Telekom, is also among the bidders.
2007.10.16 14:58
Hungary Magyar Telekom submits non-binding bid for Telekom Slovenije
The deadline for the final decision in the tender has not been set, but eexperts believe it could be end-December. Non-binding bids were welcome by 15 October.
According to the latest press reports, citing sources close to the privatisation agency, Engrotus, owned by the richest Slovenian businessman Mirko Tus, offered EUR 460 per share for the 49% stake in Telekom Slovenije. The runner-ups are Iceland's Skipti with EUR 350 and Germany's telco giant Deutsche Telekom with EUR 317 per share offers. There were some other bids in the area of EUR 300 per share and some offered even less than that. According to Croatia's Limun, the government of Slovenia still favours Deutsche Telekom and will not necessarily take the bid of Engrotus seriously.
The commission for the privatisation of Telekom Slovenije explained that Mirko Tus was the only bidder that failed to submit a financial plan for the purchase of the Slovenian national telecom company, Limun also reported. The Ministry of Economy has not say just yet what is the deadline for Tus to amend his bid.
Hungary's Magyar Telekom and Croatia's Telekom Hrvatski, both subsidiaries of Deutsche Telekom, reportedly offered EUR 317 per share for the 49% package, which surprised the privatisation agency, as well.
The Slovenian bidder's EUR 460 bid seems overly high at first signt, since it implies an 2008 EV/EBITDA ratio of over 9.5x for Telekom Slovenije. The EUR 317 per share offer made by Deutsche Telekom translates into a 7.5x 2008 EV/EBITDA ratio, which appears to be much more realistic, compared to the regional and global average of the telecom sector. We must keep in mind that the 49% package will most likely sell at a premium over the average stock exchange valuation.
Calculating at EUR/HUF of 251, the EUR 317 per share bid for the 49.13% stake we arrive at HUF 254 bn necessary resources, while Magyar Telekom's cash pool was not larger than HUF 95 bn at the end of the second quarter and it also had elbowroom in respect of indebtedness. Consequently, its dividend payment would probably not be jeopardised even if its were successful in its acquisition drive. At the same time we must highlight that the EUR 317 per share bid remains unconfirmed information and even it were a fact, it would still be no more than an indicative bid.
Hungary and the 1930s
How can this be happening? Here is a discussion of what to do about interest rates from Portfolio Hungary.
How can Hungary be in the middle of a major downturn, and still have base rates at 7.50%. You tell me. This is a real mess. It reminds me so much of the sorts of issue that came up in the 1930s. The strange thing is that almost noone is saying anything.
Hungary cenbank has room to cut rates in October, but should think twice
Wednesday, October 24, 2007 03:49:00 PM
Analysts' expectations about the next rate move in Hungary have changed quite a lot over the past week. While a few days ago they gave a bigger chance to a 25-basis-point rate cut on 29 October, the majority now believes the 7.50% base rate will be left on hold this month. Several of the 18 analysts polled by Portfolio.hu on Wednesday indicated that while a number of factors would allow the central bank (NBH) to continue monetary easing, another rate cut after the 25-bp reduction in September would not carry the proper message for investors under the current market situation that is weighed down by a great deal of both domestic and external uncertainties. This creates a visible split among analysts whether the Monetary Council will deliver one or two rate cuts by the end of the year and there are great differences in estimates on the end-2008 base rate, as well.
Ten out of the 18 respondents believe the MPC will not change the base rate in October, while 6 expect a 25-bp cut and 2 gave equal chance for both scenarios.
Those projecting a ‘hold' decision cited gloomy inflation outlook (especially with regard to food and oil prices) as the main reason behind their standpoint. They noted that the latest wage figures were also ambiguous and that the outcome of talks on 2008 wages was also hazy, which would demand a cautious interest rate policy.
Szabó Gergely Forián of Pioneer Fund Management and Eszter Gárgyán of Citibank emphasised that a rate cut next Monday would not be consistent with what the MPC said in the minutes of its previous policy meetings, adding that it could also lead to rate cut expectations running away. Gergely Tardos, analyst at OTP Bank believes that the NBH would risk credibility if it decided to lower rates under current market conditions. His opinion chimes with the thoughts of MKB Bank analyst Zsolt Kondrát.
In respect of inflationary risks, Gergely Suppan of Takarékbank noted that “we are in the middle of a food price shock right now". Dávid Németh of ING Bank stressed uncertainties about next year's electricity price changes.
György Barcza, senior analyst at ING Bank, said that besides the aforementioned factors it should also convince the MPC not to alter rates now that an updated inflation report will be published in a month and the MPC could cut rates in a more credible fashion only then, provided that report paints a favourable picture on the inflation path.
He said it would be a “major communications challenge" if the MPC decided to cut rates already next Monday. Based on what the market is pricing at the moment, the players are generally not convinced that a 25-bp cut would come already in October.
Orsolya Nyeste, analyst at Erste Bank believes that the MPC would most likely take into consideration a decease of risk premia over Hungarian assets next Monday, given that the picture of key inflation-driving factors has not got any clearer in the past month.
Several analysts that believe the MPC could in fact trim rates on 29 October cited the dovish majority on the rate setting council as one of the main reasons for such a move.
Márta Szegõ of UniCredit Bank believes the global investment environment will be of key importance for the Hungarian rate path in the months to come. She agrees with CIB Bank analyst, Dániel Bebesy on that lingering uncertainties were also a major obstacle in the local rate cut cycle. The analysts were divided on the end-2007 base rate, equally projecting 7.00% and 7.25%.
Differences were even bigger at end-2008 projections, with estimates ranging between 6.00% and 6.75%, depending on how big an importance each analyst attributed to inflation expectations sticking at high levels.
How can Hungary be in the middle of a major downturn, and still have base rates at 7.50%. You tell me. This is a real mess. It reminds me so much of the sorts of issue that came up in the 1930s. The strange thing is that almost noone is saying anything.
Hungary cenbank has room to cut rates in October, but should think twice
Wednesday, October 24, 2007 03:49:00 PM
Analysts' expectations about the next rate move in Hungary have changed quite a lot over the past week. While a few days ago they gave a bigger chance to a 25-basis-point rate cut on 29 October, the majority now believes the 7.50% base rate will be left on hold this month. Several of the 18 analysts polled by Portfolio.hu on Wednesday indicated that while a number of factors would allow the central bank (NBH) to continue monetary easing, another rate cut after the 25-bp reduction in September would not carry the proper message for investors under the current market situation that is weighed down by a great deal of both domestic and external uncertainties. This creates a visible split among analysts whether the Monetary Council will deliver one or two rate cuts by the end of the year and there are great differences in estimates on the end-2008 base rate, as well.
Ten out of the 18 respondents believe the MPC will not change the base rate in October, while 6 expect a 25-bp cut and 2 gave equal chance for both scenarios.
Those projecting a ‘hold' decision cited gloomy inflation outlook (especially with regard to food and oil prices) as the main reason behind their standpoint. They noted that the latest wage figures were also ambiguous and that the outcome of talks on 2008 wages was also hazy, which would demand a cautious interest rate policy.
Szabó Gergely Forián of Pioneer Fund Management and Eszter Gárgyán of Citibank emphasised that a rate cut next Monday would not be consistent with what the MPC said in the minutes of its previous policy meetings, adding that it could also lead to rate cut expectations running away. Gergely Tardos, analyst at OTP Bank believes that the NBH would risk credibility if it decided to lower rates under current market conditions. His opinion chimes with the thoughts of MKB Bank analyst Zsolt Kondrát.
In respect of inflationary risks, Gergely Suppan of Takarékbank noted that “we are in the middle of a food price shock right now". Dávid Németh of ING Bank stressed uncertainties about next year's electricity price changes.
György Barcza, senior analyst at ING Bank, said that besides the aforementioned factors it should also convince the MPC not to alter rates now that an updated inflation report will be published in a month and the MPC could cut rates in a more credible fashion only then, provided that report paints a favourable picture on the inflation path.
He said it would be a “major communications challenge" if the MPC decided to cut rates already next Monday. Based on what the market is pricing at the moment, the players are generally not convinced that a 25-bp cut would come already in October.
Orsolya Nyeste, analyst at Erste Bank believes that the MPC would most likely take into consideration a decease of risk premia over Hungarian assets next Monday, given that the picture of key inflation-driving factors has not got any clearer in the past month.
Several analysts that believe the MPC could in fact trim rates on 29 October cited the dovish majority on the rate setting council as one of the main reasons for such a move.
Márta Szegõ of UniCredit Bank believes the global investment environment will be of key importance for the Hungarian rate path in the months to come. She agrees with CIB Bank analyst, Dániel Bebesy on that lingering uncertainties were also a major obstacle in the local rate cut cycle. The analysts were divided on the end-2007 base rate, equally projecting 7.00% and 7.25%.
Differences were even bigger at end-2008 projections, with estimates ranging between 6.00% and 6.75%, depending on how big an importance each analyst attributed to inflation expectations sticking at high levels.
Russian Foreign Direct Investment Tops $40 Billion
Russian foreign direct investment surged to more than $40 billion in the first nine months of the year, said Igor Shuvalov, an aide to President Vladimir Putin.
Foreign direct investment last year totaled $30 billion, Shuvalov told a conference in Moscow today.
Russia's economic boom is driving investment and gross domestic product may increase more than 7.7 percent this year, up from 6.7 percent last year, he said.
The government this year will approve a bill regulating foreign investment in strategic sectors to establish ``order, clearly defined by law,'' Shuvalov said. Russian limits on foreign investment in strategic industries should mirror restrictions on Russian investment abroad, he said.
The State Duma, Russia's lower house of parliament, on Sept. 14 approved in the first of three required votes a bill on foreign investment in strategic sectors. The draft, subject to revision, applies to deals that would give a foreign company a majority stake in 39 industries, including aerospace and defense.
Foreign direct investment last year totaled $30 billion, Shuvalov told a conference in Moscow today.
Russia's economic boom is driving investment and gross domestic product may increase more than 7.7 percent this year, up from 6.7 percent last year, he said.
The government this year will approve a bill regulating foreign investment in strategic sectors to establish ``order, clearly defined by law,'' Shuvalov said. Russian limits on foreign investment in strategic industries should mirror restrictions on Russian investment abroad, he said.
The State Duma, Russia's lower house of parliament, on Sept. 14 approved in the first of three required votes a bill on foreign investment in strategic sectors. The draft, subject to revision, applies to deals that would give a foreign company a majority stake in 39 industries, including aerospace and defense.
Tuesday, October 23, 2007
Xenophobia in Russia
From Bloomberg today:
Slapping a coat of paint on the pedestal of a bust of Lenin in a provincial Russian town may not be much of a job. Kuram, 49, says it beats making the equivalent of $16 a month back home in Uzbekistan.
``If things were better there, I wouldn't be here,'' says the tractor driver, at work in Khotkovo, 60 kilometers (37 miles), northeast of Moscow. He declined to give his last name for fear of running afoul of Russian immigration authorities.
As Russia's booming economy creates greater wealth and aspirations among its citizens, it is also forcing them to confront issues more familiar in the West: discrimination, harassment and even violence aimed at foreign workers like Kuram, who see economic opportunity in taking jobs Russians can't or won't do.
A shrinking local workforce complicates matters, as oil- powered economic growth fuels demand for offices, apartments and shopping malls -- along with people to build and maintain them.
``There is such a deficit of labor all over Russia, just at a time when Russia has woken up,'' says Vladimir Mikhailov, head of construction for NTT, a company based outside Khotkovo that owns state farms, a bank and machine-tool factories.
Kuram, who lives in a trailer, earns about 7,500 rubles, or $300, a month doing odd jobs.
Sweeping Streets
He and his two co-workers, also from Uzbekistan, are among about 4.9 million labor migrants sweeping streets, washing dishes, digging ditches and doing menial building-site work, according to figures from Moscow's Russian Economics Institute. Unofficial estimates put the number at 10 million, most of them from former Soviet republics.
The migrant workers, many with darker skin or Mongoloid facial features, are a visible presence in major cities, and not always welcome -- even though the Russian Federation is a multiethnic country, with more than 100 non-Slavic nationalities, including Tatars, Bashkirs and others.
Attacks against foreigners, some fatal, have been rising. Sova, a Moscow-based group that tracks hate crimes, reports 435 victims of Russian race-based assaults in 2005 and 575 in 2006. In the first four months of this year, there were 209, a third higher than the same period last year.
Still, the migrants come because they say they need the work. The Russian government in the last year has come to the grudging conclusion that it needs them, too.
Falling Population
Russian economic growth has averaged 6.7 percent a year since 1999. Meanwhile, Russia's population fell to 143.8 million in 2006 from 148.7 million in 1992 and continues to slide by almost 1 million a year, government statistics show.
The workforce decline is dramatic. According to the Health and Social Development Ministry, it will drop 12 percent to 65.5 million by 2010 from 74.5 million now because of low fertility rates and the high number of alcohol-related deaths.
Mikhailov says 40 percent of his farm and construction workers are foreigners, many of them of Muslims who don't drink.
``To get Russians to work with their hands is very difficult,'' he says. ``Those between 30 and 40, who could work, are already off on their own. Those who couldn't are drinking now. That's the truth. Why hide it?''
Life expectancy for Russian men is 59 years, two years less than for Uzbek men, even though Russia's per-capita income is six times Uzbekistan's $2,000, according to the CIA World Factbook.
Political Convulsions
Russia is home to the world's second-largest number of immigrants, after the U.S. During the political convulsions following the 1991 collapse of the Soviet Union, millions of people crossed new national borders. Ethnic Russians returned from the republics, joined by millions of undocumented Tajiks, Uzbeks, Moldovans and others.
For people like Kuram, entering Russia isn't difficult: They don't need visas for the first three months. The hard part is working legally. Until this year, almost all labor migrants were part of the ``grey'' economy, exploited by businesses, paid miserable wages and vulnerable to harassment by Russian police.
To give them legal status, the Russian Parliament passed a law in January setting quotas nationally and by region. This year's quota was 6.1 million workers, with 700,000 for Moscow, says Andrei Markov, a World Bank human-development specialist.
`Still Raw'
Fines for employing an illegal worker are as much as 800,000 rubles, Mikhailov says. Yet it can take weeks for migrants to move through waiting lists at the Federal Migration Service, during which they cannot be legally employed. ``The law is still raw,'' he says.
At Khotkovo's main square, in front of a privatized department store named ``Beloved,'' Kuram and his friends struggle with rickety scaffolding as they paint the pedestal with the bust of Lenin.
In the nearby village of Akhtyrka, a workman rebuilds a burned-down cottage, or ``izba,'' as music in the nasal tones of his native Tajik blasts from a boom box.
Most migrants say they long to be with their families. Kuram is heading to Uzbekistan this month, he says, to see his wife and four children. He'll come back, like others seeking jobs they can't find at home.
``If America would let me in, I'd go there,'' he says, laughing at his own joke.
To contact the reporter on this story: Celestine Bohlen in Khotkovo
Slapping a coat of paint on the pedestal of a bust of Lenin in a provincial Russian town may not be much of a job. Kuram, 49, says it beats making the equivalent of $16 a month back home in Uzbekistan.
``If things were better there, I wouldn't be here,'' says the tractor driver, at work in Khotkovo, 60 kilometers (37 miles), northeast of Moscow. He declined to give his last name for fear of running afoul of Russian immigration authorities.
