Moody’s Investors’ Service cut the long-term credit rating outlook on the foreign and local currency debt of both countries to stable from positive, citing worsening macro-economic imbalances. Moody’s is the last of the three main agencies to respond to the Baltic states’ overheating economies and its rating for Latvia is still two notches above its peers. Latvia’s rating of A2 and Estonia’s rating of A1 remain firmly within the investment grade category. However, the concerns the agency raises serve as a stark reminder of the vulnerabilities of several rapidly-growing eastern European economies dependent on capital inflows and running big current account deficits.
A recent Standard & Poor’s report put Latvia at the top of the list of countries most vulnerable if the credit squeeze continues. Latvia’s current account deficit over the last 12 months of 30% of GDP is among the highest in the world. Concerns are also being raised about Estonia, Lithuania, Bulgaria and Romania. Charles Robertson, chief economist for Europe, Middle East and Africa at ING, said: “These are ratios I never thought I’d see. We used to warn that current account deficits of 7% of GDP might herald a crisis, now twice as high is common. This is new risky territory, much like [US] sub-prime [mortgage] lending was, and it requires close monitoring.”
Moody’s noted that in Latvia and Estonia, large-scale foreign borrowing by the private sector had fuelled household consumption and property investment – the primary drivers of economic growth over the past few years. But the property markets are now exhibiting what Moody’s calls “bubble-like” characteristics and Swedish banks such as SEB and Swedbank, whose subsidiaries have financed the boom, stand exposed if the bubble bursts. S&P warned: “Several sovereign [nations]… are struggling with symptoms of overheating economies which directly followed the almost indiscriminate leveraging up of the private sector, increasing the risks of a hard landing. The risks associated with a sudden stop to cheap financing increases the longer the credit boom lasts and the greater the corresponding external imbalances become.” Ciaran O’Hagan, strategist at Société Générale, says: “The key issue is whether the current account deficits are sustainable or not.”
Banks are already slowing lending growth and property prices are stabilizing but if the slowdown is too rapid it could hit confidence in the Baltic currencies and trigger a hard landing. The Latvian authorities, who faced down a currency wobble in the spring, have recently had to deny again rumors of an imminent devaluation. Steve Barrow, chief currency strategist at Bear Stearns, said: “A lot of the capital flows come from banks responding to local credit demands, especially for cheap mortgages. But if major banks take a step back and if individuals decide to cover foreign currency loans by selling the domestic currency, we can have a crisis on our hands. Things look weak [in Latvia] and if the other shoe drops in the currency markets at all soon, we suspect it might drop here”. (FT.com)
