The Latvian government is getting nervous about the level of lending coming from Swedish banks. According to the Financial Times, “Latvia’s prime minister has warned Swedish banks they risk choking off recovery in the Baltic state’s crisis-hit economy unless they resume lending.”

The Latvian authorities are complaining, it seems, that banks such as Swedbank and SEB, which dominate the Latvian market, have reined in credit as they struggle to contain rising bad loans amid the deepest recession in the European Union.

So basically, in this climate, with unemployment rising, and wages falling, and an economy contracting at nearly 20% a year, it isn’t hard to understand why not that much new bank lending is going on. Those who are creditworthy are trying hard to save, while those who need to borrow normally aren’t that creditworthy, so Dombrovskis’ plea is rather like asking the bank to subsidize new bad debts, and that is really not something you can do, and especially not when you are going along the course you are following because you wanted to, and against one hell of a lot of external advice. What kicked the whole process off was a short sharp credit crunch, but now it is the contraction in the real economy which is following its own dynamic, till someone finds a way to put a stop to it. It is the drop in output that is preventing banks from lending, and not banks being unwilling to lend that is causing the contraction to continue.

But there is another point in the FT article which should give food for thought:

Mr Dombrovskis…ruled out devaluation of the lat. While breaking the currency’s fixed exchange rate with the euro would help Latvia’s exporters, it would increase the burden of euro-denominated loans, which account for 85 per cent of lending, he said.

“We would not see much benefit from devaluation because we are a very small and open economy which means that any competitiveness gains we may get would be very short-lived,” he said. “We would redistribute wealth from pretty much all the population to a few exporters.”

Well, we haven’t advanced too far in all these months, now have we, if we are still wheeling out the argument that “external” devaluation will hit holders of euro denominated loans, since it should be generally recognized that the (very painful) internal devaluation which is now taking place is hitting Euro loan and Lati loan holders alike. And the argument is a strange one to use just shortly after the statistics office announced that due to the rapid reduction in the number of those employed and to the fact that many of them changed their working conditions from full-time to part-time, the number of hours worked in the 3rd quarter of 2009 fell by an annual 27.3%, while labour costs fell during the same time period by 30.1%. This fall in disposable income, and the continuing prolongation thereof, poses a far greater threat to the continuity of Latvian loan payments than the 15% reduction in the value of the Lat as compared to the Euro which the IMF proposed in the autumn of last year would have done. Indeed, it is, in and of itself, one of the pernicious consequences of having resigned yourself to an “L” shape non-recovery. Stress on the banking system only goes up and up, as incomes and employment fall, and the government has less and less ammunition left to counteract the contractionary pressure.

It is like sitting it out in freezing weather at the North Pole, in the vain hope that help will arrive. But help will not arrive, and the cruel truth about the post-crisis shock world we live in, is that nobody is coming to help you if you will not help yourself. In this sense, what Latvia doesn’t need is more international borrowing (hasn’t there been enough of that already) but some kind of meaningful strategy to start paying back the debt. But this means putting people back to work, and selling abroad, and financing Latvian lending from Latvian savings, and not pleading for yet more capital inflows to finance non-productive activities (attracting investment would be another matter, but as things stand right now the environment is far from “appetizing”, and according to the latest data from the Statistics Office, non-financial investment in Latvia was only 402.8 mln lats in the third quarter, a fall of 39% on the 3rd quarter of 2008).

And just to be clear, what we have seen to date is not a 30% drop in unit labour costs (which would, of course, mean a great boost to competitiveness), rather it is a drop in earnings due to the fact that the output people could have produced just isn’t needed, since no one is willing and able to buy it. In fact according to the data of the Statistics Office to hourly labour costs fell by only 3.9% in the 3rd quarter when compared with the same period a year earlier. Hardly a massive drop, and especially not when the large annual increases of earlier quarters are taken into account (see chart below). The internal devaluation has a long course still to run!

But Latvia is back in the news today for more reasons, since the constitutional court has just ruled against the government pension cuts, drawing a question mark over Latvia’s ability to meet the terms of its international lending commitments.

“The decision to cut pensions violated the individual’s right to social security and the principle of the rule of law,” the court said in its judgement, which cannot be appealed. The pension cuts – in place since July – formed a vital part of the Latvian government’s list of austerity measures, as it struggles comply with terms of the IMF-lead bailout, and the constitutional inability to implement them is another hammer blow against the credibility of the current Latvian administration.

