do the baltics deserve a second look peeter piho
TRANSCRIPT
Do the Baltics deserve a second look? Scrutinising the
reasons for investor skepticism
Peeter Piho, Swedbank Investment Funds
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May 2010
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The Baltic states
ESTONIA
LATVIA
LITHUANIA
GDP: €16.2bnPop: 1.34 mln
GDP: €18.3bnPop: 2.26mln
GDP: €27.7bnPop: 3.34mln
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Rise of the Baltics: 2000 – 2007
Continuous GDP growth at average rates ofapproximately 8.3% in Estonia, 8.7% in Latviaand 7.5% in Lithuania, facilitated by:
•stable currency rates based on currency boards in Estonia (since 1992) and Lithuania (1994), fixed exchange rate in Latvia (1994)
•strong, compliant and innovative banking system dominated by large Scandinavian banks since late ‘90s
•investor friendly economic policies
•simple, advanced taxation principles introduced early (flat income tax in all three countries, no corporate income tax in Estonia)...
... But most importantly by:
•Strong FDI inflow
•Cheap credit widely available for banks to be onlent to companies and individuals.
-15
-10
-5
0
5
10
15
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009(f)2010(f)
Real GDP Growth Rate (%)
Estonia Latvia Lithuania EU27
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Fall of the Baltics 2008-2009:
GDP plunged hitting double-digit levels
Latvia bailed out by the IMF, Lithuania borrowing in the market to compensate for deficit.
Prompt devaluation of currencies was widely expected by foreigners across the winter 2008-
2009.
Export opportunities vanished due to the global crisis.
Consumer confidence dropped to all-time lowest level
After acute lack of labour up to 2007, unemployment skyrocketed within 12-18 months from ca.
4-5% to 14-17%
Banks panicked and cut lending to corporate sector; loan portfolio decreasing
Whole region generally despised by the investors’ community
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Before it all happened, investors had their say
In 2008 investors had said:
Your economies are unbalanced and need to
be delevered
Your currencies are overvalued and currency
pegs will not hold
Your assets are too expensive...
... and did not invest any moreForeign Direct Investment Inflow (% of GDP)
Estonia, EEK Latvia, LVL Lithuania, LTLSource: Reuters EcoWin
Mar Jul Nov Mar Jul Nov Mar Jul Nov Mar Jul Nov Mar Jul Nov
05 06 07 08 09 10
-2.5
0.0
2.5
5.0
7.5
10.0
12.5
15.0
17.5
20.0
22.5
25.0
EXTERNAL DEBT/GDP 1.10.2009
0%
20%
40%
60%
80%
100%
120%
140%
160%
LAT SLK HUN EST SLV BUL LIT ROM POL CZK
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Exploring debt burden
0%
20%
40%
60%
80%
100%
120%
140%
160%
Estonia Latvia Lithuania
Banks FDI related Government Other
Gross external debt (% of GDP, Q3 2009) Nominal debt is high but there are few things to highlight:
-Financial sector debt accounts for >50%. It’s all Nordic
banks’ loand to their Baltic subsidiaries;
-Another big chunk is FDI related
-Government’s share negligible even after Latvian IMF
package and Lithuanian 2008/2009 bond programs:Government debt 2009
0%
10%
20%
30%
40%
50%
60%
70%
80%
Estonia Latvia Lithuania EU 27
Source: Eurostat
Most of the debt not actually collectible – Scandinavian banks not in position to call their loans.
The Baltic countries (except Latvia, for fiscal reasons) did not actually face liquidity crisis.
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Exploring debt burden – financial sector
Baltics total (EUR 75.4 bln)
Five largest banks have over 75% of the market share which is similar to Nordic countries
• Banking sector highly concentrated
• Scandinavian banks dominate the market
in Estonia totally, in Latvia/Lithuania
minority controlled by locals
Latvia (EUR 30.0 bln)
Lithuania (EUR 24.8 bln) Source: local banking associations and FSAs, centrals’ bank data. Data as at end 2009
SEB; 20%
Nordea;
13%
DnB Nord;
2%
Swedbank;
49%Danske;
10%
Unicredit;
2%Parex; 1%
remaining;
5%
SEB; 14%
Nordea; 10%
DnB Nord; 9%Danske; 1%
Parex; 17%
Unicredit; 4%
Hypoteku; 4%
Aizkraukles; 0%
remaining; 18% Swedbank; 23%
Swedbank; 22%
Nordea; 10%
DnB Nord; 14%
Danske; 7%
Unicredit; 1%
SEB; 30%
Parex; 2%
remaining; 1%Snoras; 7%
Siauliu; 2%
Ukio; 5%
DnB Nord;
9%
Parex; 7%
Unicredit; 2%
Nordea; 11%
Swedbank;
30%
remaining;
15%
Danske; 5%
SEB; 21%
Estonia (EUR 20.6 bln)
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Lending before and after September 2008• Combination of abundance of cheap
international credit and small size of the Baltic
markets pushed banks to fuel the loan growth
for years.
