The Baltics: Holding Steady

With Iceland, Hungary and even Russia in jitters, you would think that the Baltics would catch the financial crisis cold any day now. Market experts have been predicted this for months (see story in the latest The Economist). But these are the same experts who missed the magnitude of the unfolding crisis, so no reason to listen. So far, Estonia, Latvia and Lithuania have held remarkably well.

There are some reasons to be worried. Fitch, a rating agency, calculates their gross external financing requirements in 2009 to be 400% of likely year-end, foreign-exchange reserves in Latvia, 350% in Estonia and 250% in Lithuania. These are the highest ratios among new European Union members. Second, the economies are very dependent on exports to the EU, where demand will drop significantly in 2009 and perhaps in 2010. Third, all three countries have currency boards, with pegs to the euro. If foreigners start withdrawing money out of the region, the money supply shrinks, forcing a recession. 

On the positive side, the Baltics have little public debt, and Estonia in fact has a surplus. The countries' energy bill will drop significantly, which would be welcome news for government finances and businesses alike. Also, all three countries have made big reforms to make business easier. Estonia ranks 22, Lithuania 28 and Latvia 29 in the latest Doing Business rankings. This will enable the workers and businesses to be flexible and move to less affected sectors. This lesson may have been learned from their neighbors, the Nordics, during the early 1990s banking crises. Then, the heavily regulated economies of the Nordics suffered a long recession, and only significant job creating reforms brought them back. The Baltics have less need for reforms, in comparison.

In short, the prospects of a Baltic meltdown are exaggerated.