As Russia's booming economy creates greater wealth and aspirations among its citizens, it is also forcing them to confront issues more familiar in the West: discrimination, harassment and even violence aimed at foreign workers like Kuram, who see economic opportunity in taking jobs Russians can't or won't do.
A shrinking local workforce complicates matters, as oil- powered economic growth fuels demand for offices, apartments and shopping malls -- along with people to build and maintain them.
``There is such a deficit of labor all over Russia, just at a time when Russia has woken up,'' says Vladimir Mikhailov, head of construction for NTT, a company based outside Khotkovo that owns state farms, a bank and machine-tool factories.
Kuram, who lives in a trailer, earns about 7,500 rubles, or $300, a month doing odd jobs.
Sweeping Streets
He and his two co-workers, also from Uzbekistan, are among about 4.9 million labor migrants sweeping streets, washing dishes, digging ditches and doing menial building-site work, according to figures from Moscow's Russian Economics Institute. Unofficial estimates put the number at 10 million, most of them from former Soviet republics.
The migrant workers, many with darker skin or Mongoloid facial features, are a visible presence in major cities, and not always welcome -- even though the Russian Federation is a multiethnic country, with more than 100 non-Slavic nationalities, including Tatars, Bashkirs and others.
Attacks against foreigners, some fatal, have been rising. Sova, a Moscow-based group that tracks hate crimes, reports 435 victims of Russian race-based assaults in 2005 and 575 in 2006. In the first four months of this year, there were 209, a third higher than the same period last year.
Still, the migrants come because they say they need the work. The Russian government in the last year has come to the grudging conclusion that it needs them, too.
Falling Population
Russian economic growth has averaged 6.7 percent a year since 1999. Meanwhile, Russia's population fell to 143.8 million in 2006 from 148.7 million in 1992 and continues to slide by almost 1 million a year, government statistics show.
The workforce decline is dramatic. According to the Health and Social Development Ministry, it will drop 12 percent to 65.5 million by 2010 from 74.5 million now because of low fertility rates and the high number of alcohol-related deaths.
Mikhailov says 40 percent of his farm and construction workers are foreigners, many of them of Muslims who don't drink.
``To get Russians to work with their hands is very difficult,'' he says. ``Those between 30 and 40, who could work, are already off on their own. Those who couldn't are drinking now. That's the truth. Why hide it?''
Life expectancy for Russian men is 59 years, two years less than for Uzbek men, even though Russia's per-capita income is six times Uzbekistan's $2,000, according to the CIA World Factbook.
Political Convulsions
Russia is home to the world's second-largest number of immigrants, after the U.S. During the political convulsions following the 1991 collapse of the Soviet Union, millions of people crossed new national borders. Ethnic Russians returned from the republics, joined by millions of undocumented Tajiks, Uzbeks, Moldovans and others.
For people like Kuram, entering Russia isn't difficult: They don't need visas for the first three months. The hard part is working legally. Until this year, almost all labor migrants were part of the ``grey'' economy, exploited by businesses, paid miserable wages and vulnerable to harassment by Russian police.
To give them legal status, the Russian Parliament passed a law in January setting quotas nationally and by region. This year's quota was 6.1 million workers, with 700,000 for Moscow, says Andrei Markov, a World Bank human-development specialist.
`Still Raw'
Fines for employing an illegal worker are as much as 800,000 rubles, Mikhailov says. Yet it can take weeks for migrants to move through waiting lists at the Federal Migration Service, during which they cannot be legally employed. ``The law is still raw,'' he says.
At Khotkovo's main square, in front of a privatized department store named ``Beloved,'' Kuram and his friends struggle with rickety scaffolding as they paint the pedestal with the bust of Lenin.
In the nearby village of Akhtyrka, a workman rebuilds a burned-down cottage, or ``izba,'' as music in the nasal tones of his native Tajik blasts from a boom box.
Most migrants say they long to be with their families. Kuram is heading to Uzbekistan this month, he says, to see his wife and four children. He'll come back, like others seeking jobs they can't find at home.
``If America would let me in, I'd go there,'' he says, laughing at his own joke.
To contact the reporter on this story: Celestine Bohlen in Khotkovo
Obestity Epidemic?
People are getting fatter in all parts of the world, with the possible exception of east Asia, doctors found in a one-day global snapshot of obesity.
Overall, 24 percent of men and 27 percent of women seeing their doctors that day were obese, and another 30 percent of men and 40 percent of women were overweight, the researchers found.
That puts the rest of the world close to par with the United States, long considered the country with the worst weight problem. An estimated two-thirds of Americans are overweight and a third of these are obese.
"The study results show that excess body weight is pandemic, with one-half to two-thirds of the overall study population being overweight or obese," said Beverley Balkau, director of research at the French National health research institute INSERM in Villejuif, who led the study published in the journal Circulation.
People who are overweight have a higher risk of heart disease, diabetes and some types of cancer.
Balkau and colleagues evaluated 168,159 adults who happened to be seeing their primary care doctors in 63 countries across five continents -- but not the United States --in 2006.
In all regions except southern and eastern Asia, 60 percent of men and 50 percent of women were either overweight or obese, they found.
This was measured using body mass index, or BMI, which calculates height to weight and is considered an accurate way of assessing overweight in most adults except highly muscled athletes. A BMI of 18-24 is considered healthy. People with BMIs of 25 to 30 are overweight and anyone with a BMI of 30 or more is obese.
Just 7 percent of people in eastern Asia were obese, compared to 36 percent of people seeing their doctors in Canada, 38 percent of women in Middle Eastern countries and 40 percent in South Africa.
Canada and South Africa led in the percentage of overweight people, with an average BMI of 29 among both men and women in Canada and 29 among South African women.
In Northern Europe men had an average BMI of 27 and women 26 -- just into the overweight category. In southern Europe, the average BMI was 28. In Australia BMI was 28 for men and 27.5 for women while in Latin America the average BMI was just under 28.
Other experts noted that the people studied were all seeing doctors at the time.
This clearly would affect the results, said Dr. Gerald Fletcher, a cardiologist at the Mayo Clinic in Jacksonville, Florida and a spokesman for the American Heart Association.
While the poorest people in industrialized countries tend to be among the most overweight, this is not the case in the developing world, where the poorest have little chance of ever seeing a doctor and are also often undernourished.
But the findings also mean doctors can do more to help patients, Fletcher said.
"Health care providers are not paying enough attention to people who are too fat," Fletcher said in a telephone interview.
"We don't look at prevention enough."
Overall, 24 percent of men and 27 percent of women seeing their doctors that day were obese, and another 30 percent of men and 40 percent of women were overweight, the researchers found.
That puts the rest of the world close to par with the United States, long considered the country with the worst weight problem. An estimated two-thirds of Americans are overweight and a third of these are obese.
"The study results show that excess body weight is pandemic, with one-half to two-thirds of the overall study population being overweight or obese," said Beverley Balkau, director of research at the French National health research institute INSERM in Villejuif, who led the study published in the journal Circulation.
People who are overweight have a higher risk of heart disease, diabetes and some types of cancer.
Balkau and colleagues evaluated 168,159 adults who happened to be seeing their primary care doctors in 63 countries across five continents -- but not the United States --in 2006.
In all regions except southern and eastern Asia, 60 percent of men and 50 percent of women were either overweight or obese, they found.
This was measured using body mass index, or BMI, which calculates height to weight and is considered an accurate way of assessing overweight in most adults except highly muscled athletes. A BMI of 18-24 is considered healthy. People with BMIs of 25 to 30 are overweight and anyone with a BMI of 30 or more is obese.
Just 7 percent of people in eastern Asia were obese, compared to 36 percent of people seeing their doctors in Canada, 38 percent of women in Middle Eastern countries and 40 percent in South Africa.
Canada and South Africa led in the percentage of overweight people, with an average BMI of 29 among both men and women in Canada and 29 among South African women.
In Northern Europe men had an average BMI of 27 and women 26 -- just into the overweight category. In southern Europe, the average BMI was 28. In Australia BMI was 28 for men and 27.5 for women while in Latin America the average BMI was just under 28.
Other experts noted that the people studied were all seeing doctors at the time.
This clearly would affect the results, said Dr. Gerald Fletcher, a cardiologist at the Mayo Clinic in Jacksonville, Florida and a spokesman for the American Heart Association.
While the poorest people in industrialized countries tend to be among the most overweight, this is not the case in the developing world, where the poorest have little chance of ever seeing a doctor and are also often undernourished.
But the findings also mean doctors can do more to help patients, Fletcher said.
"Health care providers are not paying enough attention to people who are too fat," Fletcher said in a telephone interview.
"We don't look at prevention enough."
Master Liquidity Enhancement Conduit
U.S. asset-backed commercial paper shrank for a 10th straight week last week, defying for now efforts by a group of America's biggest banks to shore up an important but ailing corner of the credit market.
The total asset-backed market has withered by as much as 25 percent from its record size in early August, and now stands at its smallest in 18 months, Federal Reserve data showed on Thursday.
Commercial paper is a vital source of short-term funding for daily operations at many companies, but its issuance largely ground to a halt as a crisis that began in risky mortgages led to a broader credit crunch.
The overall U.S. commercial paper sector did increase $1.3 billion to $1.866 trillion in the week ended Oct. 17. But asset-backed commercial paper, the hardest hit sector in the crisis because of its links to housing, fell $11.0 billion after a $6.8 billion decline the previous week.
"That's a dead market," said Howard Simons, strategist with Bianco Research in Chicago, of the housing-related subsectors of asset-backed commercial paper.
Such sentiment fed into recent worries that a massive fund organized by Bank of America Corp. (BAC.N: Quote, Profile, Research), Citigroup Inc. (C.N: Quote, Profile, Research) and JP Morgan Chase & Co. (JPM.N: Quote, Profile, Research) to rescue these tarnished assets may not work.
Many fear the so-called master liquidity enhancement conduit (M-LEC), which will buy securities from structured investment vehicles known as SIVs, will only target higher-rated paper, a fairly small chunk of the total.
Outstanding asset-backed commercial paper, often referred to as ABCP, diminished to $888.3 billion in the latest week from $899.3 billion the previous week.
Encouragingly, other areas showed expansion. Nonfinancial commercial paper showed its biggest increase in eight weeks.
"The figures as they stand would have been taken positively in the several weeks prior, but because of the announcement this week of the M-LEC and the decline in the asset backed category, the largest in three weeks, there will probably be more negativity expressed about today's figure than would have been deserved," said Tony Crescenzi, chief bond market strategist, Miller, Tabak & Co. in New York.
"There is a feeling there could be a new round of weakness in the asset-backed commercial paper market," said Crescenzi.
In early August a crisis erupted in credit markets that rocked the usually-sedate world of short-term lending, including commercial paper. Many money managers struck riskier ABCP off their list of approved securities in August, darkening the prospects for SIVs.
"The numbers tell the story," said Stephen Wesselkamper, a portfolio manager at Victory Capital Management in Cleveland, Ohio. "People are not willing to wade into these markets until there's more disclosure. In many cases we're funding assets that we really don't know what they are,"
Financial corporate commercial paper issuance rose $5.8 billion, after a $15.1 billion increase the week before.
The total asset-backed market has withered by as much as 25 percent from its record size in early August, and now stands at its smallest in 18 months, Federal Reserve data showed on Thursday.
Commercial paper is a vital source of short-term funding for daily operations at many companies, but its issuance largely ground to a halt as a crisis that began in risky mortgages led to a broader credit crunch.
The overall U.S. commercial paper sector did increase $1.3 billion to $1.866 trillion in the week ended Oct. 17. But asset-backed commercial paper, the hardest hit sector in the crisis because of its links to housing, fell $11.0 billion after a $6.8 billion decline the previous week.
"That's a dead market," said Howard Simons, strategist with Bianco Research in Chicago, of the housing-related subsectors of asset-backed commercial paper.
Such sentiment fed into recent worries that a massive fund organized by Bank of America Corp. (BAC.N: Quote, Profile, Research), Citigroup Inc. (C.N: Quote, Profile, Research) and JP Morgan Chase & Co. (JPM.N: Quote, Profile, Research) to rescue these tarnished assets may not work.
Many fear the so-called master liquidity enhancement conduit (M-LEC), which will buy securities from structured investment vehicles known as SIVs, will only target higher-rated paper, a fairly small chunk of the total.
Outstanding asset-backed commercial paper, often referred to as ABCP, diminished to $888.3 billion in the latest week from $899.3 billion the previous week.
Encouragingly, other areas showed expansion. Nonfinancial commercial paper showed its biggest increase in eight weeks.
"The figures as they stand would have been taken positively in the several weeks prior, but because of the announcement this week of the M-LEC and the decline in the asset backed category, the largest in three weeks, there will probably be more negativity expressed about today's figure than would have been deserved," said Tony Crescenzi, chief bond market strategist, Miller, Tabak & Co. in New York.
"There is a feeling there could be a new round of weakness in the asset-backed commercial paper market," said Crescenzi.
In early August a crisis erupted in credit markets that rocked the usually-sedate world of short-term lending, including commercial paper. Many money managers struck riskier ABCP off their list of approved securities in August, darkening the prospects for SIVs.
"The numbers tell the story," said Stephen Wesselkamper, a portfolio manager at Victory Capital Management in Cleveland, Ohio. "People are not willing to wade into these markets until there's more disclosure. In many cases we're funding assets that we really don't know what they are,"
Financial corporate commercial paper issuance rose $5.8 billion, after a $15.1 billion increase the week before.
India gyrates as the World and his wife want in
Efforts by India to control massive flows of money into its markets have prompted two sharp falls and one new all-time high, all in two days. Welcome to emerging markets, the world's new favorite asset class.
India on Wednesday shocked investors by announcing planned new curbs on investment in its equities by anonymous overseas funds, sparking a selloff in Bombay of as much as nine percent.
But after the panic selling, it was back to panic buying, followed shortly by more panic selling. India's benchmark Sensex (.BSESN: Quote, Profile, Research) index hit another all-time high on Thursday before falling again to end the day 5 percent down.
The Sensex is now up 30 percent this year and almost 15 percent since the Federal Reserve cut rates in September.
Expect the wild ride to continue, as recent data show that the World, his wife, their milkman and the neighborhood stray cat are all going long emerging markets at the same time.
A Merrill Lynch poll of global fund managers controlling $671 billion of assets showed a stampede into emerging markets in October. A total of 61 percent of funds were aggressively or moderately overweight emerging market equities, up 50 percent since August and the most since April 2004.
Twenty percent of funds were "aggressively overweight" emerging market stocks, compared to just 4 percent on U.S. shares and 1 percent on UK shares.
What's more funds in all regions outside of emerging markets said they were looking for stocks with exposure to overseas demand, a strong indication that even those unable to buy emerging markets are seeking to get exposure to growth there.
Why? Investors are worried that growth in the developed world will be crimped by the bursting of the housing and credit bubbles and see emerging markets as the sole hope.
"People have become more pessimistic about the developed world and emerging markets are seen as the oasis," said David Bowers, an independent consultant to Merrill Lynch on the survey.
"There is a cast-iron belief that emerging markets and China are bomb proof when it comes to the rest of the world slowing."