According to the Baltic Course, Valdis Dombrovskis told Latvian State Radio that the Constitutional Court’s ruling on pensions must be carried out, and not debated. I am sure this will really come as music to the ears of people in Brussels and Washington. Basically pension reform forms a key part of the mid term strategy for sustainability of Latvian finances, and without the ability of the Latvian government to carry these out, then frankly the coherence of the whole strategy falls apart. If the Latvian constitution does not permit pension changes, then the Latvian constitution has to be changed, and the only surprising thing is that all this wasn’t foreseen when the initial loan negotiations took place in late 2008. Basically, it is impossible for the EU Commission and the IMF to accept any other view, since if any state could ring fence a whole part of social provision before entering debt negotiations, then non of the structural reform programs could possibly work. This may seem harsh, but it is the price you have to pay for becoming insolvent as a society. Latvia’s problems are not short term liquidity ones, but problems of the sustainability of an entire economic and demographic model, and, as in the case of Greece, these problems will not be solved by two or three years of (rather painful) fiscal deficit cosmetics. Real changes need to be made, and especially in raising the long term growth potential of the country, and frankly it is these changes which we have yet to see evidence for.

The issue is not simply one of limping into the Euro in 2012, even if as Mark Griffiths, the IMF’s mission head in Latvia, said in Riga last week the Latvian government does face a lot of “hard work” in trimming the budget deficit enough to qualify for euro adoption, and how much more so if they cannot constitutionally implement the cuts they agree to.

“The key is meeting the deficit targets, and meeting the Maastricht criteria and euro adoption, that’s the path,” Griffiths said. “The government needs to work hard over the next year to find the measures which will deliver that adjustment to meet those targets. It’s going to be a challenging task.”

Oh yes, and Latvia was also in the news yesterday for another reason, since Latvian stocks dropped the most among equity markets worldwide as small investors sold stocks before the government starts to tax investment gains. The OMX Riga Index fell as much as 4.3 percent to 271.55, its lowest intraday level since August 21. In dollar terms, the drop was the biggest among 90 benchmark indexes tracked by Bloomberg. The reason for the sell off was that Latvia’s 2010 budget includes measures which will impose taxes on dividends, gains from trading stocks and bonds and interest income. These measures were agreed to in order to ensure the continued transfer of the 7.5 billion-euro bailout from the European Commission and the International Monetary Fund.

Latvian investors have increasingly sold their holdings ahead of the Dec. 31 deadline. Dividends and interest income will be taxed at 10 percent, while tax on gains from trading stocks and bonds will be 15 percent.

Finally one that wasn’t in the news, but should have been, since while everyone knows that at 20.3% Latvia’s unemployment is the highest in the European Union (see chart below), what they don’t know is that more Latvian’s than even are now being forced to leave their country in search of work.

According to a report by Oļegs Krasnopjorovs, economist with the Bank of Latvia, during the first half of 2009 8,300 Latvian residents left for Great Britain, a twofold increase over the year earlier period. 3,600 people emigrated to crisis-ridden Ireland in the first 11 months of 2009 – 3% more year-on-year. Among the new EU member states, Latvia has seen the sharpest increase in emigration to these two countries.

According to Krasnopjorovs, the data (which comes from the UK and Irish social security systems) confirm the trend identified by the Latvian Statistics Office, who examined data on long-term migration. In the first ten months of 2009, the number of long-term emigrants was 6,300, up 18% more year-on-year; moreover the steepest rise took place in the last few months, reaching a ten-year peak. For several years now the number of emigrants has exceeded that of immigrants in Latvia, with the exception of the second half of 2007 when a sharp rise in salaries and a steep drop in unemployment were fueled by the credit and construction boom, leading to labour force shortages and the expectation that incomes would rise even further.

The real problem here, of course, is that the Latvian economy remains mired in deep recession, and shows few signs of real recovery, something which is not surprising given that domestic consumption is in limbo land (where it is likely to stay), while the Prime Minister seems to attach little priority to boosting exports, and regaining competitiveness. Indeed, the contraction has rather gathered than lost momentum in recent months, and on a seasonally adjusted basis Latvian GDP fell another 4% between the second and third quarters of 2009. This was much faster than the 0.2% contraction between Q1 and Q2.

Year on year Latvian GDP fell by 19.0% in the third quarter.The decrease was largely due to a 28.7% drop in external trade (share in GDP 15.6%), a 18.2% one in transport and communications (12.5% GDP share), an 17.4% fall in manufacturing (10.2% GDP share, incredible) and by a 36% drop in construction (7.5% GDP share, not far below manufacturing).

Private final consumption fell by 28.1%. Government final consumption decreased by 12.4%, while expenditure on gross capital formation fell 39.4%. Goods exports (68.2% of total exports) fell by 11.7% and services exports by 20.5%. Goods imports (82.1 % of total imports) were down much more sharply – by 36.6% -and services imports by 29.1%. Which meant net trade was positive, otherwise the fall in GDP would have been greater, and nearer to the levels seen in domestic demand.

And entering the fourth quarter there were few signs of any real improvement. Retail sales fell in October by 1.3% from September (on a seasonally adjusted, constant price basis).

