The Baltics’ Beguiling Bragging Rights

With the rest of Europe foundering Lithuania started the year with a major issue and Estonia reaffirmed its euro entry decision as Latvia exited its IMF program with good marks and welcomed further formal monitoring. Unlike cross-border owners elsewhere Scandinavian giants like Swedbank reiterated their intention to keep operations in place to participate in recovery and apply debt workout expertise. Norway’s sovereign wealth fund hinted at greater sub-regional public and private equity exposure in a continued diversification strategy, and pioneer managers like East Capital highlighted smaller company healthy earnings as near-term portfolio favorites. In their final review Latvian officials stressed the intention to meet stricter revised EU stability and growth pact criteria for single-currency eligibility by 2014. Fiscal and inflation performance as well as business, labor and education conditions will be improved, despite the temporary deposit and payment freeze imposed by Krajbanka’s malfeasance and shutdown which also affected foreign units. GDP growth could halve to 2.5 percent this year on “trading partner stagnation” as the current account reverts to slight deficit. Inflation should drop from 4 percent to 2.5 percent as nominal wages continue to shrink with unemployment at 15 percent. The budget gap will narrow to 3 percent of GDP on better tax compliance, a financial stability levy increase, cuts in central and local government spending, and social security adjustments. A top priority is “fighting the grey economy,” according to the letter of commitment even though the revenue result is “uncertain.” A fiscal responsibility law will enshrine medium-term discipline despite calls on state coffers to honor Krajbanka’s obligations and assist Baltic Air alongside commercial investors. These stakes will be sold off in future privatizations under an overall government enterprise good governance thrust which could place private pension funds in an enhanced oversight role.

Domestic borrowing will preserve benchmark maturities and combine with a return to international capital markets that began with a June 2011 Eurobond in an attempt to minimize rollover risk.  The narrow band exchange rate will stay intact until Euro adoption with interest rates converging toward ECB levels.  Higher bank capital standards will follow new EU regulations and consumers and supervisors will receive additional powers and protections.  Troubled institutions from the 2008-09 period will continue along their resolution path with the Mortgage Bank to be divested and replaced with a s single development lender and Citadele to get final bids by the end of Q1.  The residual Parex Bank is still the subject of numerous lawsuits and criminal inquiries against the former majority shareholders.  International hedge funds have accused the government of bungling investigations and harming their interests in a record unworthy of boasting.