"The bull case is that there is a shortage of organic growth anywhere else because companies have been run for cash and not for growth the past five years (in the developed world)," he said.
WORLD TO EMERGING MARKETS: MAKE MORE SECURITIES
India's experience in the past couple of days is an object lesson in the distortions and strains this phenomenon is causing.
India is concerned about flows into its economy and share markets, partly because some of the flows are so-called hedge fund "hot money" and partly because it has driven a rise in the value of the rupee which is complicating Indian authorities' attempts to manage the economy and monetary policy.
The Securities and Exchange Board of India said it would over 18 month wind down participatory note programs, which are used by foreigners, often hedge funds, to invest in shares anonymously.
Foreign institutions have put more than $17 billion in Indian shares this year, as against a record $10.7 billion in 2005.
There is a lot of money that wants in, but not enough to invest in. Initial public offerings were $6.8 billion through September, a new record on even a full year basis, but you can expect that there will be much more securities issuance to come throughout emerging markets, and not just in equities.
A host of emerging market bonds have been launched to warm receptions in recent days, despite continuing difficulties in many other debt markets.
Sri Lanka, which is contending with a long-running rebellion and 17 percent inflation, found that not only was it able to make its debut issue, borrowing for a long five years, but that the $500 million deal drew commitments of $1.25 billion.
India on Wednesday shocked investors by announcing planned new curbs on investment in its equities by anonymous overseas funds, sparking a selloff in Bombay of as much as nine percent.
But after the panic selling, it was back to panic buying, followed shortly by more panic selling. India's benchmark Sensex (.BSESN: Quote, Profile, Research) index hit another all-time high on Thursday before falling again to end the day 5 percent down.
The Sensex is now up 30 percent this year and almost 15 percent since the Federal Reserve cut rates in September.
Expect the wild ride to continue, as recent data show that the World, his wife, their milkman and the neighborhood stray cat are all going long emerging markets at the same time.
A Merrill Lynch poll of global fund managers controlling $671 billion of assets showed a stampede into emerging markets in October. A total of 61 percent of funds were aggressively or moderately overweight emerging market equities, up 50 percent since August and the most since April 2004.
Twenty percent of funds were "aggressively overweight" emerging market stocks, compared to just 4 percent on U.S. shares and 1 percent on UK shares.
What's more funds in all regions outside of emerging markets said they were looking for stocks with exposure to overseas demand, a strong indication that even those unable to buy emerging markets are seeking to get exposure to growth there.
Why? Investors are worried that growth in the developed world will be crimped by the bursting of the housing and credit bubbles and see emerging markets as the sole hope.
"People have become more pessimistic about the developed world and emerging markets are seen as the oasis," said David Bowers, an independent consultant to Merrill Lynch on the survey.
"There is a cast-iron belief that emerging markets and China are bomb proof when it comes to the rest of the world slowing."
"The bull case is that there is a shortage of organic growth anywhere else because companies have been run for cash and not for growth the past five years (in the developed world)," he said.
WORLD TO EMERGING MARKETS: MAKE MORE SECURITIES
India's experience in the past couple of days is an object lesson in the distortions and strains this phenomenon is causing.
India is concerned about flows into its economy and share markets, partly because some of the flows are so-called hedge fund "hot money" and partly because it has driven a rise in the value of the rupee which is complicating Indian authorities' attempts to manage the economy and monetary policy.
The Securities and Exchange Board of India said it would over 18 month wind down participatory note programs, which are used by foreigners, often hedge funds, to invest in shares anonymously.
Foreign institutions have put more than $17 billion in Indian shares this year, as against a record $10.7 billion in 2005.
There is a lot of money that wants in, but not enough to invest in. Initial public offerings were $6.8 billion through September, a new record on even a full year basis, but you can expect that there will be much more securities issuance to come throughout emerging markets, and not just in equities.
A host of emerging market bonds have been launched to warm receptions in recent days, despite continuing difficulties in many other debt markets.
Sri Lanka, which is contending with a long-running rebellion and 17 percent inflation, found that not only was it able to make its debut issue, borrowing for a long five years, but that the $500 million deal drew commitments of $1.25 billion.
Record level of ‘Bric’ IPOs offsets fall
Record levels of initial public offerings in emerging economies offset declines elsewhere and helped support the global new issues market in the third quarter, according to a report on the sector by Ernst & Young on Tuesday.
Nearly half of the $57bn raised globally by IPOs in the latest quarter was by companies in the so-called “Bric” countries of Brazil, Russia, India and China, which produced a record 118 IPOs.
Seven out of the top 10 IPOs in the third quarter were from emerging markets. The Asia-Pacific – led by China and Hong Kong – had the lion’s share in terms of both the number of IPOs completed and the total capital raised.
“The record numbers of IPOs in the emerging markets show that it is these countries that are driving global economic growth,” said Gil Forer, global director of IPO Initiatives at E&Y.
Investor sentiment for emerging market assets has been exuberant in recent weeks – in spite of the global credit squeeze and ongoing market uncertainty. In addition to frenetic activity in the primary markets, there has also been sharp rallies in many stock markets, including China, Hong Kong and India.
“The prospect of an economic slowdown has heightened interest in companies that have genuinely superior growth stories,” said John Crompton, head of equity capital markets for Europe, Middle East and Africa at Merrill Lynch.
“Expect to see these trends reflected in the new issue markets. Emerging markets look likely to generate substantial new issue volumes.”
Over the weekend, Petro-China, the state-owned oil and gas group, launched a long-awaited domestic listing in Shanghai, a deal that could raise more than $9bn.
On Monday, Turkey’s Digiturk, a digital television broadcaster, set a price range for an IPO in London, while a number of Russian firms indicated plans to pursue share sales by the end of the year.
Meanwhile, Grupo Clarín, Argentina’s biggest media group, raised more than $500m on the London Stock Exchange on Friday.
In contrast to the rising activity in emerging markets, IPO volumes by developed markets have declined, possibly because of the uncertainty caused by the credit squeeze, the E&Y report said.
Overall global IPO volume fell by 36 per cent to $57bn raised in the third quarter from $89bn raised in the second – though the amount was still more than the $45bn raised in the third quarter last year.
Nearly half of the $57bn raised globally by IPOs in the latest quarter was by companies in the so-called “Bric” countries of Brazil, Russia, India and China, which produced a record 118 IPOs.
Seven out of the top 10 IPOs in the third quarter were from emerging markets. The Asia-Pacific – led by China and Hong Kong – had the lion’s share in terms of both the number of IPOs completed and the total capital raised.
“The record numbers of IPOs in the emerging markets show that it is these countries that are driving global economic growth,” said Gil Forer, global director of IPO Initiatives at E&Y.
Investor sentiment for emerging market assets has been exuberant in recent weeks – in spite of the global credit squeeze and ongoing market uncertainty. In addition to frenetic activity in the primary markets, there has also been sharp rallies in many stock markets, including China, Hong Kong and India.
“The prospect of an economic slowdown has heightened interest in companies that have genuinely superior growth stories,” said John Crompton, head of equity capital markets for Europe, Middle East and Africa at Merrill Lynch.
“Expect to see these trends reflected in the new issue markets. Emerging markets look likely to generate substantial new issue volumes.”
Over the weekend, Petro-China, the state-owned oil and gas group, launched a long-awaited domestic listing in Shanghai, a deal that could raise more than $9bn.
On Monday, Turkey’s Digiturk, a digital television broadcaster, set a price range for an IPO in London, while a number of Russian firms indicated plans to pursue share sales by the end of the year.
Meanwhile, Grupo Clarín, Argentina’s biggest media group, raised more than $500m on the London Stock Exchange on Friday.
In contrast to the rising activity in emerging markets, IPO volumes by developed markets have declined, possibly because of the uncertainty caused by the credit squeeze, the E&Y report said.
Overall global IPO volume fell by 36 per cent to $57bn raised in the third quarter from $89bn raised in the second – though the amount was still more than the $45bn raised in the third quarter last year.
Saturday, October 13, 2007
Bulgaria′s PM Downplays Fears of Economy Overheating
Ivo Prokopiev, Chairman of the Confederation of Employers and Industrialists in Bulgaria (L) and Prime Minister Sergey Stanishev (R) joined the annual meeting of business and government. The economy of Bulgaria, which joined the European Union in January, is not showing signs of overheating, the prime minister has argued in defiance of experts' increasing warnings.
"I don't think it is correct to talk about Bulgaria's economy overheating," Sergey Stanishev said at the annual meeting of government and business that discussed the risks and opportunities of the second decade of growth. The forum was organized by the "Capital" economic weekly and the German "Handelsblatt" business daily in partnership with the Confederation of Employers and Industrialists in Bulgaria (CEIB).
Stanishev admitted the government had its doubts about the budget at the beginning of the year following the decision to cut the corporate tax from 15% to 10%. "We feared a repeat of Hungary's scenario, but managed to steer clear by implementing a number of measures," he said. According to him everyone is talking about the budget surplus, but few are aware of the risks that a widening current account deficit poses.
Stanishev reiterated his warnings of financial destabilization and hyperinflation if wages are doubled throughout the public sector. "In order to catch up with the developed countries of the European Union and have a knowledge-based economy, we need reforms of a new generation in education, development and the labour market," he said.
According to CEIB chair Ivo Prokopiev, the property market and construction sector will continue to be major drive of the economy for another five or seven years. "During this period we must find smart, based on new technologies industries, which will create added value and become the economy's new drive," Prokopiev said.
The World Bank and international ratings agency Standard&Poor's have recently warned that the economy of Bulgaria is at a risk of overheating and called for a policy mix cooling down excessive domestic demand to minimize the risk of asset and debt bubbles emerging and bursting.
"I don't think it is correct to talk about Bulgaria's economy overheating," Sergey Stanishev said at the annual meeting of government and business that discussed the risks and opportunities of the second decade of growth. The forum was organized by the "Capital" economic weekly and the German "Handelsblatt" business daily in partnership with the Confederation of Employers and Industrialists in Bulgaria (CEIB).
Stanishev admitted the government had its doubts about the budget at the beginning of the year following the decision to cut the corporate tax from 15% to 10%. "We feared a repeat of Hungary's scenario, but managed to steer clear by implementing a number of measures," he said. According to him everyone is talking about the budget surplus, but few are aware of the risks that a widening current account deficit poses.
Stanishev reiterated his warnings of financial destabilization and hyperinflation if wages are doubled throughout the public sector. "In order to catch up with the developed countries of the European Union and have a knowledge-based economy, we need reforms of a new generation in education, development and the labour market," he said.
According to CEIB chair Ivo Prokopiev, the property market and construction sector will continue to be major drive of the economy for another five or seven years. "During this period we must find smart, based on new technologies industries, which will create added value and become the economy's new drive," Prokopiev said.
The World Bank and international ratings agency Standard&Poor's have recently warned that the economy of Bulgaria is at a risk of overheating and called for a policy mix cooling down excessive domestic demand to minimize the risk of asset and debt bubbles emerging and bursting.
Inflation soars in all three Baltic states, triggering renewed fears of contagion
From the Baltic Times:
Inflation soars in all three Baltic states, triggering renewed fears of contagion
RIGA - Consumer prices soared in September throughout the Baltic region, surpassing analysts’ expectations and sparking new fears of macroeconomic imbalances that could eventually lead to hard times.
In Latvia, the Baltic’s inflationary champion, consumer prices rose 11.4 percent annually as of September, the highest level in 10 years. Inflation for the month reached 10.9 percent, the highest since January 1997, the statistics agency said.
In Estonia, annual inflation reached 7.2 percent, significantly beyond the estimates of some 6.3 – 6.5 percent and leading some analysts to believe that 8 percent was a real possibility for the entire calendar year.
Finally, in Lithuania, where inflation has been relatively tame in recent years, the consumer price index catapulted to 7.1 percent based on September data. Again, the result was far higher than analysts’ expectations and pointed to the strong influence of global factors on domestic prices.
All the Baltic inflation data was released over the course of two business days (Oct. 5 and Oct. 8) and just after the three prime ministers met to discuss regional relations. The three heads of government agreed that global factors were partly to blame and that fiscal policy should be used to combat the runaway price increases.
“Inflation is an objective byproduct of the current economic development,” Latvia’s Aigars Kalvitis said, “and it will be impossible to solve the inflation problem in short term.”
Commenting as to why inflation in Latvia was considerably higher than in the neighboring states, Kalvitis pointed to Latvia’s skyrocketing wages, which increased 34 percent in the first half of the year. The comparable figures in Estonia and Lithuania were approximately 20 percent.
“[Inflation] is nothing special for the Baltic states,” said Estonia’s Andrus Ansip. “The situation is similar in other member states of the EU. Certain similarities with the U.S. can also be traced.”
Inflation in the Baltics is indeed as a result of phenomenal economic growth sparked by domestic demand and inexpensive credit, as well as years of a booming property market. In the upcoming months, rising energy prices – Russia’s Gazprom is charging more for a 1,000 cubic meters of gas – and soaring food prices are expected to lead consumer prices even higher.
No one is expecting the rate of increase in consumer prices to fall anytime soon. Some have said the first signs of a fall may occur only in the spring.
Latvia and Estonia were the two fastest growing economies in the EU last year, an accomplishment they could repeat this year. However, high inflation, unbridled wage increases, current account deficits and a labor deficit are conspiring to undermine economic gains and burst the Baltics’ bubble. A “hard-landing” scenario with GDP growth slowing to around zero cannot be ruled out, analysts say.
The September inflation data “is yet another sign that the Latvian economy is overheating – the risk of a hard-landing should not be ignored,” wrote Danske Bank in a research note Oct. 8. The bank said that the government’s anti-inflation plan has failed to accomplish what it was designed to do and that inflation could climb to 12 percent by the end of the year and 13 – 14 percent in the first quarter of 2008.
Latvia’s inflation last fell in May, when it hit an annual rate of 8.2 percent (as opposed to 8.9 percent in April).
Elina Allikalt, an analyst with Hansabank Markets in Estonia, said that her inflation estimates for that country over the coming months remained high, with October price increases expected to end up in the 7.3 - 7.7 percent range. Eight percent couldn’t be ruled out, she said.
“At the same time, the high anticipated inflation in October may be partially held back by the declining prices for motor fuel and a correction in the prices of various services,” Allikalt said.
Administratively regulated prices in Estonia climbed 7.4 percent and non-administered prices by 7.2 percent year-on-year, according to the statistics office.
If inflation has dogged Estonia and Latvia for months now, in Lithuania it is a relatively young phenomenon. In August annual inflation was 5.5 percent, so the sudden leap to 7.1 percent in September is a cause for serious concern.
Bulgaria is current the inflationary leader in the EU after its August inflation skyrocketed to 12 percent.
Meanwhile, a report by the Estonian Institute of Economic Research released Oct. 3 found that the labor shortage will remain a problem and will hinder attempts to increase output. The institute wrote in its survey that 42 percent of the managers interviewed said that the labor deficit was an obstacle to boosting output.
Inflation soars in all three Baltic states, triggering renewed fears of contagion
RIGA - Consumer prices soared in September throughout the Baltic region, surpassing analysts’ expectations and sparking new fears of macroeconomic imbalances that could eventually lead to hard times.
In Latvia, the Baltic’s inflationary champion, consumer prices rose 11.4 percent annually as of September, the highest level in 10 years. Inflation for the month reached 10.9 percent, the highest since January 1997, the statistics agency said.