Industrial output, however, seems to be holding up a little better, and output has stabilized since the spring. The problem is that manufacturing industry is now such a small share in GDP that it will be hard to pull the entire economy on the basis of anything other than very strong rates of increase. Industrial production was up in October by 0.1% over September, marginal, but at least it wasn’t a fall. Unfortunately most of the increase was in the energy sector, with electricity and gas up by 10.3%, mining and quarrying contracted, by 2.1% as did manufacturing, by 1.9%.

The largest third quarter capital inflows registered under the capital and financial account were the result of government borrowing from the IMF-lead support program. There was some new foreign direct investment in Latvian companies to the amount of LVL 370.2 million, which to some extent offset direct investment outflows. Net external debt shrank by LVL 0.5 billion in nominal terms, but due to the fall in GDP (as I explained earlier) the ratio of net external debt to GDP posted only a tiny drop, reaching 56.4%, and gross external debt to GDP (excluding foreign assets) was up, reaching 145.8%.

So, as I say, a start has been made, even if there is still a long, long road to travel. Internal devaluation is the chosen path of the Latvian people, and the best thing I can suggest at this point is to get it moving in earnest (in fact there is some evidence from November producer prices that the rate of price fall is now accelerating), and that Latvia’s leaders start to value what they have (that is, export potential) instead of dreaming of what they can no longer have (dynamic domestic consumption driving growth). Living in the past is never a good idea, not even in the sentimental moments of Yuletide. A Merry Xmas to you all!

Alcatel-Lucent paves the way for Ukraine’s Kyivstar regards next generation GSM & IP networks with all IP network transformation.

Alcatel-Lucent (ALU) today announced that it has been selected by Kyivstar GSM, the largest operator in Ukraine, to design, install, and maintain a country-wide Metropolitan transmission packet based IP/MPLS network as part of its larger IP network transformation.

Alcatel-Lucent will deliver its next generation solution that will enable Kyivstar to pave the way for a fully converged IP network and support its evolution to possible 3G and LTE networks. With this Alcatel-Lucent-powered all-IP network Kyivstar will also be able to offer innovative IP services such as IPTV and enhanced communications services to both its residential and enterprise customers with maximum quality of service while realizing CAPEX and operational savings due to the efficiencies of IP-based technology.

“We will benefit from Alcatel-Lucent‘s worldwide experience in network transformation and state of the art IP networking technologies to smoothly and rapidly migrate to an all IP infrastructure,” said Alexander Dorofiy, Kyivstar Deputy CTO. “Alcatel-Lucent’s solutions and services give us the business and technology tools we need to compete and to offer subscribers a full scope of converged services.”

“By converging all services over a unified IP-based infrastructure, Kyivstar can build new revenue streams as well as customer loyalty while creating the platform to deploy next generation mobile technologies, such as 3G and LTE, as well as the advanced IP services that run over them,” said Alexander Tikhonov, Head of Alcatel-Lucent business in CIS.

Alcatel-Lucent will supply products from its industry leading Service Router (SR) portfolio including the 7750 SR, 7210 Service Access Switch and the 5620 Service Aware Manager to address the access, aggregation and core network layers. To offer a full end-to-end solution, Alcatel-Lucent will also supply its next generation Enterprise product, the Omni Switch 6250, to deliver residential access and 3G backhauling. Alcatel-Lucent will also provide professional services.

The network transformation will be performed in two phases: phase one will cover the needs of end-users services (HSI, VoIP, IPTV) and up-coming 3G mobile traffic. During the second phase 2G traffic will be gradually moved from SDH to the converged IP network.

International and emerging markets offerings are the coolest kids at the ETF party right now, favored in a big way over traditional long U.S. equity ETFs. International ETFs saw $5 billion in new inflows in November.

Vanguard Emerging Markets ETF (VWO) led all ETFs with $1.3 billion in new investments. Investors seem to prize Latin America and Pacific Rim ETFs.

There are plenty of other opportunities in the emerging markets ETF universe. In fact, investors can use dozens of country-specific ETFs to gain exposure to compelling emerging markets that don’t always grab headlines. One of those is iShares MSCI Turkey Investable Market Index (TUR). The investment thesis surrounding Turkey is worth considering. Given Turkey’s geographic proximity to both Europe and Asia, opportunities for trade are bountiful.

JPMorgan recently upgraded Turkish equities to “overweight” from “neutral,” saying that Turkey’s exporters will benefit from an economic recovery in Europe and the Middle East. Ratings agency Fitch followed that with an upgrade of its own, raising Turkey’s credit rating to just two notches below investment grade. They cite Turkey’s resilience to the global economic slowdown and the country’s access to credit markets.

