The Baltics’ Querulous Euro Queue

Baltic stock markets were buoyed by EU approval for Latvia to follow Estonia into the euro as Brussels hailed the “entry and not exit queue” although 60 percent of Latvian opinion is currently against joining. Popular grumbling was again reflected in a strong local election showing by the pro-Russian Harmony Center party which controls Riga, as the ECB also warned of fast growth in non-resident deposits from the broader CIS accelerating after the Cyprus debacle. $500 million was added in Q1 to this pool which accounts for half the system total, although supervisors recently imposed stricter capital and liquidity requirements with the buildup. They as well introduced anti-money laundering rules in response to watchdog criticism and negative headlines over the Magnitsky fraud case in Moscow, which spurred US sanctions over human rights and judicial abuses. GDP growth has declined from last year’s 5 percent on softer exports, but domestic demand remains supportive after the post-2008 rescue internal devaluation process which reduced labor and overhead costs. The IMF ended its presence in the capital as the investment-grade sovereign rating was restored and fiscal and inflation performance reverted to the Maastricht criteria. Euro opponents note that Estonian prices doubled after admission and that the country cannot afford that risk as the EU’s third poorest after Bulgaria and Romania. Both Estonia and Lithuania, which lingers in the ERM “waiting room,” were up around 10 percent on the MSCI frontier index through mid-June. The new Lithuanian coalition government has promised to tackle double-digit unemployment and keep the budget deficit at 3 percent of GDP with help from state company dividends and divestitures. The minimum wage was hiked 20 percent this year despite the slim odds of repeating 2012’s excellent harvest with agriculture an export mainstay.

Bulgarian stocks have rallied 50 percent as the incoming Socialist-led government headed by a former Finance Minister reiterated anti-corruption and structural reform commitments within the context of preserving the currency peg and fiscal discipline. The banking sector, with high non-performing loans and Greek ownership, continues to suffer after imposition of an interest tax and FDI is skittish after the Czech utility CEZ’s license was cancelled and a state railway sale was postponed. GDP growth will be only 1 percent in 2013 but the current account deficit has come down to minimal levels as foreign reserves dipped to $12 billion in Q1 after Eurobond repayment. Romania managed a 5 percent gain as the European Commission recommended removal of the excess deficit procedure and the currency held relatively firm despite global flight with the minor foreign ownership position. Both JP Morgan and Barclays included local debt in benchmark indices, and the central bank is set to cut rates despite a GDP growth upgrade to 2.5 percent. Other Balkan exchanges were mixed, with Croatia ahead on July EU accession and Slovenia off slightly as the former prime minister was convicted of bribery and officials scrambled to counter bailout talk by again lining up regional buyers for a retail store chain.