In Estonia, annual inflation reached 7.2 percent, significantly beyond the estimates of some 6.3 – 6.5 percent and leading some analysts to believe that 8 percent was a real possibility for the entire calendar year.
Finally, in Lithuania, where inflation has been relatively tame in recent years, the consumer price index catapulted to 7.1 percent based on September data. Again, the result was far higher than analysts’ expectations and pointed to the strong influence of global factors on domestic prices.
All the Baltic inflation data was released over the course of two business days (Oct. 5 and Oct. 8) and just after the three prime ministers met to discuss regional relations. The three heads of government agreed that global factors were partly to blame and that fiscal policy should be used to combat the runaway price increases.
“Inflation is an objective byproduct of the current economic development,” Latvia’s Aigars Kalvitis said, “and it will be impossible to solve the inflation problem in short term.”
Commenting as to why inflation in Latvia was considerably higher than in the neighboring states, Kalvitis pointed to Latvia’s skyrocketing wages, which increased 34 percent in the first half of the year. The comparable figures in Estonia and Lithuania were approximately 20 percent.
“[Inflation] is nothing special for the Baltic states,” said Estonia’s Andrus Ansip. “The situation is similar in other member states of the EU. Certain similarities with the U.S. can also be traced.”
Inflation in the Baltics is indeed as a result of phenomenal economic growth sparked by domestic demand and inexpensive credit, as well as years of a booming property market. In the upcoming months, rising energy prices – Russia’s Gazprom is charging more for a 1,000 cubic meters of gas – and soaring food prices are expected to lead consumer prices even higher.
No one is expecting the rate of increase in consumer prices to fall anytime soon. Some have said the first signs of a fall may occur only in the spring.
Latvia and Estonia were the two fastest growing economies in the EU last year, an accomplishment they could repeat this year. However, high inflation, unbridled wage increases, current account deficits and a labor deficit are conspiring to undermine economic gains and burst the Baltics’ bubble. A “hard-landing” scenario with GDP growth slowing to around zero cannot be ruled out, analysts say.
The September inflation data “is yet another sign that the Latvian economy is overheating – the risk of a hard-landing should not be ignored,” wrote Danske Bank in a research note Oct. 8. The bank said that the government’s anti-inflation plan has failed to accomplish what it was designed to do and that inflation could climb to 12 percent by the end of the year and 13 – 14 percent in the first quarter of 2008.
Latvia’s inflation last fell in May, when it hit an annual rate of 8.2 percent (as opposed to 8.9 percent in April).
Elina Allikalt, an analyst with Hansabank Markets in Estonia, said that her inflation estimates for that country over the coming months remained high, with October price increases expected to end up in the 7.3 - 7.7 percent range. Eight percent couldn’t be ruled out, she said.
“At the same time, the high anticipated inflation in October may be partially held back by the declining prices for motor fuel and a correction in the prices of various services,” Allikalt said.
Administratively regulated prices in Estonia climbed 7.4 percent and non-administered prices by 7.2 percent year-on-year, according to the statistics office.
If inflation has dogged Estonia and Latvia for months now, in Lithuania it is a relatively young phenomenon. In August annual inflation was 5.5 percent, so the sudden leap to 7.1 percent in September is a cause for serious concern.
Bulgaria is current the inflationary leader in the EU after its August inflation skyrocketed to 12 percent.
Meanwhile, a report by the Estonian Institute of Economic Research released Oct. 3 found that the labor shortage will remain a problem and will hinder attempts to increase output. The institute wrote in its survey that 42 percent of the managers interviewed said that the labor deficit was an obstacle to boosting output.
Lorenzo Bini Smaghi on the Baltic and Bulgarian Currency Pegs
Real convergence in Central, Eastern and South-Eastern Europe
Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECB at the ECB Conference on central, eastern and south-eastern Europe,
Frankfurt, 1 October 2007
Introduction [1]
Ladies and Gentlemen:
I would like to welcome you all to Frankfurt, and to our economic conference on central, eastern and south-eastern Europe.
Let me start by saying a few words about the meeting itself, which is the second of its kind. With this conference the ECB aims to foster cooperation and provide a forum for a multilateral discussion among central bankers in the region. Taking a regional perspective is useful given the similarities in economic structures of the countries concerned. To a large extent, these similarities reflect the common background of transition to a market economy. This transition has important implications, in particular with respect to policy challenges.
In the region, ten countries are Member States of the European Union, while the remaining seven are candidate or potential candidate countries at different stages of the process. [2] But the feedback we have received from last year's conference indicated that this heterogeneity actually reinforces the usefulness of taking a regional perspective.
This brings me to the overriding theme of this conference, real convergence. As central bankers, we are used to discuss nominal convergence, since it is at the heart of our main task, maintaining price stability. It is also at the heart of the Maastricht criteria on the adoption of the euro. However, we chose this time to focus on the other side of the coin. There are three reasons for this. First, catching up is the main goal of all the countries under review. Second, real convergence has gained momentum in recent years, also in countries where progress had been slower in the 1990s. Third, real convergence has important implications for nominal convergence.
Against this background, I will first briefly review some stylised facts of real convergence in central, eastern and south-eastern Europe. I will then turn to selected aspects of the convergence process, namely
growth and convergence,
financial globalisation and the current account,
financial development,
and finally, implications for monetary policy.
By contrasting theory and empirical evidence I would like to bring the attention to some interesting and unresolved issues and to identify key policy challenges that the conference participants might want to consider further.
1. Real convergence in central, eastern and south-eastern Europe – where do we stand?
Let me start with some facts and figures. The convergence experience in central, eastern and south-eastern Europe can be summarised as follows:
Following notable output losses during the early 1990s, all countries in the region have seen a strong recovery. With a few exceptions, most of them have passed their pre-transition levels of real per capita income.
The recovery resulted in convergence towards the real income per capita level in the euro area. In the EU Member States of the region, real per capita income reached 40% of the euro area level in 2005, an increase of about nine percentage points since 1993. In candidate and potential candidate countries – excluding Turkey – a rise of seven percentage points was recorded in the same period, so that at end-2005, their average real per capita income stood at about 23% of the euro area level.
The timing and speed of convergence has varied substantially, reflecting differences in political stability and progress in structural reforms. Strong growth, fostered by structural reforms, investment and FDI, has been a key feature of economic developments in almost all New Member States since the mid-1990s. In most candidate and potential candidate countries, instead, the catching-up process has gained speed only in this decade.
Total factor productivity has been the main driver of growth and convergence across the region. Labour productivity has increased in all countries, closing the gap relative to the euro area. At the same time, in many countries labour utilisation is substantially below the euro area level, reflecting the large size of the informal sector as well as labour market frictions and mismatches.
To sum up: substantial progress has been made, but gaps in terms of income per capita relative to the euro area remain large. This suggests that the challenges of real convergence, which you have the opportunity to discuss today and tomorrow, will remain relevant for several years.
2. Convergence in central, eastern and south-eastern Europe – theory and evidence
Growth and convergence
In the last few years, the economic profession has been engaged in a controversial discussion on the origins of growth. [3] To a large extent, the debate was triggered by the empirical observation of increasing divergence of per capita income across countries. [4] Indeed, the evidence seemed to contradict a key prediction of standard growth theory: countries with relatively low per capita income should catch-up with richer ones. In theory, since capital is generally scarce in low income countries its rate of return should be higher than in richer economies, investment should be stronger, resulting in an increasing capital stock, production and finally income. Thus, per capita income differences should fall over time. Clearly, the global evidence on divergence of per capita income is inconsistent with this reasoning.
Two avenues have been followed to address this contradiction. The first one tries to take into account factors that actually prevent the marginal product of capital to fall – or at least: prevent it from falling to zero – even if the capital intensity of production is rising over time, as theory would predict. Literally millions of cross-country regressions [5] have been run to identify factors conditioning convergence, from the investment rate itself to macroeconomic, financial sector and institutional variables. And while absolute convergence has not been supported by the data, conditional convergence has been found to hold, even if not in all samples and periods.
Evidence of convergence in central, eastern and south-eastern Europe lends strong support to the conditional convergence hypothesis of standard growth theory. To be sure the acquis communautaire is a structural factor which has provided a common framework for the countries in the region to engage in rapid convergence. [6] To sustain the catching-up with living standards in the euro area, continued structural convergence along the lines of the acquis communautaire is crucial, in particular in candidate and potential candidate countries.
However, there are also features in the current catching-up process that are at odds with established growth empirics. In particular, several empirical studies suggest that convergence in the region seems to have been driven by the growth of total factor productivity. [7] This contrasts with the evidence found for other rapidly converging economies, for example in Asia, where capital accumulation has been identified as the main driver of real convergence with advanced economies. [8]
Transition is the prime candidate to account for this anomaly. The heritage of central planning left many economies with large inefficiencies in production, which offered a vast potential for efficiency gains in the course of the regime shift. Economies in the region have made extensive use of this potential. This nevertheless raises an important question on the sustainability of the convergence process in the future. If strong TFP growth has been mainly the result of transition, it is not a renewable source of convergence for the future (i.e., when transition is over). Other sources must be found. One factor is efficient financial intermediation. After all, the financial sector is the “brain” of the market economy in allocating resources and allowing capital to flow to its most productive use. [9] This is what the empirical literature on finance and growth suggests, namely that financial development is significantly correlated with total factor productivity and less so with private savings rates or capital accumulation. [10] Clearly, financial development in the region has advance rapidly. Nonetheless, capital accumulation should be expected to make a larger contribution to growth and real convergence in the future. However, while investment rates have been rising in central, eastern and south-eastern Europe, they are not particularly high by emerging market standards. Compared with emerging Asia they can even be considered as rather low. Why have investment rates been relatively subdued and what are the policies to be pursued fostering capital formation?
Financial globalisation and the current account
Conceptually, the policy question may be easy to answer: continued structural reforms, enhancing flexibility in labour and product markets, improving the business climate and governance. These are the standard responses. However, a rise in investment might contribute to a further widening of current account deficits. Indeed, in recent years investment in the region has been increasingly financed by tapping foreign savings. As a result, current account deficits have reached levels of more than 10% of GDP in several countries.
From a theoretical perspective, current account deficits may actually be interpreted as in line with the predictions of standard theory. [11] However, other emerging market economies have seen just the opposite pattern, namely convergence accompanied by improving current account balances, most visible in the high and widening current account surpluses in emerging Asia. It is even more striking that current account surpluses have been observed in parallel with increasing financial globalisation. Financial globalisation should facilitate capital flowing from rich to poor countries, the opposite of what we observe. This is known, as you know, as the “Lucas paradox” from the seminal article where Lucas pointed out that capital is flowing from emerging to advanced economies, contradicting predictions of standard models of trade and growth. [12] This paradox can still be observed in many parts of the world, resulting in what are commonly known as global imbalances. [13]
Various explanations have been suggested to account for this at least seemingly paradoxical development. On the one hand, rate of return differentials might be smaller than suggested by the relative scarcity and abundance of capital, reflecting larger risks related to a higher level of uncertainty due to less developed legal and financial systems. Vice versa, the lower level of institutional quality in many emerging market economies might result in an outflow of capital because of lesser opportunities for financial investment. [14]
Countries in central, eastern and south-eastern Europe seem once again to be special among emerging markets. Their process of real convergence has been accompanied by very different current account developments than in other emerging markets. Why have countries in the region, while accumulating sizeable foreign exchange reserves, used so much foreign savings to finance current spending? Have financial factors that explain the current account surpluses in emerging Asia had a different impact in emerging Europe? [15]
Finding an answer to these questions is important not only to square empirical evidence with theory, but also from a policy perspective. Should policy makers get comfort from the fact that the imbalances in central, eastern and south-eastern Europe are in line with standard economic theory? Or should we be worried that these imbalances can be very disruptive for convergence if they prove to be unsustainable, as corrections can be painful and costly? [16]
Financial development
Let me now focus more closely on financial factors in the region, in particular the banking sector, which has seen a very peculiar form of structural convergence and financial integration. In most countries the banking sector is dominated by subsidiaries or branches of banks headquartered in the euro area. [17] While similar developments have been also seen in other emerging market economies [18], the process is unique in emerging Europe [19], where banks have expanded their presence in what has been perceived to become a single, large European financial market in the future.
Financial deepening in the region has been extremely rapid. Credit growth rates have been particularly high for consumer and mortgage lending, reaching in some countries and in some years more than 100% p.a.
Should we be worried by these developments? Research suggests that rapid credit growth does not necessarily lead to financial turbulence, but it is one of the main predictors. [20] Moreover, the structure of credit, featuring prominently loans denominated in foreign currency, gives reason for concern. How sustainable are debt burdens in the case of an economic downturn or significant exchange rate depreciation? Are the speed limits to real convergence set by financial factors?
The main policy challenge: overheating
This brings me to the last point I would like to deal with in these introductory remarks, namely the challenges for monetary policy. Until recently, demand pressures arising from strong credit growth and capital inflows have not been reflected in rising inflation for three reasons. First, strong productivity growth. Second, the current account, financed largely by FDI, which served as a convenient outlet for buoyant demand. Third, in nearly all these economies there is still substantial slack in the labour market, which is being nevertheless quickly absorbed.
Over the last two years, domestic demand pressures have started to increase and have been reflected in domestic price developments. Does this mean that countries have reached or even passed their growth potential? The evidence is not clear-cut. While there has been strong growth in recent years, labour utilisation has remained low. The same holds for participation and employment rates. Unemployment, even though declining recently, is still high in many countries. There thus seems to be ample space for a larger contribution of labour to growth, mitigating the constraints for a further rise of potential output. At the same time, labour markets in the region are characterised by substantial mismatches. [21] Moreover, labour market disequilibria may be exacerbated by significant migration flows, limiting the supply response to the rise in demand at least in some countries. As a result, we observe the paradox of low labour utilisation and tight labour markets at the same time.
Theory suggests that in a process of rapid real convergence countries should experience higher overall inflation rates, due to the Balassa-Samuelson effect. However, the recent rise in inflation can hardly be explained by this effect alone. A review of empirical studies on the size of the Balassa-Samuelson effect in central, eastern and south-eastern European countries suggests that the effect is not very large and might even have declined over time. [22] This would suggest that the latest increase in inflation reflects overheating rather than a catching-up phenomenon.
Keeping nominal convergence on track is the main policy challenge in the region. The problem becomes particularly acute in countries which have given up monetary policy independence by choosing an exchange rate target or adopting a currency board arrangement.
The key question for these countries is: how is it possible to keep inflation under control by pegging the exchange rate, which means adopting de facto the monetary policy of the euro area, especially since the euro area economy is growing at a rate that is less than a third of what a catching-up economy should aim to achieve? In other words, how is it possible to keep inflation under control with very low or even at times negative real interest rates? What are the risks for financial stability of having persistently low real interest rates, much lower than the rate of growth of the economy?
I will not go into details on this issue, but I would like to recall that even in advanced economies periods of low interest rates might fuel financial turbulence, as the recent events show.
