* The Baltics are firmly in ‘normalisation’ mode. Following unsustainable gains in GDP over 2006-07, economic activity collapsed in 2008-09. Last year saw stabilization on this front which has now translated into concrete signs of recovery.
* Balance of payments trends very much reflected the boom bust nature of the last cycle. Multi year double digit C/A deficits were forced sharply into surplus by end-09, initially triggered by a halt in capital inflows to the banking sector from Scandinavia, later exacerbated by the global crisis and in Latvia’s case an outflow of non-resident deposits. Current account surpluses have now peaked and we expect a shift back into deficit, albeit at least initially modest, over the coming quarters.
* Inflows of capital in the form of EU structural funds, a modest recovery in FDI and increased sovereign Eurobond issuance will facilitate this shift back into C/A deficit but continued outflows from the banking sector combined with Latvia’s scheduled repayments to the EU will limit the ability of at least Latvia and Lithuania to run excessively wide deficits which are once again reliant on debt creation. Further efforts to consolidate fiscal policy are essential to ensure that the public sector does not crowd out the private sector.
* Estonia entered EMU last January. As members of ERM II, Latvia and Lithuania hope to enter as soon as possible. Estonia’s ability to avoid another ‘boom/bust’ cycle in its initial years of EMU participation will be important in convincing an ever increasing number of EMU policy makers on the merits of further EMU expansion.
Gillian Edgeworth, Dmitry Veselov
UniCredit Research