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to SSG 04
Port of Gdansk, Poland.
Photo: Port of Gdansk Authority SA
Too much too fast for Baltic Rim countries
Undoubtedly, the Baltic Rim countries of Poland, Estonia, Latvia and Lithuania are among the fastest growing economies in the world. As such, they are vital to the future prosperity of the Baltic Sea region.
It all began in the early 1990s and culminated with membership of the European Community in 2004. These countries have embraced democracy and more specifically rekindled the traditional cultural and geographical relations. Historically, the four countries have very strong ties with the rest of Scandinavia; only these ties were severed by the Cold War period until glasnost in the early 1990s. Nordea has recently published a new publication entitled Baltic Rim Outlook, in which the bank takes a closer look at the economic development in these countries.
Growth too high
When economic growth takes off as it has done in these four countries, there are inherent dangers, which can eventually lead to increased inflation and in time suffocate growth. It is, therefore, important to look for a balanced development.
In the past couple of years most of the money has been channelled into private consumption and real estate investment. Such a development is quite understandable, given decades of economic under-performance. All four countries now feel they have an unsustainable growth rate with GDP up 11.0 per cent in the third quarter of last year. They want to ease this back to around 7.0 per cent, and even that may be too high. They have set the ball rolling at a good pace, but it could be 2007 before they can rein in the growth rates to 7.0 per cent per annum, or less.
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Mika Erkkilä, Nordea Finland. |
In need of restraining
Ideally, all countries would need some sort of restraining arrangement like the European Monetary Union (EMU). However, all four countries will have to bring inflation under control before they can even think of joining the EMU.
According to Nordea’s assessment, and in particular that of their senior analyst in Finland, Mika Erkkilä, even Estonia may miss the official January 2007 deadline to join because of too high inflation. Latvia, the fastest growing economy in the EU, may miss the EMU membership for the time being as domestic demand accelerates and demand far outpaces production and sucks in import. The official EMU deadline is 2008, but it is doubtful whether Latvia will be ready to join by then. The repercussions could be less palatable, like a turbulent financial market. Lithuania has had a more moderate development of late, with a GDP growth of just over 7.0 per cent. Therefore, Lithuania may join the EMU from January next year. Lithuania is also contemplating tax cuts, as income tax is relatively high at 33 per cent. The plan now is to reduce it in two steps to 24 per cent.
Poland a special case
Poland will have to wait for EMU membership – for political reasons – maybe until 2010, and even that looks fairly optimistic. With GDP growth of a “mere” 3.5 per cent Poland is well within the EMU range.
Compared with the other countries, Poland’s economy has been slightly sluggish. However, things are looking up, as all activity indicators are pointing upwards. One of Poland’s main problems remains the inefficient use of investments, both EU funds and domestic money, and a strict regulatory regime. A modest increase in investments is now expected, and this assumption is built on domestic bank lending to industry. According to an assessment made by Nordea analyst Anders Svendsen, the outcome of the parliamentary and presidential elections last autumn changed the outlook for EMU membership. The conservative Law and Justice (PiS) and the liberal Civic Platform (PO) won a landslide victory. The parties could not agree and the PiS formed a weak minority government.
Political uncertainty
This has created sufficient uncertainty to influence the economic assessment. We indicated that Poland was a special case, as a fairly large economy performing well below capacity. Everyone talks of Poland’s potential to become a very important European economy, but so far the political and fiscal preconditions are just not there.
Poland has suffered from ever increasing energy prices, which have hampered the difficult work to pull the economic rabbit out of the hat. It will certainly not be possible before price regulations and other remnants from an earlier age are dispensed with.
The Polish Government believes EMU membership should be possible in 2008. But introducing the euro in Poland will not necessarily solve all problems. This is why there is a set of criteria to be met in order to join. And since the Polish Government has no alternative exchange rate strategy, if EMU membership should not materialise in 2008, Poland could find it difficult to maintain a fixed exchange rate. What Poland needs is a credible Plan B to satisfy investors. It is self-evident that the Polish economy is a difficult beast to deal with compared with the economies of Estonia, Latvia and Lithuania, but until Poland’s problems are sorted out, the whole Baltic region will suffer.
//Petter Arentz
Latest update 18-10-2006 8:49
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No 18/2008
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2006