To be sure, keeping nominal convergence on track is not only a challenge for monetary policy, but also for fiscal and structural policies. Improving supply side conditions and a tight budget can certainly mitigate inflationary pressures stemming from strong domestic demand. One has nonetheless to be realistic in defining the requirements for budgetary, income and structural policies that are consistent with achieving at the same time real and nominal convergence. I guess the real question to ask is: how large should the budget surplus be to counteract the inflationary effects produced by a pro-cyclical monetary policy and would this be acceptable for a catching-up country? How far reaching, and acceptable to the population, should structural reforms be? All in all, the requirements for the budgetary and structural policies associated with an exchange rate linked to the euro might just be too demanding to counteract the procyclical effects of very low real interest rates. This might lead to boom and bust cycles, with potentially very severe adjustments costs that may delay real convergence.
Conclusions
After having raised several provocative questions to launch the conference, let me conclude.
Substantial progress in real convergence has been achieved in central, eastern and south-eastern Europe. This has happened with respect to real per capita income but also to economic structures, the business and institutional environment as well as macroeconomic policies. At the same time, the path for catching up remains large and fraught with risks. The income gap with the euro area, while significantly reduced, is still large. In candidate and potential candidate countries much remains to be done to also advance structural convergence. And the recent signs of overheating present a significant challenge for macroeconomic and structural policies.
I wanted to open this conference by raising issues that – having the conference programme in mind – will be further developed in the next 36 hours, from an analytical as well as a policy perspective. I wish you stimulating discussions and a successful conference.
Thank you very much for your attention.
Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECB at the ECB Conference on central, eastern and south-eastern Europe,
Frankfurt, 1 October 2007
Introduction [1]
Ladies and Gentlemen:
I would like to welcome you all to Frankfurt, and to our economic conference on central, eastern and south-eastern Europe.
Let me start by saying a few words about the meeting itself, which is the second of its kind. With this conference the ECB aims to foster cooperation and provide a forum for a multilateral discussion among central bankers in the region. Taking a regional perspective is useful given the similarities in economic structures of the countries concerned. To a large extent, these similarities reflect the common background of transition to a market economy. This transition has important implications, in particular with respect to policy challenges.
In the region, ten countries are Member States of the European Union, while the remaining seven are candidate or potential candidate countries at different stages of the process. [2] But the feedback we have received from last year's conference indicated that this heterogeneity actually reinforces the usefulness of taking a regional perspective.
This brings me to the overriding theme of this conference, real convergence. As central bankers, we are used to discuss nominal convergence, since it is at the heart of our main task, maintaining price stability. It is also at the heart of the Maastricht criteria on the adoption of the euro. However, we chose this time to focus on the other side of the coin. There are three reasons for this. First, catching up is the main goal of all the countries under review. Second, real convergence has gained momentum in recent years, also in countries where progress had been slower in the 1990s. Third, real convergence has important implications for nominal convergence.
Against this background, I will first briefly review some stylised facts of real convergence in central, eastern and south-eastern Europe. I will then turn to selected aspects of the convergence process, namely
growth and convergence,
financial globalisation and the current account,
financial development,
and finally, implications for monetary policy.
By contrasting theory and empirical evidence I would like to bring the attention to some interesting and unresolved issues and to identify key policy challenges that the conference participants might want to consider further.
1. Real convergence in central, eastern and south-eastern Europe – where do we stand?
Let me start with some facts and figures. The convergence experience in central, eastern and south-eastern Europe can be summarised as follows:
Following notable output losses during the early 1990s, all countries in the region have seen a strong recovery. With a few exceptions, most of them have passed their pre-transition levels of real per capita income.
The recovery resulted in convergence towards the real income per capita level in the euro area. In the EU Member States of the region, real per capita income reached 40% of the euro area level in 2005, an increase of about nine percentage points since 1993. In candidate and potential candidate countries – excluding Turkey – a rise of seven percentage points was recorded in the same period, so that at end-2005, their average real per capita income stood at about 23% of the euro area level.
The timing and speed of convergence has varied substantially, reflecting differences in political stability and progress in structural reforms. Strong growth, fostered by structural reforms, investment and FDI, has been a key feature of economic developments in almost all New Member States since the mid-1990s. In most candidate and potential candidate countries, instead, the catching-up process has gained speed only in this decade.
Total factor productivity has been the main driver of growth and convergence across the region. Labour productivity has increased in all countries, closing the gap relative to the euro area. At the same time, in many countries labour utilisation is substantially below the euro area level, reflecting the large size of the informal sector as well as labour market frictions and mismatches.
To sum up: substantial progress has been made, but gaps in terms of income per capita relative to the euro area remain large. This suggests that the challenges of real convergence, which you have the opportunity to discuss today and tomorrow, will remain relevant for several years.
2. Convergence in central, eastern and south-eastern Europe – theory and evidence
Growth and convergence
In the last few years, the economic profession has been engaged in a controversial discussion on the origins of growth. [3] To a large extent, the debate was triggered by the empirical observation of increasing divergence of per capita income across countries. [4] Indeed, the evidence seemed to contradict a key prediction of standard growth theory: countries with relatively low per capita income should catch-up with richer ones. In theory, since capital is generally scarce in low income countries its rate of return should be higher than in richer economies, investment should be stronger, resulting in an increasing capital stock, production and finally income. Thus, per capita income differences should fall over time. Clearly, the global evidence on divergence of per capita income is inconsistent with this reasoning.
Two avenues have been followed to address this contradiction. The first one tries to take into account factors that actually prevent the marginal product of capital to fall – or at least: prevent it from falling to zero – even if the capital intensity of production is rising over time, as theory would predict. Literally millions of cross-country regressions [5] have been run to identify factors conditioning convergence, from the investment rate itself to macroeconomic, financial sector and institutional variables. And while absolute convergence has not been supported by the data, conditional convergence has been found to hold, even if not in all samples and periods.
Evidence of convergence in central, eastern and south-eastern Europe lends strong support to the conditional convergence hypothesis of standard growth theory. To be sure the acquis communautaire is a structural factor which has provided a common framework for the countries in the region to engage in rapid convergence. [6] To sustain the catching-up with living standards in the euro area, continued structural convergence along the lines of the acquis communautaire is crucial, in particular in candidate and potential candidate countries.
However, there are also features in the current catching-up process that are at odds with established growth empirics. In particular, several empirical studies suggest that convergence in the region seems to have been driven by the growth of total factor productivity. [7] This contrasts with the evidence found for other rapidly converging economies, for example in Asia, where capital accumulation has been identified as the main driver of real convergence with advanced economies. [8]
Transition is the prime candidate to account for this anomaly. The heritage of central planning left many economies with large inefficiencies in production, which offered a vast potential for efficiency gains in the course of the regime shift. Economies in the region have made extensive use of this potential. This nevertheless raises an important question on the sustainability of the convergence process in the future. If strong TFP growth has been mainly the result of transition, it is not a renewable source of convergence for the future (i.e., when transition is over). Other sources must be found. One factor is efficient financial intermediation. After all, the financial sector is the “brain” of the market economy in allocating resources and allowing capital to flow to its most productive use. [9] This is what the empirical literature on finance and growth suggests, namely that financial development is significantly correlated with total factor productivity and less so with private savings rates or capital accumulation. [10] Clearly, financial development in the region has advance rapidly. Nonetheless, capital accumulation should be expected to make a larger contribution to growth and real convergence in the future. However, while investment rates have been rising in central, eastern and south-eastern Europe, they are not particularly high by emerging market standards. Compared with emerging Asia they can even be considered as rather low. Why have investment rates been relatively subdued and what are the policies to be pursued fostering capital formation?
Financial globalisation and the current account
Conceptually, the policy question may be easy to answer: continued structural reforms, enhancing flexibility in labour and product markets, improving the business climate and governance. These are the standard responses. However, a rise in investment might contribute to a further widening of current account deficits. Indeed, in recent years investment in the region has been increasingly financed by tapping foreign savings. As a result, current account deficits have reached levels of more than 10% of GDP in several countries.
From a theoretical perspective, current account deficits may actually be interpreted as in line with the predictions of standard theory. [11] However, other emerging market economies have seen just the opposite pattern, namely convergence accompanied by improving current account balances, most visible in the high and widening current account surpluses in emerging Asia. It is even more striking that current account surpluses have been observed in parallel with increasing financial globalisation. Financial globalisation should facilitate capital flowing from rich to poor countries, the opposite of what we observe. This is known, as you know, as the “Lucas paradox” from the seminal article where Lucas pointed out that capital is flowing from emerging to advanced economies, contradicting predictions of standard models of trade and growth. [12] This paradox can still be observed in many parts of the world, resulting in what are commonly known as global imbalances. [13]
Various explanations have been suggested to account for this at least seemingly paradoxical development. On the one hand, rate of return differentials might be smaller than suggested by the relative scarcity and abundance of capital, reflecting larger risks related to a higher level of uncertainty due to less developed legal and financial systems. Vice versa, the lower level of institutional quality in many emerging market economies might result in an outflow of capital because of lesser opportunities for financial investment. [14]
Countries in central, eastern and south-eastern Europe seem once again to be special among emerging markets. Their process of real convergence has been accompanied by very different current account developments than in other emerging markets. Why have countries in the region, while accumulating sizeable foreign exchange reserves, used so much foreign savings to finance current spending? Have financial factors that explain the current account surpluses in emerging Asia had a different impact in emerging Europe? [15]
Finding an answer to these questions is important not only to square empirical evidence with theory, but also from a policy perspective. Should policy makers get comfort from the fact that the imbalances in central, eastern and south-eastern Europe are in line with standard economic theory? Or should we be worried that these imbalances can be very disruptive for convergence if they prove to be unsustainable, as corrections can be painful and costly? [16]
Financial development
Let me now focus more closely on financial factors in the region, in particular the banking sector, which has seen a very peculiar form of structural convergence and financial integration. In most countries the banking sector is dominated by subsidiaries or branches of banks headquartered in the euro area. [17] While similar developments have been also seen in other emerging market economies [18], the process is unique in emerging Europe [19], where banks have expanded their presence in what has been perceived to become a single, large European financial market in the future.
Financial deepening in the region has been extremely rapid. Credit growth rates have been particularly high for consumer and mortgage lending, reaching in some countries and in some years more than 100% p.a.
Should we be worried by these developments? Research suggests that rapid credit growth does not necessarily lead to financial turbulence, but it is one of the main predictors. [20] Moreover, the structure of credit, featuring prominently loans denominated in foreign currency, gives reason for concern. How sustainable are debt burdens in the case of an economic downturn or significant exchange rate depreciation? Are the speed limits to real convergence set by financial factors?
The main policy challenge: overheating
This brings me to the last point I would like to deal with in these introductory remarks, namely the challenges for monetary policy. Until recently, demand pressures arising from strong credit growth and capital inflows have not been reflected in rising inflation for three reasons. First, strong productivity growth. Second, the current account, financed largely by FDI, which served as a convenient outlet for buoyant demand. Third, in nearly all these economies there is still substantial slack in the labour market, which is being nevertheless quickly absorbed.
Over the last two years, domestic demand pressures have started to increase and have been reflected in domestic price developments. Does this mean that countries have reached or even passed their growth potential? The evidence is not clear-cut. While there has been strong growth in recent years, labour utilisation has remained low. The same holds for participation and employment rates. Unemployment, even though declining recently, is still high in many countries. There thus seems to be ample space for a larger contribution of labour to growth, mitigating the constraints for a further rise of potential output. At the same time, labour markets in the region are characterised by substantial mismatches. [21] Moreover, labour market disequilibria may be exacerbated by significant migration flows, limiting the supply response to the rise in demand at least in some countries. As a result, we observe the paradox of low labour utilisation and tight labour markets at the same time.
Theory suggests that in a process of rapid real convergence countries should experience higher overall inflation rates, due to the Balassa-Samuelson effect. However, the recent rise in inflation can hardly be explained by this effect alone. A review of empirical studies on the size of the Balassa-Samuelson effect in central, eastern and south-eastern European countries suggests that the effect is not very large and might even have declined over time. [22] This would suggest that the latest increase in inflation reflects overheating rather than a catching-up phenomenon.
Keeping nominal convergence on track is the main policy challenge in the region. The problem becomes particularly acute in countries which have given up monetary policy independence by choosing an exchange rate target or adopting a currency board arrangement.
The key question for these countries is: how is it possible to keep inflation under control by pegging the exchange rate, which means adopting de facto the monetary policy of the euro area, especially since the euro area economy is growing at a rate that is less than a third of what a catching-up economy should aim to achieve? In other words, how is it possible to keep inflation under control with very low or even at times negative real interest rates? What are the risks for financial stability of having persistently low real interest rates, much lower than the rate of growth of the economy?
I will not go into details on this issue, but I would like to recall that even in advanced economies periods of low interest rates might fuel financial turbulence, as the recent events show.
To be sure, keeping nominal convergence on track is not only a challenge for monetary policy, but also for fiscal and structural policies. Improving supply side conditions and a tight budget can certainly mitigate inflationary pressures stemming from strong domestic demand. One has nonetheless to be realistic in defining the requirements for budgetary, income and structural policies that are consistent with achieving at the same time real and nominal convergence. I guess the real question to ask is: how large should the budget surplus be to counteract the inflationary effects produced by a pro-cyclical monetary policy and would this be acceptable for a catching-up country? How far reaching, and acceptable to the population, should structural reforms be? All in all, the requirements for the budgetary and structural policies associated with an exchange rate linked to the euro might just be too demanding to counteract the procyclical effects of very low real interest rates. This might lead to boom and bust cycles, with potentially very severe adjustments costs that may delay real convergence.
Conclusions
After having raised several provocative questions to launch the conference, let me conclude.
Substantial progress in real convergence has been achieved in central, eastern and south-eastern Europe. This has happened with respect to real per capita income but also to economic structures, the business and institutional environment as well as macroeconomic policies. At the same time, the path for catching up remains large and fraught with risks. The income gap with the euro area, while significantly reduced, is still large. In candidate and potential candidate countries much remains to be done to also advance structural convergence. And the recent signs of overheating present a significant challenge for macroeconomic and structural policies.
I wanted to open this conference by raising issues that – having the conference programme in mind – will be further developed in the next 36 hours, from an analytical as well as a policy perspective. I wish you stimulating discussions and a successful conference.
Thank you very much for your attention.
Unpegging the Lev?
From Bloomberg yesterday:
UniCredit Bulgaria CEO Warns of Any Plan to Unpeg Lev (Update2)
By Elizabeth Konstantinova
Oct. 11 (Bloomberg) -- UniCredit Bulbank Bulgaria Chief Executive Officer Levon Hampartzoumian warned against any proposal to abolish the lev's peg to the euro, saying it would destabilize the economy.
European Central Bank board member Lorenzo Bini Smaghi in a speech on Oct. 1 blamed fixed exchange rates in Bulgaria and the three Baltic states for accelerating inflation and current-account deficits because the currency board systems limit their central bankers' ability to control surging price growth.
``Loosening of the peg would mean there will be a narrow circle of so-called experts, who would be able to play with the printing machine, which is not desirable,'' said Hampartzoumian, whose bank is Bulgaria's largest, in an interview yesterday. ``It may bring some short-term advantages but in the long term will remove the anchor which is keeping the stability of the system.''
A surge in investment, imports and wages after Bulgaria's EU entry on Jan. 1 caused its current-account deficit and credit growth to balloon and its inflation rate to jump to 12 percent, the highest in the 27-nation bloc. The economic imbalances may delay its plans to join the exchange-rate mechanism, a two-year test of currency stability before euro adoption.
