Baltic economies - a painful downfall after years of prosperity

In the first six months of 2009, the Baltic states' GDP shrank by nearly 20%, which was the worst result in Europe. As a consequence of job cuts in private enterprises and the public sector, the unemployment level has tripled in comparison with the preceding year to exceed 15% in all three countries. It is still unclear from the economic data for the past few months whether recession in the Baltic states will continue to worsen. However, it seems that the economic indices will not fall so rapidly in the next quarters as they did in the first half of the year.
If the governments of Lithuania, Latvia and Estonia manage to stabilise the state budget situation, the greatest challenge they will have to face will be the worsening financial situation of the population, which may give rise to social tensions and public protests.

The difficult first half of the year

The statistical offices of Lithuania, Latvia and Estonia published economic data from the second quarter of 2009, according to which GDP in Lithuania shrank 22.4%, in Latvia 19.6% and in Estonia 16.6% compared to the same period of 2008. Data for the first quarter showed GDP fell by 13.3%, 18.1% and 15.1% respectively. Such dramatic GDP reductions were caused by the constant worsening of the situation in the key sectors of their economies: industry, trade and the building sector. The decrease in production and trade turnover was an effect of a shrinking internal demand and the falling value of exports (in individual months of the second quarter, the export value in each of the countries reduced by nearly 30% in comparison with the preceding year). The record-breaking recession in the Baltic states is first of all a consequence of the strong susceptibility of their small and open economies to changes of the situation on global markets and of the failure to carry out public finance reforms in those countries at the time of economic growth a few years ago. The economic slump further deepens the existing financial problems of the Baltic states. Budget deficits in Latvia and Lithuania, according to most recent estimates, will reach 10% and 5% of GDP respectively. It may not be ruled out that the worsening economic situation in Lithuania will force Vilnius to follow in Riga's footsteps and apply for a stabilisation loan to the IMF. Estonia has relatively the best financial situation. It still expects to maintain its budget gap at a level lower than 3%, which would allow it to join the Eurozone in 2011.

Governmental anti-crisis activities

The deep recession and falling budget incomes in Lithuania, Latvia and Estonia has forced the governments of those countries to concentrate on moves aimed at reducing the budget gaps. On one hand, tax levels have been increased (for example, the VAT rate has been raised in all the three countries), and on the other, state expenses are being cut partly through the reduction of the employment and wage levels in the public sector.
The restrictive fiscal policy has failed to slow down the recession, and the steps taken by Vilnius, Riga and Tallinn to counteract an economic breakdown by offering various forms of support to business are rather ineffective due to the scale of the present crisis and the insufficient funds to adopt such a policy (most of the funds received by Latvia from the IMF and the EU have been allocated to the handling of the country's debt and stabilisation of the banking sector). The possible devaluation of the national currencies of Lithuania, Latvia and Estonia, which are linked to the euro, would improve the competitiveness of the Baltic states' exports only to a small extent because the share of imported components and raw materials used in production processes is quite large. The countries' governments, which are unwilling to carry out a devaluation, also argue that it may cause more bankruptcies of individuals and companies who have taken loans in euros. An additional argument raised in the case of Estonia is the need to meet the criteria in order to be able to join the Eurozone (Latvia and Lithuania will not meet the criteria in the coming years due to excessive budget deficits).

Social consequences of the crisis

The unemployment level in the Baltic states has tripled over the past year increasing from 5.1% to 15.8% in Lithuania, from 6.4% to 17.2% in Latvia and from 4.6% to 17% in Estonia. The rapid increase in unemployment is a consequence of job cuts, first of all in the industrial and building sectors. The difficult situation on the labour market is additionally aggravated due to staff reductions in the public sector (mainly in the administration, although Latvia is also planning numerous job cuts in the healthcare and education sectors; several thousand teachers from among the total number of over thirty thousand will be made redundant this September), dictated by the need to cut state budget expenses. The forecasted continuation of recession in 2010 in the Baltic states will result in further growth of the unemployment rates. This is likely to stimulate economic emigration, which has significantly slowed down over the past few years after the boom ensuing from EU accession. Since social expenses have been reduced, the most serious consequence of higher unemployment levels will be the significant worsening of people's economic situation, which may provoke social tension and protests.

Forecast

According to recent forecasts, including one presented by Swedbank (the largest bank in the Baltic states), the economies of Lithuania, Latvia and Estonia are unlikely to sustain such dramatic falls of economic indices as in the first two quarters of this year. However, the scale of the present recession, the significant debts of companies and individuals in those countries and the fact that all trade partners of the Baltic states have economic problems indicate that the process of overcoming the crisis will be difficult and the way in which it will be carried out will depend largely on the improvement of the global economic situation. In the second half of this year, the Baltic states may still have problems sticking to the limits of planned budget deficits. However, if a threat to the stability of public finances appears, the governments of those countries may expect assistance form the IMF and the EU, which already granted a loan of 7.5 billion euros to Latvia last December.

Paweł Siarkiewicz

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