• Lehman crisis triggered a panic and banks
pulled the breaks. By Feb 2010 they have
taken out over EUR 2 billion purely from
corporate clients.
• Some of that reduction was prudent, some
clearly an over-reaction, and some needs to be
substituted by more appropriate capital.
• Deleverage represents ca 7% of the portfolio in
2008 and ca 6% of pre-crisis GDP.
• The key question is what will the banks do next
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Interbank Rates, 6 Month
TALIBOR RIGIBOR VILIBOR EURIBOR
04 05 06 07 08 09 10
0
2
4
6
8
10
12
14
16
18
20
Exploring exchange rate risk
Currency pegs in place:
Estonia (kroon, EEK) Currency board since 20.06.1992 (initially fixed vs.DEM)
Latvia (lats, LVL) 01.01.2005 pegged to the €, +/-1% range. 1994-2004 was pegged to SDR basket of 4 currencies;
Lithuania (litas, LTL) Currency board; 02.02.2002 at a fixed exchange rate against EUR. 1994-2002 fixed vs.USD
In 2008/2009 the market believed that devaluation
is underway, starting from Latvia
27%
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Devaluation unlikely from the beginning
Symbolic status of the pegs – overlooked by foreigners
It would not have resolved problems due to open nature of the economies
Substantially all bank loans in the Baltics have been nominated in euros, correct. But collection in € when currencies devalued
All relevant parties against devaluation:
• Government
• Banks
• Entrepreneurs
• People (=mortgage borrowers)
Loan exposure in the Baltics
162
172
95.489.9
0
20
40
60
80
100
120
140
160
180
200
bn S
EK
Loan exposure in the Baltics
Shareholders' equity
- Would have triggered credit losses for leading banks in the magnitude jeopardizing their capital base (see chart);
- Would have hit private individuals –borrowers; that would have been politically unacceptable;
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Response 1Internal devaluation instead of nominal exchange rate adjustment
Countries opted for adjustment via domestic labour market and fiscal tightening. Massive wage and employment cuts have proven the flexibility of real economy and labour market.
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Labour market flexibility has supported internal adjustment
Source: Carley
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Response 2Fiscal tightening
Governments cutting costs heavily:
Estonia and Lithuania voluntarily;
Latvia under IMF programme;
Estonia with it’s budget position at -1,7% one of 5 EU countries that met Maastricht criterion in 2009.
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Consequences 1Loss of external competitiveness has now been stopped
Internal devaluation takes generally longer time to have a meaningful effect.First positive signs in export performance started to emerge at the end of 2009.
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Consequences 2Economic grounds for devaluation have effectively been removed
15
Source: EurostatSource: Eurostat
-6
-4
-2
0
2
4
6
8
10
12
14
16
18
Inflation (HICP) growth (%)
Estonia Latvia Lithuania EU Average
-1400
-1200
-1000
-800
-600
-400
-200
0
200
400
600
800
Balance of payments, current account (EUR mln)
Estonia Latvia Lithuania
Estonia’s euro accession
Maastricht criteria as of end 2009
Criterion Target value Estonia
Inflation 1,5% 0,2%
Government debt 60,0% 7,2%
Budget balance -3,0% -1,7%
Interest rates 6,1% N/A
Latvia and Lithuiania targeting to join in
2014
12 May publication of Estonia’s convergence report
June recommendation of euro-area Member States
8 June ECOFIN meeting, discussion of Estonia's compliance
18 June the European Council discusses Estonia's readiness to join the euro area
13 July ECOFIN's final decision about Estonia’s accession
1 Jan 2011 Eurozone entry
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2010 - 2011 Time to enter for daring investors
From macroeconomic point of view:
Acute recession is over. Export is a key to set the pace for recovery.
Estonian eurozone entry will add stability to entire region. Devaluation currently off the table, internal adjustment instead of exchange rate.
Painful cost-cutting done, competitiveness improved.
In the market, almost no PE backed deals over the last two years. It will change since:
Availability of financing still restrained, fundamentally healthy companies seeking replacement capital.
Extensive, diverse pipeline across the region and sectors.
Valuation gap narrowed down.
Revival of private equity (and property) investors’ interest visible.
Strategic investors already buying (2 major delistings)
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Thank you!
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