Different Systems
Of the 10 eastern EU members, Lithuania, Estonia, Latvia and Bulgaria have currency-board arrangements that fix their currencies to the euro. Hungary's forint has a 15 percent trade band, giving policy makers more flexibility to use interest rates to control inflation, while the rest, including Poland and the Czech Republic, have free-floating currencies.
Latvia's inflation rate was 11.4 percent in September, Estonia's rate was 7.2 percent and Lithuania's rate was 7.1 percent. By contrast, Poland's inflation rate for that month was 1.5 percent and the Czech Republic's was 2.8 percent.
Kalin Hristov, an adviser to the central bank's governor, said there is no talk in the institution to drop the currency board, pointing out that the inflation jump in Bulgaria is only recent.
``Countries with currency boards have had the lowest inflation in the past 10 years, with the exception of the past several months,'' said Kristov.
1997 Crisis
Bulgaria imposed the currency board in 1997 to recover from a financial crisis that closed one-third of the country's banks. The system bans central bank lending and ensures that money in circulation match foreign exchange reserves. Central bank Governor Ivan Iskrov said on Sept. 18 that Bulgaria plans to keep the currency board in place until it adopts the euro.
``Blaming the currency board is passing the buck,'' said Lubomir Christov, the chief executive officer of the Central Depository in Sofia, in an interview today. ``High economic growth is possible only in circumstances of monetary stability. Abolishing the currency board will be a disaster.''
The currency board has helped Bulgaria keep a lid on public spending and meet all euro-adoption requirements except inflation. The seven-month current-account gap accounted for 11.2 percent of gross domestic product and will expand to 20 percent of GDP, according to an International Monetary Fund forecast.
``In terms of predictability and stability of the system the currency peg has much more positive than negative effects,'' Hampartzoumian, 54, said. ``It is an academic discussion whether a country the size of Bulgaria can have an independent policy. It is better to stay pegged.''
Growth Rates
The nation of 7.8 million people, which is the EU's poorest country, needs faster growth than in the 13-nation euro region to catch up with western European living standards. The $31.5 billion economy grew 6.6 percent in the second quarter driven by investment and consumption.
``The current-account deficit is supported by increasing exports and economic growth,'' Hampartzoumian said. ``If we have sustainable growth and a high current-account deficit, it is quite clear that inflation is to be an issue especially in regard to joining the ERM-2 and subsequently adopting the euro.''
On the prospects for when the nation should adopt the euro, Hampartzoumian said that from a business perspective ``the sooner, the better.'' Still, he said, ``there are prerequisites.'' The country extended its euro-adoption target to after 2011 so it can bring wages and labor productivity closer to EU levels. The nation's GDP per capita is now one-third of the EU average.
Bulgaria's economy ``has a lot of room to grow'' as the country needs new roads, seaports and airports and improvements in its communal services infrastructure, Hampartzoumian said.
System Reforms
Reforming Bulgaria's Soviet-style health-care and education systems to meet the demands of a market economy is crucial to sustaining long-term growth, Hampartzoumian said.
``The costs associated with these segments of the economy have to be reduced, and at the same time their efficiency has to increase dramatically,'' he said. ``For many reasons, mostly political, these sectors were not the subject of serious attention by the politicians in the past five or six years and now it's time to rethink the approach and design an implementation plan.''
Commercial banks' lending growth surged to 47 percent in June forcing the central bank to raise minimum reserve requirements from Sept. 1.
``This is a measure that has some effect, but this is not a panacea,'' Hampartzoumian said. ``We will still have double-digit growth in lending in the system as a whole. The extensive opportunities for growth are becoming limited.''
UniCredit Bulgaria CEO Warns of Any Plan to Unpeg Lev (Update2)
By Elizabeth Konstantinova
Oct. 11 (Bloomberg) -- UniCredit Bulbank Bulgaria Chief Executive Officer Levon Hampartzoumian warned against any proposal to abolish the lev's peg to the euro, saying it would destabilize the economy.
European Central Bank board member Lorenzo Bini Smaghi in a speech on Oct. 1 blamed fixed exchange rates in Bulgaria and the three Baltic states for accelerating inflation and current-account deficits because the currency board systems limit their central bankers' ability to control surging price growth.
``Loosening of the peg would mean there will be a narrow circle of so-called experts, who would be able to play with the printing machine, which is not desirable,'' said Hampartzoumian, whose bank is Bulgaria's largest, in an interview yesterday. ``It may bring some short-term advantages but in the long term will remove the anchor which is keeping the stability of the system.''
A surge in investment, imports and wages after Bulgaria's EU entry on Jan. 1 caused its current-account deficit and credit growth to balloon and its inflation rate to jump to 12 percent, the highest in the 27-nation bloc. The economic imbalances may delay its plans to join the exchange-rate mechanism, a two-year test of currency stability before euro adoption.
Different Systems
Of the 10 eastern EU members, Lithuania, Estonia, Latvia and Bulgaria have currency-board arrangements that fix their currencies to the euro. Hungary's forint has a 15 percent trade band, giving policy makers more flexibility to use interest rates to control inflation, while the rest, including Poland and the Czech Republic, have free-floating currencies.
Latvia's inflation rate was 11.4 percent in September, Estonia's rate was 7.2 percent and Lithuania's rate was 7.1 percent. By contrast, Poland's inflation rate for that month was 1.5 percent and the Czech Republic's was 2.8 percent.
Kalin Hristov, an adviser to the central bank's governor, said there is no talk in the institution to drop the currency board, pointing out that the inflation jump in Bulgaria is only recent.
``Countries with currency boards have had the lowest inflation in the past 10 years, with the exception of the past several months,'' said Kristov.
1997 Crisis
Bulgaria imposed the currency board in 1997 to recover from a financial crisis that closed one-third of the country's banks. The system bans central bank lending and ensures that money in circulation match foreign exchange reserves. Central bank Governor Ivan Iskrov said on Sept. 18 that Bulgaria plans to keep the currency board in place until it adopts the euro.
``Blaming the currency board is passing the buck,'' said Lubomir Christov, the chief executive officer of the Central Depository in Sofia, in an interview today. ``High economic growth is possible only in circumstances of monetary stability. Abolishing the currency board will be a disaster.''
The currency board has helped Bulgaria keep a lid on public spending and meet all euro-adoption requirements except inflation. The seven-month current-account gap accounted for 11.2 percent of gross domestic product and will expand to 20 percent of GDP, according to an International Monetary Fund forecast.
``In terms of predictability and stability of the system the currency peg has much more positive than negative effects,'' Hampartzoumian, 54, said. ``It is an academic discussion whether a country the size of Bulgaria can have an independent policy. It is better to stay pegged.''
Growth Rates
The nation of 7.8 million people, which is the EU's poorest country, needs faster growth than in the 13-nation euro region to catch up with western European living standards. The $31.5 billion economy grew 6.6 percent in the second quarter driven by investment and consumption.
``The current-account deficit is supported by increasing exports and economic growth,'' Hampartzoumian said. ``If we have sustainable growth and a high current-account deficit, it is quite clear that inflation is to be an issue especially in regard to joining the ERM-2 and subsequently adopting the euro.''
On the prospects for when the nation should adopt the euro, Hampartzoumian said that from a business perspective ``the sooner, the better.'' Still, he said, ``there are prerequisites.'' The country extended its euro-adoption target to after 2011 so it can bring wages and labor productivity closer to EU levels. The nation's GDP per capita is now one-third of the EU average.
Bulgaria's economy ``has a lot of room to grow'' as the country needs new roads, seaports and airports and improvements in its communal services infrastructure, Hampartzoumian said.
System Reforms
Reforming Bulgaria's Soviet-style health-care and education systems to meet the demands of a market economy is crucial to sustaining long-term growth, Hampartzoumian said.
``The costs associated with these segments of the economy have to be reduced, and at the same time their efficiency has to increase dramatically,'' he said. ``For many reasons, mostly political, these sectors were not the subject of serious attention by the politicians in the past five or six years and now it's time to rethink the approach and design an implementation plan.''
Commercial banks' lending growth surged to 47 percent in June forcing the central bank to raise minimum reserve requirements from Sept. 1.
``This is a measure that has some effect, but this is not a panacea,'' Hampartzoumian said. ``We will still have double-digit growth in lending in the system as a whole. The extensive opportunities for growth are becoming limited.''
Friday, October 12, 2007
ECB Change of View on Currency Pegs?
From Bloomberg
ECB May Oppose Rate Pegs in Baltics, Bulgaria, Danske Bank Says
By Milda Seputyte
Oct. 4 (Bloomberg) -- The European Central Bank `seems' to want the Baltic nations and Bulgaria to drop their exchange-rate pegs because they contribute to increasing economic imbalances, Danske Bank said.
``It seems that the ECB is suggesting what would have been unthinkable a year ago: that it is time to change the exchange- rate policies in the CEE countries with exchange-rate pegs,'' Lars Christensen, a senior analyst at Danske Bank, said today in an e-mailed note.
The three Baltic countries of Lithuania, Latvia and Estonia, along with Bulgaria, are struggling to balance the need for growth with controlling inflation and current-account deficits. Two ECB board members, Lorenzo Bini Smaghi and Jurgen Stark, said on Oct. 2 that hard peg arrangements foil government attempts to slow inflation as countries import monetary policy of the euro zone with low-interest rates.
The four countries with hard pegs to the euro have seen inflation pick up to more than double the levels in the euro zone, indicating that the economies are overheating.
Bulgaria's inflation rate, the highest in the EU, rose to 12 percent in August, while Latvia, with the fastest growing economy in the EU, had an inflation rate of 10.1 percent in August, compared with an average rate of 1.7 percent in the euro region.
``The key question for these countries is: how is it possible to keep inflation under control by pegging the exchange rate, which means adopting de facto the monetary policy of the euro area?'' Smaghi said on Oct. 2.
Growth was twice as fast and inflation was 1 1/2 times faster in countries with hard pegs than in countries such as the Czech Republic and Poland, which allow their currencies to trade freely on the market, Stark said.
``It is quite clear that urgent policy action is needed to bring down the imbalances,'' Christensen said. ``These countries will not get any help from the ECB in defending their currency pegs unless action is taken very soon.
ECB May Oppose Rate Pegs in Baltics, Bulgaria, Danske Bank Says
By Milda Seputyte
Oct. 4 (Bloomberg) -- The European Central Bank `seems' to want the Baltic nations and Bulgaria to drop their exchange-rate pegs because they contribute to increasing economic imbalances, Danske Bank said.
``It seems that the ECB is suggesting what would have been unthinkable a year ago: that it is time to change the exchange- rate policies in the CEE countries with exchange-rate pegs,'' Lars Christensen, a senior analyst at Danske Bank, said today in an e-mailed note.
The three Baltic countries of Lithuania, Latvia and Estonia, along with Bulgaria, are struggling to balance the need for growth with controlling inflation and current-account deficits. Two ECB board members, Lorenzo Bini Smaghi and Jurgen Stark, said on Oct. 2 that hard peg arrangements foil government attempts to slow inflation as countries import monetary policy of the euro zone with low-interest rates.
The four countries with hard pegs to the euro have seen inflation pick up to more than double the levels in the euro zone, indicating that the economies are overheating.
Bulgaria's inflation rate, the highest in the EU, rose to 12 percent in August, while Latvia, with the fastest growing economy in the EU, had an inflation rate of 10.1 percent in August, compared with an average rate of 1.7 percent in the euro region.
``The key question for these countries is: how is it possible to keep inflation under control by pegging the exchange rate, which means adopting de facto the monetary policy of the euro area?'' Smaghi said on Oct. 2.
Growth was twice as fast and inflation was 1 1/2 times faster in countries with hard pegs than in countries such as the Czech Republic and Poland, which allow their currencies to trade freely on the market, Stark said.
``It is quite clear that urgent policy action is needed to bring down the imbalances,'' Christensen said. ``These countries will not get any help from the ECB in defending their currency pegs unless action is taken very soon.
Hard Landing in the Baltics?
In Bloomberg today:
Baltic States Risk `Hard Landing,' Devaluation, Nordea Says
By Milda Seputyte and Aaron Eglitis
Oct. 11 (Bloomberg) -- The three Baltic countries are at risk of a ``hard landing'' that could trigger speculation their currencies may be devalued, Nordea Markets said.
Slowing credit growth could decrease domestic demand, raise unemployment and lead to a fall in property prices, Roger Wessman, an economist at Helsinki-based Nordea, said in an e- mailed presentation.
Economic growth in Estonia, Latvia and Lithuania accelerated as cheap credit in foreign currency boosted demand for imports, widened their current-account deficits and spurred inflation to more than three times the levels in the euro region.
``Economic growth boosted by foreign loans cannot continue forever,'' Wessman said in a conference in Vilnius today, according to an online business news service VZ.LT. ``If the decline will be very sharp, a devaluation may be needed to restrain the decline and to help the economy revive.''
The current economic situation in the Baltic states is similar to the developments before the economic slump in Sweden and Finland in the early 1990s, Wessman said.
Sweden and Finland, like the Baltics, had artificially low interest rates and borrowed in foreign currency, fueling a boom, he said. This was followed by a downturn that saw real estate prices drop and unemployment rise. Both countries devalued their currencies.
Housing prices in Helsinki fell by 50 percent from 1988 to 1992, according to Wessman. Unemployment grew to 21 percent in 1992 from about 4 percent in 1990.
Devaluation Fears
Fears of devaluation could cause consumers to switch their loans from euros to domestic currencies, depleting foreign currency reserves and forcing a devaluation, Wessman said.
Estonia, Lithuania and Latvia, which use the currency-board system rather than allowing their currencies to float freely, have already dropped plans to be among the first of the 2004 European Union entrants to switch to the common currency after inflation accelerated beyond limits required for adoption.
Growth was twice as fast in countries with pegs than in countries such as the Czech Republic and Poland, which allow their currencies to trade freely.
Latvia's inflation rate was 11.4 percent in September, Estonia's rate was 7.2 percent and Lithuania's was 7.1 percent. That compares with a 1.7 percent average rate in the 13 nations that use the euro.
Baltic States Risk `Hard Landing,' Devaluation, Nordea Says
By Milda Seputyte and Aaron Eglitis
Oct. 11 (Bloomberg) -- The three Baltic countries are at risk of a ``hard landing'' that could trigger speculation their currencies may be devalued, Nordea Markets said.
Slowing credit growth could decrease domestic demand, raise unemployment and lead to a fall in property prices, Roger Wessman, an economist at Helsinki-based Nordea, said in an e- mailed presentation.
Economic growth in Estonia, Latvia and Lithuania accelerated as cheap credit in foreign currency boosted demand for imports, widened their current-account deficits and spurred inflation to more than three times the levels in the euro region.
``Economic growth boosted by foreign loans cannot continue forever,'' Wessman said in a conference in Vilnius today, according to an online business news service VZ.LT. ``If the decline will be very sharp, a devaluation may be needed to restrain the decline and to help the economy revive.''
The current economic situation in the Baltic states is similar to the developments before the economic slump in Sweden and Finland in the early 1990s, Wessman said.
Sweden and Finland, like the Baltics, had artificially low interest rates and borrowed in foreign currency, fueling a boom, he said. This was followed by a downturn that saw real estate prices drop and unemployment rise. Both countries devalued their currencies.
