Parex anniversary: Is the next crisis approaching?

Foto: Lita Krone, LETA
Mortens Hansens
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It is already here, that is in some parts of the world, in other parts it may be approaching, but I will argue that the answer to the question is a very firm “No!’ in the case of Latvia or the Baltics for that matter.

I hear so many talks about “the coming crisis” – I just wonder why? Perhaps, because it recently was 10 years since the demise of Lehman Brothers? Or, at the time of writing this piece, exactly 10 years since the collapse of Parex Bank? Or, as I have heard some say, “it is about time for the next crisis”, whatever that means?!?

The economy has been growing for quite a while now, see Figure 1. In fact, almost as long as the (in)famous “Seven Fat Years” (which were actually almost nine years – this time the economy has been growing since Q3 of 2010, i.e. for eight years so far). But why should it then stop?

Figure 1: Economic growth, Latvia, quarterly data, 1996 Q1 – 2018 Q2

Source: Central Statistical Bureau of Latvia

Last time, the Lehman and Parex incidents caused a “sudden stop” – lending, based on which the economy had been growing super-fast in 2004-07, stopped and thus did economic activity. But at the moment there is no credit boom in Latvia at all; thus no boom to go bust. There is no real estate bubble either; thus no bubble to burst.

Brexit, you may say! Whatever will come of Brexit, it is not of grand importance to the Latvian economy. Trade matters but the UK accounts for only 5-6% of Latvian exports and a super-hard Brexit, significantly limiting Latvian exports to the UK is an unrealistic scenario. Even if it should happen, it will not send the Latvian economy into a tailspin. Think of the sanctions vis-à-vis Russia. Impact on the overall economy? Tiny! Brexit will mostly affect Britain and Ireland for which the UK is a very important export destination.

The Donald and a US-China trade war, then! Again I would argue that the impact here would be limited. Latvia is much more affected by what happens in countries such as Lithuania, Estonia, Germany, Sweden etc, i.e. the major trading partners. They are not the US or China.

Emerging market trouble – Turkey for instance! Classical emerging market crisis – and I expect more of those. Interest rates are rising in the US and that market becomes more attractive for investors. They pull their dollars out of Turkey, which sees its currency tumble because its firms had borrowed heavily in dollars in the first place. Not smart – dollar loans must be repaid in dollars by firms which have earnings in devalued Turkish lira. Expect many bankruptcies and a recession in Turkey. Again, no heavy borrowing has taken place this time in Latvia and – contrary to ten years ago – there is no currency mismatch either. Whatever borrowing there is, is in euros, just like earnings.

In all the cases mentioned Latvia is in an ideal position, economically as well as geographically. Economically by having no imbalances (except one; see end of story), geographically in the sense that Latvia is not close in terms of distance or economic relation to the events mentioned.

Ah! Italy, then! The EU Commission has, for the first time ever, rejected a country’s (Italy’s) budget proposal. Another euro crisis but with a bigger country this time? I am quite sure that the Commission and Italy will find some solution. The EU is good at that but in an annoying way in that compromises are usually coming in the very last minute – but no one has an interest in crisis development in Italy. Especially not the Italians since their banks have lent heavily to the Italian government and are thus first in line to go down in case of a crisis. Thus expect some sort of compromise.

I really just see one short term problem here and it is the labour market. Unemployment, due to so many years of growth coupled with migration and poor demographics, is getting increasingly tight with unemployment at its lowest for 10 years, see Figure 2.

Figure 2: Unemployment rate in Latvia, 2002-I – 2018-V

Source: Central Statistical Bureau of Latvia

But this does not erupt into a crisis. Rather, some firms will have to decline on potential contracts, some firms will lose some of their competitiveness due to rising wages they have to pay and thereby lose contracts. Altogether this will slow down the economy but not in any way or form make a repetition of 2008-10.

Rather, firms will have to think of labour-saving technologies, of ‘smart’ immigration etc. Completely normal!

Thus, sorry, but no crisis approaching this time due to an economy with no imbalances – except clear signs of overheating in the labour market.

Morten Hansen is Head of the Economics Department at Stockholm School of Economics in Riga and a member of the Fiscal Discipline Council.
Points of view expressed here are not necessarily those of the Fiscal Discipline Council.

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