September 25, 2007 / 3:43 PM / in 10 years

Amid credit crunch fears, less lending good for Baltics

5 Min Read

By Patrick Lannin

RIGA, Sept 25 (Reuters) - A tightening in credit conditions has spread fear in world markets, but a reduction in lending is part of the medicine being prescribed to help cool overheating in Latvia and the other Baltic economies.

Less lending by banks and high local interest rates have already led to a credit squeeze in Latvia and more austerity is being urged in the form of wage freezes, higher budget surpluses and a halt to large public sector building projects.

Similar remedies are on the agenda, though to a lesser extent, in less overheated Estonia and Lithuania.

Inflation in all 3 countries has delayed plans to adopt the euro this year or next year to sometime around 2010-2013 and tightening measures are aimed at helping bring down the rate of price rises and lead to more sustainable growth.

"It is becoming more and more difficult now to get a loan and at the same time households are getting more cautious about decisions on taking a loan or not, that is a very healthy situation," said Andris Vilks, chief economist at second-largest Latvian bank, SEB Unibanka.

Banks in Latvia have also got reluctant to lend to each other, leading to a lack of liquidity in the local market and overnight rates that have touched their highest since 1999.

Faced with rising prices, Latvian Prime Minister Aigars Kalvitis has started talking of the need for painful measures like salary freezes in the public sector and restraint in the private sector to avoid an inflationary spiral. Inflation was 10.1 pct in August.

The country's president, Valdis Zatlers, has also joined in, saying he will freeze his and his staff's wages.

The government is also planning to increase the budget surplus, the main way the government can take money out of the economy and another example of belt tightening.

Convergence Brings Problems

In Estonia, where inflation is a more moderate 5.7 percent year-on-year, the government is already running budget surpluses but is also being told to increase them. Banks have also become more conservative in their lending policies.

"It would be nice to see next year a bigger surplus than the government is currently planning and we a are bit conerned they are planning so strong growth in spending," said Maris Lauri, chief economist at Hansbanka.

"Less credit is a good thing, but it is also important that we do not lose all credit, then you will have a big crash in the economy," she added.

Lithuania, where inflation was 5.5 percent in August, has been less ambitious in its budget, intending to run a deficit of 0.5 percent of GDP next year and to reach balance in 2009.

However, fresh data on Tuesday showed a widening in the current account deficit to 16.1 percent of GDP in the second quarter from 13.2 percent in the first three months of the year. In Latvia, the deficit is a whopping 23.5 percent of GDP.

In all three countries, calls for more restraint in wages and spending run up against the fact that their economies are on a convergence course with western Europe, where prices and wages are generally higher.

One clear sign of this has been the rapid rise in property prices, which in parts the capital cities are already at the same level as richer Nordic cities.

Driving the need for convergence in wages is also the fact that, particularly in Latvia, people are voting with their feet and moving to the West for higher salaries.

This worsens an already tight labour market and leads to worries of falling population in countries which are already among the smallest in the European Union.

For Raimondas Kuodis, chief economist at the Lithuanian central bank, less credit would be a good thing as it would lead to less demand for consumer durables, which are mainly imported. This would lead to a falling trade deficit.

He remained calm over the outlook for his country.

"I think that the base line scenario for adjustment is not a hard landing, but basically a mild adjustment which would take primarily through the trade balance," he said.

((Reporting by Patrick Lannin; patrick.lannin@reuters.com; Reuters messaging: patrick.lannin.reuters.com@reuters.net; Phone: +371 29 269 191;editing by Ian Jones)) Keywords: BALTIC CREDIT/

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