Housing prices in Helsinki fell by 50 percent from 1988 to 1992, according to Wessman. Unemployment grew to 21 percent in 1992 from about 4 percent in 1990.
Devaluation Fears
Fears of devaluation could cause consumers to switch their loans from euros to domestic currencies, depleting foreign currency reserves and forcing a devaluation, Wessman said.
Estonia, Lithuania and Latvia, which use the currency-board system rather than allowing their currencies to float freely, have already dropped plans to be among the first of the 2004 European Union entrants to switch to the common currency after inflation accelerated beyond limits required for adoption.
Growth was twice as fast in countries with pegs than in countries such as the Czech Republic and Poland, which allow their currencies to trade freely.
Latvia's inflation rate was 11.4 percent in September, Estonia's rate was 7.2 percent and Lithuania's was 7.1 percent. That compares with a 1.7 percent average rate in the 13 nations that use the euro.
Sunday, October 7, 2007
Quarterly Economic Policy Statexment of Eesti Pank
Estonia's economic adjustment proceeds according to expectations
Recent economic developments in Estonia are characterised by smooth adjustment following rapid growth in previous years and accord with the base scenario of Eesti Pank's spring forecast. Owing mainly to gradually declining domestic demand, i.e, investment and consumption, the second quarter's economic growth slowed to 7.3%. The total volume of new loans is falling, the real estate market has stabilised, and preliminary estimates point to the fact the peak of private consumption has also passed. Meanwhile, the creation of new jobs continued and unemployment fell to a record low level of 5%. Estonia's export growth has remained rather dynamic, being slightly stronger in the second quarter compared to the first quarter.
Despite Estonia's slowing economic growth, the first-quarter increase in consumer prices was somewhat faster than forecasted. The inflation rate, which amounted to 6.4% in July, reaching the highest level in three years, was driven by the global increase in food prices and the fact that the exceptional period of lower VAT on thermal energy in Estonia has terminated. Domestic demand should continue to slow at the beginning of 2008, thus price pressures should also alleviate. However, certain tax policy measures scheduled to be taken in 2008 will somewhat postpone a perceptible slowdown in the growth rate of consumer prices.
According to Eesti Pank's preliminary estimate, the current account deficit, i.e, the difference between domestic savings and investment, in absolute volume did not deteriorate further in the second half of 2007. This is in line with slowing domestic demand and credit growth and with increasing export growth.
Notwithstanding the smooth slowdown of the economy, the factors endangering soft landing have not disappeared. The biggest threats lie in real wages surging to considerably surpass labour productivity, thus jeopardising Estonia's economic growth and not allowing inflation to decrease in the next years. In order to minimise risks related to falling competitiveness it is important for both employers and employees to adjust their behaviour with a view to alleviating the differences between wage growth and productivity growth.
Moreover, against the backdrop of the expected cooling down of the real estate market, balanced economic development greatly depends on banks maintaining credit policies that are conservative and consider all possible risks. It is important that the annual credit volume growth be kept on the level that is in keeping with the expected growth of private persons' and enterprises' solvency and income. A deceleration in the improvement of the economy's balance indicators may undermine the confidence of foreign investors and rating agencies in the Estonian economy in the circumstances where the global financial sector is being affected by the bad loans problems arising from the US real estate sector.
Fiscal policy still plays a key role in supporting the smooth adjustment of the economy. Eesti Pank firmly holds that the 2007 fiscal surplus must be comparable to the level of the 2006 surplus and that it is important to refrain from increasing expenditure by a supplementary budget. Moreover, it is necessary to send a clear signal that the government is aware of the existing risks and plans to address them via the 2008 state budget and fiscal policy planned for 2008-2010.
Eesti Pank's assessments and recommendations
Eesti Pank expects Estonia's economic growth to slow gradually. The threat of a more abrupt adjustment has slightly increased. Price developments in the local real estate market and the tight labour market constitute the main risks.
As regards wage formation, households and enterprises must maintain realistic expectations. Enterprises will not be able to maintain the prompt wage growth without substantially increasing their productivity. Thus, everybody should take into account that their income growth may be inhibited in the future. It is important to keep wage formation flexible and wage growth productivity-led.
Supported by rapid wage growth and several external factors, inflation has soared faster than expected in recent months. If economic adjustment continues, inflationary pressures should ease next year, although rising excise duties will prevent the headline inflation rate from declining for some time.
The credit market has undergone the expected cool-down. It is important that banks keep the annual credit growth in line with the expected growth of private persons' and enterprises' solvency and income.
In order to ensure economic sustainability, Estonia must continue to pursue conservative fiscal policy. The budget surplus of 2007 should be kept on the level comparable to the surplus of the last year. This means the government must avoid any additional expenditure this year. Taking into consideration various risks and the rather optimistic forecast of the Ministry of Finance, the 2008 surplus should amount to approximately 2%. This means government expenditure should not be increased compared to what was planned for the medium term in spring.
It is in the best interests of Estonia to adopt the euro as soon as possible. Based on current estimations, the earliest possible term for the changeover is 2011. The introduction of the euro would level off risks and make it easier for Estonia to fulfil its longer-term economic objectives.
Overview of the most important developments
External environment has been favourableThe exporting sector has been enjoying rather favourable external demand during the past couple of years and economic expansion has been faster than forecasted. At the beginning of 2007, the EU economic growth was very close to the average growth potential. The growth rate slowed more than expected in the second quarter of the year, but the economic expansion of Estonia's closest neighbours is still fast.
The price growth of oil and commodities has continued at a rapid pace. Both oil prices and the CRB index of commodities reached record-high levels in July and first days of August. In July, the former increased to 78.21 dollars per barrel, which is the new historical record, and raw materials prices have grown approximately 15% since the beginning of the year.
Although the global inflation level is stably low, the ECB does not consider price pressures to be non-existent and market participants anticipate euro-area interest rates to continue to rise.
One of the most notable phenomena in the recent global economic developments is the deepening and transfer into the global financial sector of the bad loans problems arising from the US real estate market. Currently there exist no reasons to believe that an extensive reassessment of financial sector risks would pose a considerable threat to the global and EU (and thus also Estonia's) economy. Nevertheless, taking into account the generally spreading risk apprehension, Estonia should just in case take into account a possible slowdown in the external demand growth rate.
Estonia's economic growth slowed according to expectationsAccording to the preliminary assessment of the Statistical Office, Estonia's economic growth declined to 7.3% in the second quarter of this year. The decline was broad-based and characteristic of the activities focusing on the domestic market as well as of the exporting sector. Domestic demand growth decelerated on account of both private consumption and investment. It is presumed private consumption reached its peak at the end of 2006 and at the beginning of 2007. It is possible that the tenser relations with Russia may have had a slight impact (up to 0.5 pp according to preliminary assessments) on Estonia's economic growth, because commodities procurements were somewhat complicated and the income related to the transit of oil and oil products decreased as well.
The average goods and services export growth rate has been fast, although the situation varies by groups of goods and by markets. Although the growth rate of merchandise exports slowed considerably at the end of 2006 and at the beginning of 2007, we are mainly speaking about the so-called transit goods. When we leave aside transit and the subcontracting sector, there are no reasons to assume the competitive ability of other sectors has substantially declined.
By fields of activity, the construction, banking, and retail sectors experienced the most dynamic growth. The industrial confidence, however, deteriorated, dropping to the level of 2005. Enterprises started to make more careful forecasts of future developments with the slowdown in demand growth being the limiting factor. In addition, materialisation of the real estate market related risks may lead to a deceleration in the construction sector's growth rate.
The spring forecast of Eesti Pank expected this year's economic growth to be 8.4%, which is close to the average of the first half-year. The new autumn forecast of Eesti Pank will be completed in October.
Labour market tensions have not yet alleviated In spite of slower economic growth, the number of jobs increased, although more sluggishly than before. In the second quarter of 2007, 1.3% more people worked in Estonia year-on-year. Employment increased to 62.9% of Estonia's workforce and the unemployment level fell to 5%.
Labour productivity growth (5.9%) has been faster than in 2006. Maintaining at least the current labour productivity rate is a precondition for continuous investment and rapid economic growth in the future. However, currently there are not that many direct signs indicating that wage growth has started to decelerate. Real wage growth is still rapid, raising the purchasing power of people and creating additional costs for enterprises. As long as there persists the danger that productivity improvement is insufficient compared to wage growth, the latter keeps posing a threat to the competitiveness of Estonian enterprises.
Most of the new jobs created in the second quarter of 2007 are in the service sector and in the fields of activity focusing on the domestic market. For example, the number of construction sector workers has not been so large since end-1980s. This, in turn, refers to the fact that although growth rates no longer keep up with the levels of previous years, the construction sector has not yet passed its cyclical peak.
The credit and leasing market is coolingAgainst the backdrop of the expected cooling down of the real estate market, balanced economic development greatly depends on banks maintaining credit policies that are conservative and consider all possible risks. It is important that the annual credit volume growth be kept on the level that is in keeping with the expected growth of private persons' and enterprises' solvency and income.
At the end of the first half-year, the total volume of the loan and leasing portfolios of banks and their subsidiary leasing companies was 42% larger than a year ago. Meanwhile, the loan stock growth has dropped considerably year-on-year. In the first half of 2007, the loan and leasing portfolio of banks grew by 31 billion kroons. This is practically equal to the volume of the loans issued in the first half of 2006 and smaller than the total amount of loans issued in the second half of the previous year.
The deceleration in the growth of bank loans primarily reflects slower housing loan growth, which fell to 49% year-on-year. The consumer credit growth rate still exceeds that of mortgage loans. The credit market started to slow in the second quarter. It was the most evident in the indicators for June, when the volume of loans issued was 23% smaller year-on-year. In June and July, the turnover of housing loans remained for the first time in recent years below the level of the same month of the previous year. The volume of consumer credit growth was also a third smaller in June than in earlier months.
The main reason behind the changes in the credit market was decreasing demand, which was in turn conditioned by higher interest rates that have risen considerably during the past year and by the surge in real estate prices. In addition, the credit policies of banks have also become more conservative and take account of all borrowers-related risks. The expected further increase in interest rates should help inhibit credit growth in future as well. From the point of view of financing business activity, it is positive that the deceleration of the growth rate of financing portfolios is primarily related to the fields of activity focusing on domestic demand.
The quality of banks' loan portfolios is good as before. The share of the so-called bad loans, i.e, loans the servicing of which has delayed over 60 days, constitutes only 0.4% of the total loans issued by banks.
Inflationary pressures are expected to persist in the near futureAlthough Estonia's economic growth is slowing, the inflation rate is not expected to decline in the near future. During the first half-year, the annual consumer price growth fluctuated between 4.7% and 5.8%. Inflation has been driven by strong domestic demand, rapid wage growth, and several external factors.
The July inflation rate was the highest in three years (6.4%), but it was exceptional and caused by the rise in VAT on thermal energy. In addition to the appreciation of thermal energy, the prices of dairy products increased remarkably in July. The 4.6% price increase of milk and dairy products was caused by the notable price growth of milk powder in the global market.
Deceleration of the inflation rate requires a further slowdown in the growth of domestic demand, especially private consumption, which is in turn related to declining borrowing and income growth. Demand pressures should decrease in the second half-year in line with slowing economic growth. Alleviation of price pressures resulting therefrom can be expected to take place next year. However, certain tax policy measures scheduled to be taken in 2008 will somewhat postpone a perceptible slowdown in the growth rate of consumer prices.
The government has to continue with conservative fiscal polices Government expenditure increased rapidly in the first half of 2007 but remained nevertheless below the revenues growth rate. The first-quarter fiscal surplus was close to the 2006 average, constituting 3.5% of GDP. In the second quarter, the general government budget surplus turned out smaller and did not exceed the 3% level.
So far, the government has maintained the budget surplus on a level comparable to 2006. Thus, in the first half of 2007, fiscal policy supported the gradual deceleration of domestic demand and the soft landing scenario. Eesti Pank is of the opinion that similar policies should be pursued in the second half-year as well. By the end of July, the government's current surplus had risen to 3 billion kroons, being again in the same magnitude compared to the same time of previous years.
Eesti Pank's view is that the government must maintain the current conservative trend. Any additional expenditure should be avoided in 2007 as well as in compiling the budget for 2008. According to the forecast of the Ministry of Finance, the dynamic growth of Estonia's economy will continue in the next years, supported by both rapid domestic demand and exports. Taking into account the demand-side pressures that will continue if this forecast comes true, the government will have to continue with tight policies in the years to come and strive for at least 2% consolidated budget surplus of GDP. In addition, should the current forecast prove to be over-optimistic, the government will have to be ready for expenditures in a decline stage.
Recent economic developments in Estonia are characterised by smooth adjustment following rapid growth in previous years and accord with the base scenario of Eesti Pank's spring forecast. Owing mainly to gradually declining domestic demand, i.e, investment and consumption, the second quarter's economic growth slowed to 7.3%. The total volume of new loans is falling, the real estate market has stabilised, and preliminary estimates point to the fact the peak of private consumption has also passed. Meanwhile, the creation of new jobs continued and unemployment fell to a record low level of 5%. Estonia's export growth has remained rather dynamic, being slightly stronger in the second quarter compared to the first quarter.
Despite Estonia's slowing economic growth, the first-quarter increase in consumer prices was somewhat faster than forecasted. The inflation rate, which amounted to 6.4% in July, reaching the highest level in three years, was driven by the global increase in food prices and the fact that the exceptional period of lower VAT on thermal energy in Estonia has terminated. Domestic demand should continue to slow at the beginning of 2008, thus price pressures should also alleviate. However, certain tax policy measures scheduled to be taken in 2008 will somewhat postpone a perceptible slowdown in the growth rate of consumer prices.
According to Eesti Pank's preliminary estimate, the current account deficit, i.e, the difference between domestic savings and investment, in absolute volume did not deteriorate further in the second half of 2007. This is in line with slowing domestic demand and credit growth and with increasing export growth.
Notwithstanding the smooth slowdown of the economy, the factors endangering soft landing have not disappeared. The biggest threats lie in real wages surging to considerably surpass labour productivity, thus jeopardising Estonia's economic growth and not allowing inflation to decrease in the next years. In order to minimise risks related to falling competitiveness it is important for both employers and employees to adjust their behaviour with a view to alleviating the differences between wage growth and productivity growth.
Moreover, against the backdrop of the expected cooling down of the real estate market, balanced economic development greatly depends on banks maintaining credit policies that are conservative and consider all possible risks. It is important that the annual credit volume growth be kept on the level that is in keeping with the expected growth of private persons' and enterprises' solvency and income. A deceleration in the improvement of the economy's balance indicators may undermine the confidence of foreign investors and rating agencies in the Estonian economy in the circumstances where the global financial sector is being affected by the bad loans problems arising from the US real estate sector.
Fiscal policy still plays a key role in supporting the smooth adjustment of the economy. Eesti Pank firmly holds that the 2007 fiscal surplus must be comparable to the level of the 2006 surplus and that it is important to refrain from increasing expenditure by a supplementary budget. Moreover, it is necessary to send a clear signal that the government is aware of the existing risks and plans to address them via the 2008 state budget and fiscal policy planned for 2008-2010.
