Estonia and Latvia’s economies are the fastest growing in Europe thanks largely to an unrestrained borrow-and-buy consumption boom, and nowhere is this better reflected than in the two countries’ current account deficit.
On June 22 the Bank of Latvia announced that the current account deficit in the first quarter of 2007 reached 25.7 percent of quarterly gross domestic product, or 1 billion euros. This is by far the highest in the European Union. A year ago the deficit was 14.6 percent.
Estonia announced on June 26 that its first quarter current account deficit was 17.9, confirming the dangerous trend in the Baltic state’s wealthiest economy. In the fourth quarter of 2006 the deficit was 17.6 percent.
The current account is part of what economists call the balance of payments, which reflects a country’s balance of trade and payment transfers (in both public and private sectors). The number essentially provides insight into how much a country is “absorbing” from the outside world and how much it is “giving” in return.
There can be a deficit in the current account, and there can be a surplus. In the Baltics’ cases, the deficits are large, and widening, showing that the countries are consuming far more than they’re producing.
Martins Gravins, spokesman for the Bank of Latvia, said that total direct investment in Latvia grew by 7.3 percent year-on-year, covering one third of the current account deficit. The largest part of the deficit was financed by foreign banks, which in Latvia control over half of the banking industry.
Analysts are at odds as to how large the current account deficit will be in 2007. SEB Latvijas Unibanka has projected a deficit of 24 - 25 percent of GDP, while Hansabanka analysts expect it to end up in the 18 - 20 percent range, the Baltic News Service reported.
Andris Vilks, chief economist at SEB Latvijas Unibanka, said the first quarter result was a bit smaller than preliminary figures, which is positive. “The deficit, however, is surprisingly high for the beginning of the year and signals that Latvia must act to bring it back to a more or less normal level – in the Baltic context, of course,” he said.
Hansabanka’s chief economist, Martins Kazaks, said that the first quarter data corresponded to preliminary estimates, but that analysts had hoped for a smaller deficit of some 21 percent of GDP.
“The updated figures show that the imbalanced development in 2006 also continued in the first quarter of this year, with Latvians spending recklessly. And despite a relatively impressive growth in exports, imports have still been growing too rapidly. So there is no good news in the first quarter data,” Kazaks said.
As he explained, the government is unable to pinpoint successful industries for export development and that the optimal policy for Latvia would be to declare support for export. Also, economic policy might be changed by relieving the tax burden on the workforce and raising taxes on consumption.
“In such a situation resourceful Latvians would surely turn to export industries and by boosting their earnings in foreign markets would steady the macroeconomic situation in Latvia,” Kazaks said.
In Estonia, the yawning current account deficit has analysts readjusting their predictions for 2007.
Anne Karik-Uustalu, an analyst at Sampo Pank, said prior to the June 26 announcement that no positive news could be expected as regards the overall size of the deficit. According to her estimates, the deficit may have reached 21 percent of GDP in the first quarter and close to 16.5 percent of GDP in the last four quarters.
The high figure may bring negative attention to Estonia, she added. The positive aspect is that the trade balance is showing a certain improvement in comparison with the first quarter of 2006, she said. In the four-quarter count the gap in the trade balance nevertheless grew wider, to an estimated 11 percent of GDP.
Karik-Uustalu also pointed at the net outflow of revenue resulting from the high productivity of investments made in Estonia, which has significantly boosted the current account deficit.
“Considering the overall increase in profits, this seems logical. That is one reason why capital keeps coming to Estonia,” she said.
“The big outflow of revenue is also a thing that largely happens in the books, since a large part of the revenue is immediately reinvested into companies in Estonia. This shows that the Estonian economy is strongly integrated with Europe’s economic space, especially of the Nordic countries,” Karik-Uustalu said.