Eesti Pank's assessments and recommendations
Eesti Pank expects Estonia's economic growth to slow gradually. The threat of a more abrupt adjustment has slightly increased. Price developments in the local real estate market and the tight labour market constitute the main risks.
As regards wage formation, households and enterprises must maintain realistic expectations. Enterprises will not be able to maintain the prompt wage growth without substantially increasing their productivity. Thus, everybody should take into account that their income growth may be inhibited in the future. It is important to keep wage formation flexible and wage growth productivity-led.
Supported by rapid wage growth and several external factors, inflation has soared faster than expected in recent months. If economic adjustment continues, inflationary pressures should ease next year, although rising excise duties will prevent the headline inflation rate from declining for some time.
The credit market has undergone the expected cool-down. It is important that banks keep the annual credit growth in line with the expected growth of private persons' and enterprises' solvency and income.
In order to ensure economic sustainability, Estonia must continue to pursue conservative fiscal policy. The budget surplus of 2007 should be kept on the level comparable to the surplus of the last year. This means the government must avoid any additional expenditure this year. Taking into consideration various risks and the rather optimistic forecast of the Ministry of Finance, the 2008 surplus should amount to approximately 2%. This means government expenditure should not be increased compared to what was planned for the medium term in spring.
It is in the best interests of Estonia to adopt the euro as soon as possible. Based on current estimations, the earliest possible term for the changeover is 2011. The introduction of the euro would level off risks and make it easier for Estonia to fulfil its longer-term economic objectives.
Overview of the most important developments
External environment has been favourableThe exporting sector has been enjoying rather favourable external demand during the past couple of years and economic expansion has been faster than forecasted. At the beginning of 2007, the EU economic growth was very close to the average growth potential. The growth rate slowed more than expected in the second quarter of the year, but the economic expansion of Estonia's closest neighbours is still fast.
The price growth of oil and commodities has continued at a rapid pace. Both oil prices and the CRB index of commodities reached record-high levels in July and first days of August. In July, the former increased to 78.21 dollars per barrel, which is the new historical record, and raw materials prices have grown approximately 15% since the beginning of the year.
Although the global inflation level is stably low, the ECB does not consider price pressures to be non-existent and market participants anticipate euro-area interest rates to continue to rise.
One of the most notable phenomena in the recent global economic developments is the deepening and transfer into the global financial sector of the bad loans problems arising from the US real estate market. Currently there exist no reasons to believe that an extensive reassessment of financial sector risks would pose a considerable threat to the global and EU (and thus also Estonia's) economy. Nevertheless, taking into account the generally spreading risk apprehension, Estonia should just in case take into account a possible slowdown in the external demand growth rate.
Estonia's economic growth slowed according to expectationsAccording to the preliminary assessment of the Statistical Office, Estonia's economic growth declined to 7.3% in the second quarter of this year. The decline was broad-based and characteristic of the activities focusing on the domestic market as well as of the exporting sector. Domestic demand growth decelerated on account of both private consumption and investment. It is presumed private consumption reached its peak at the end of 2006 and at the beginning of 2007. It is possible that the tenser relations with Russia may have had a slight impact (up to 0.5 pp according to preliminary assessments) on Estonia's economic growth, because commodities procurements were somewhat complicated and the income related to the transit of oil and oil products decreased as well.
The average goods and services export growth rate has been fast, although the situation varies by groups of goods and by markets. Although the growth rate of merchandise exports slowed considerably at the end of 2006 and at the beginning of 2007, we are mainly speaking about the so-called transit goods. When we leave aside transit and the subcontracting sector, there are no reasons to assume the competitive ability of other sectors has substantially declined.
By fields of activity, the construction, banking, and retail sectors experienced the most dynamic growth. The industrial confidence, however, deteriorated, dropping to the level of 2005. Enterprises started to make more careful forecasts of future developments with the slowdown in demand growth being the limiting factor. In addition, materialisation of the real estate market related risks may lead to a deceleration in the construction sector's growth rate.
The spring forecast of Eesti Pank expected this year's economic growth to be 8.4%, which is close to the average of the first half-year. The new autumn forecast of Eesti Pank will be completed in October.
Labour market tensions have not yet alleviated In spite of slower economic growth, the number of jobs increased, although more sluggishly than before. In the second quarter of 2007, 1.3% more people worked in Estonia year-on-year. Employment increased to 62.9% of Estonia's workforce and the unemployment level fell to 5%.
Labour productivity growth (5.9%) has been faster than in 2006. Maintaining at least the current labour productivity rate is a precondition for continuous investment and rapid economic growth in the future. However, currently there are not that many direct signs indicating that wage growth has started to decelerate. Real wage growth is still rapid, raising the purchasing power of people and creating additional costs for enterprises. As long as there persists the danger that productivity improvement is insufficient compared to wage growth, the latter keeps posing a threat to the competitiveness of Estonian enterprises.
Most of the new jobs created in the second quarter of 2007 are in the service sector and in the fields of activity focusing on the domestic market. For example, the number of construction sector workers has not been so large since end-1980s. This, in turn, refers to the fact that although growth rates no longer keep up with the levels of previous years, the construction sector has not yet passed its cyclical peak.
The credit and leasing market is coolingAgainst the backdrop of the expected cooling down of the real estate market, balanced economic development greatly depends on banks maintaining credit policies that are conservative and consider all possible risks. It is important that the annual credit volume growth be kept on the level that is in keeping with the expected growth of private persons' and enterprises' solvency and income.
At the end of the first half-year, the total volume of the loan and leasing portfolios of banks and their subsidiary leasing companies was 42% larger than a year ago. Meanwhile, the loan stock growth has dropped considerably year-on-year. In the first half of 2007, the loan and leasing portfolio of banks grew by 31 billion kroons. This is practically equal to the volume of the loans issued in the first half of 2006 and smaller than the total amount of loans issued in the second half of the previous year.
The deceleration in the growth of bank loans primarily reflects slower housing loan growth, which fell to 49% year-on-year. The consumer credit growth rate still exceeds that of mortgage loans. The credit market started to slow in the second quarter. It was the most evident in the indicators for June, when the volume of loans issued was 23% smaller year-on-year. In June and July, the turnover of housing loans remained for the first time in recent years below the level of the same month of the previous year. The volume of consumer credit growth was also a third smaller in June than in earlier months.
The main reason behind the changes in the credit market was decreasing demand, which was in turn conditioned by higher interest rates that have risen considerably during the past year and by the surge in real estate prices. In addition, the credit policies of banks have also become more conservative and take account of all borrowers-related risks. The expected further increase in interest rates should help inhibit credit growth in future as well. From the point of view of financing business activity, it is positive that the deceleration of the growth rate of financing portfolios is primarily related to the fields of activity focusing on domestic demand.
The quality of banks' loan portfolios is good as before. The share of the so-called bad loans, i.e, loans the servicing of which has delayed over 60 days, constitutes only 0.4% of the total loans issued by banks.
Inflationary pressures are expected to persist in the near futureAlthough Estonia's economic growth is slowing, the inflation rate is not expected to decline in the near future. During the first half-year, the annual consumer price growth fluctuated between 4.7% and 5.8%. Inflation has been driven by strong domestic demand, rapid wage growth, and several external factors.
The July inflation rate was the highest in three years (6.4%), but it was exceptional and caused by the rise in VAT on thermal energy. In addition to the appreciation of thermal energy, the prices of dairy products increased remarkably in July. The 4.6% price increase of milk and dairy products was caused by the notable price growth of milk powder in the global market.
Deceleration of the inflation rate requires a further slowdown in the growth of domestic demand, especially private consumption, which is in turn related to declining borrowing and income growth. Demand pressures should decrease in the second half-year in line with slowing economic growth. Alleviation of price pressures resulting therefrom can be expected to take place next year. However, certain tax policy measures scheduled to be taken in 2008 will somewhat postpone a perceptible slowdown in the growth rate of consumer prices.
The government has to continue with conservative fiscal polices Government expenditure increased rapidly in the first half of 2007 but remained nevertheless below the revenues growth rate. The first-quarter fiscal surplus was close to the 2006 average, constituting 3.5% of GDP. In the second quarter, the general government budget surplus turned out smaller and did not exceed the 3% level.
So far, the government has maintained the budget surplus on a level comparable to 2006. Thus, in the first half of 2007, fiscal policy supported the gradual deceleration of domestic demand and the soft landing scenario. Eesti Pank is of the opinion that similar policies should be pursued in the second half-year as well. By the end of July, the government's current surplus had risen to 3 billion kroons, being again in the same magnitude compared to the same time of previous years.
Eesti Pank's view is that the government must maintain the current conservative trend. Any additional expenditure should be avoided in 2007 as well as in compiling the budget for 2008. According to the forecast of the Ministry of Finance, the dynamic growth of Estonia's economy will continue in the next years, supported by both rapid domestic demand and exports. Taking into account the demand-side pressures that will continue if this forecast comes true, the government will have to continue with tight policies in the years to come and strive for at least 2% consolidated budget surplus of GDP. In addition, should the current forecast prove to be over-optimistic, the government will have to be ready for expenditures in a decline stage.
Wednesday, October 3, 2007
Strong dinar, weak economy - Serbia is in trouble
From the BBJ today:
The runaway, vertigo-inducing hyperinflation was one of the symbols of Slobodan Milosevic’s era, so the first thing the new Serbian authorities did was to anchor the dinar and send a promising message of economic stability.
Now, as the nation looks Friday on the seventh year since Milosevic’s fall, the dinar is now stronger than ever, but the message it originally carried has been lost in the process. The Serbian currency is today swimming against the global trend and has been gaining on the euro, but with a desperate, one-handed battle against inflation instead of promised economic wellness as the backdrop. Following Milosevic’s fall, the dinar had been pegged to the German mark at 30 to one, or the equivalent of 60 for the euro, which arrived in 2002. After steadily weakening to reach 87.87 for the euro in May 2006, the dinar turned around and has since gained 11%, reaching the 78.18 mark last week. That however does not reflect the condition of the Serbian economy but a series of measures aimed at curbing the booming crediting activity. Actually, by being left to stand as the sole instrument against inflationary pressures, the overpriced dinar has been harmful in other segments of the economy, an expert warned.
“The exchange rate is now the only tool in combating inflation. ..and that is wrong,” said Vladimir Gligorov, a Balkans economics expert with the Vienna Institute for International Economic Studies. While it insists that it has rarely intervened to influence the exchange rate, the Serbian central bank has brutally tightened the monetary policy over the past few years to make the domestic currency scarce and expensive. That has dampened consumption and slowed prices, but monetary discipline alone cannot stem inflation in the long run, particularly when it stands against populist economic policies. And economic populism has ruled in Serbia since a series of elections became imminent in the H1 of 2006, starting with a constitution referendum in October.
The International Monetary Fund has been warning Serbia of overspending even before the middle of 2006, but the trend of loose finances has since then become even worse. In the 12 months until mid-2007, the average salary in Serbia rose by a “staggering” 30%, despite a modest productivity growth of 6-7%, the IMF resident representative in Serbia, Harald Hirschhofer recently said. While the central bank measures may help to depress the inflation to single digits, with the official annual target rate of 6.5% already revised upward to 8.5%, the burst dams to spending “cause concern,” Hirschhofer said. The swollen wages have started to unbearably pressure the prices, the majority of which are controlled by decree, not the market. “With retail prices growing by just 4.5% in the period, the average Serb could buy ... 26% more goods than a year before,” Hirschhofer explained. Turning imports artificially cheap is another damaging effect of an overrated currency, which fuelled the “very worrying” explosive growth of foreign-trade and current account deficits, Gligorov said.
The trade deficit reached $5.55 billion, within a 16.69 total trade volume, in the first eight months of 2007. The deficit was by 38.6% larger than in the corresponding period and is expected to reach an $9.9 billion by the end of 2007. While income from past privatizations, credits and hard currency inflow from the large Diaspora so far could finance the deficit, Serbia will run into trouble if it continues lagging with structural reforms, experts warn. However, nobody has been thinking about basic economic policy and everybody only talks about Kosovo,’ Gligorov said. He predicted that, with presidential and local elections looming, nothing would change in the near future despite the alarm bells, because “the situation currently suits the average consumer” - in other words, the voter. (m&c.com)
The runaway, vertigo-inducing hyperinflation was one of the symbols of Slobodan Milosevic’s era, so the first thing the new Serbian authorities did was to anchor the dinar and send a promising message of economic stability.
Now, as the nation looks Friday on the seventh year since Milosevic’s fall, the dinar is now stronger than ever, but the message it originally carried has been lost in the process. The Serbian currency is today swimming against the global trend and has been gaining on the euro, but with a desperate, one-handed battle against inflation instead of promised economic wellness as the backdrop. Following Milosevic’s fall, the dinar had been pegged to the German mark at 30 to one, or the equivalent of 60 for the euro, which arrived in 2002. After steadily weakening to reach 87.87 for the euro in May 2006, the dinar turned around and has since gained 11%, reaching the 78.18 mark last week. That however does not reflect the condition of the Serbian economy but a series of measures aimed at curbing the booming crediting activity. Actually, by being left to stand as the sole instrument against inflationary pressures, the overpriced dinar has been harmful in other segments of the economy, an expert warned.
“The exchange rate is now the only tool in combating inflation. ..and that is wrong,” said Vladimir Gligorov, a Balkans economics expert with the Vienna Institute for International Economic Studies. While it insists that it has rarely intervened to influence the exchange rate, the Serbian central bank has brutally tightened the monetary policy over the past few years to make the domestic currency scarce and expensive. That has dampened consumption and slowed prices, but monetary discipline alone cannot stem inflation in the long run, particularly when it stands against populist economic policies. And economic populism has ruled in Serbia since a series of elections became imminent in the H1 of 2006, starting with a constitution referendum in October.
The International Monetary Fund has been warning Serbia of overspending even before the middle of 2006, but the trend of loose finances has since then become even worse. In the 12 months until mid-2007, the average salary in Serbia rose by a “staggering” 30%, despite a modest productivity growth of 6-7%, the IMF resident representative in Serbia, Harald Hirschhofer recently said. While the central bank measures may help to depress the inflation to single digits, with the official annual target rate of 6.5% already revised upward to 8.5%, the burst dams to spending “cause concern,” Hirschhofer said. The swollen wages have started to unbearably pressure the prices, the majority of which are controlled by decree, not the market. “With retail prices growing by just 4.5% in the period, the average Serb could buy ... 26% more goods than a year before,” Hirschhofer explained. Turning imports artificially cheap is another damaging effect of an overrated currency, which fuelled the “very worrying” explosive growth of foreign-trade and current account deficits, Gligorov said.
The trade deficit reached $5.55 billion, within a 16.69 total trade volume, in the first eight months of 2007. The deficit was by 38.6% larger than in the corresponding period and is expected to reach an $9.9 billion by the end of 2007. While income from past privatizations, credits and hard currency inflow from the large Diaspora so far could finance the deficit, Serbia will run into trouble if it continues lagging with structural reforms, experts warn. However, nobody has been thinking about basic economic policy and everybody only talks about Kosovo,’ Gligorov said. He predicted that, with presidential and local elections looming, nothing would change in the near future despite the alarm bells, because “the situation currently suits the average consumer” - in other words, the voter. (m&c.com)
Monday, October 1, 2007
Subscribe to:
Posts (Atom)