These could be positive catalysts for TUR going forward. The ETF is volatile and made a big down move from a closing high of $55.37 in October to $44.60 in late November. December has been better; investors bid the ETF back above its 50-day moving average to a close of $50.93 today. If TUR can hold support at $50, it could continue to make its way higher. Even with the volatility, TUR is up nearly 90% year-to-date.

Investors should note the sector allocations within TUR. Nearly 52% of holdings are in the financial services sector. Industrial materials and telecom combine for another 26%. Even so, some analysts expect the ISE National 100 Index to test its record high of 58,864 in the next six to nine months. From there, the index could move as high as 63,000, which would be a boon for TUR.

It appears the table is set for TUR to join the ranks of more popular emerging markets ETFs. The outlook for Turkish equities may prove too alluring to ignore. TUR could deliver some tidy returns in 2010.

The start of gas trading activities by the CEGH Gas Exchange of the Vienna Stock Exchange (Wiener Börse) today marks a further step towards positioning the Central European Gas Hub (CEGH) as an important international hub and trading gateway into the CEE area.

The CEGH ranks among the largest gas trading platforms in Continental Europe and seeks to facilitate access to gas trading. There are 100 trading participants currently registered on the platform and total trading volumes have increased, by roughly 2 bcm per month, since the founding of the gas hub four years ago. The start of trading activities by CEGH at Vienna Stock Exchange now marks a further important step.

“The opening of CEGH Gas Exchange of Wiener Börse sets another milestone for the creation of an European gas market and considerably strengthens the energy trading sector in Austria. This further improves the security of gas supply for Austrian customers based on market-oriented measures,” commented the Austrian Minister for Economic Affairs at the opening celebration.

For OMV, which still has a 100% share in CEGH, the expansion of these gas trading activities contributes further to consolidating its logistic gas business.

“The direct access to the infrastructure of the OMV distribution node Baumgarten, which is an interconnector of important transit pipeline systems and comprehensive storage facilities, allows the CEGH to be in a position to fulfill all necessary prerequisites of a state-of-the-art energy trading platform,” stressed Werner Auli, OMV Executive Board Member for Gas & Power. Furthermore, the cooperation between the CEGH and the Vienna Stock Exchange will further enhance the pivotal role of the Baumgarten compressor station, which is wholly owned by OMV Gas GmbH, as a physical distribution node in Central Europe. Roughly one third of total Russian gas exports to Western Europe are already transported via the OMV compressor station in Baumgarten. Short-term trade will optimally complement long-term delivery agreements, whilst safeguarding competition on the deregulated energy market.

“The CEGH Gas Exchange of Wiener Börse secures – for both of us – one of the most important positions for the future gas market at a regional and a European level. And it shows that at the Vienna Stock Exchange we have further expanded our strategic business fields,” explains Heinrich Schaller, Board Member of the Vienna Stock Exchange. The Vienna Stock Exchange will hold a 20% stake in CEGH.

Trading on the spot market of the CEGH Gas Exchange of Wiener Börse will be carried out via the Vienna Stock Exchange XETRA® electronic trading system. The CEGH will be responsible for the market and customer relationship management, while overall market supervision will be with the Vienna Stock Exchange.

Stock exchange trading at the CEGH Gas Exchange of Wiener Börse is subject to strict rules and requirements in accordance with the Stock Exchange Act, which guarantees a clear structuring and regulation of trading activities minimizing any risk for all trading participants. The settlement of trading activities on the spot market will be split in line with the standard practice of the energy business between the Leipzig-based European Commodity Clearing AG (ECC), which will be in charge of the financial settlement of transactions and the clearing of the gas volumes, and the hub trading points of the CEGH, which will be responsible for the physical settlement of trading activities on the basis of the stock exchange trading.

“This Stock exchange trading will ensure the highest degree of standardized trading and round off the wide range of services currently available; optimally complementing OTC trading,” added Harald Wüstrich, Managing Director of the CEGH AG.

A cooperation agreement signed between OMV and Gazprom in January 2008, envisages the participation of Gazprom Germania and Centrex in the CEGH with a 30% and 20% stake respectively. This is subject to prior approval under EU merger control law granted by the European Commission. This envisaged partnership will further enhance a secured supply of gas, via the distribution node Baumgarten, whilst also increasing liquidity for short-term trading activities.

Bulgaria’s banks are being cautious in their response to government calls to increase the flow of loans, wary of potential problems that could arise in the new year, while awaiting more positive signs from the economy before turning on the lending taps again.

As part of its efforts to get the economy, and more particularly liquidity, moving again, the Bulgarian National Bank (BNB) cut its basic interest rate for the fifth month in a row on December 1, reducing its key lending rate to 0.55%, down 0.06 percentage points compared to November. At the beginning of the year, the bank’s basic rate was 5.17%, with the latest cut taking the BNB’s rates to their lowest level since free market banking was introduced in the wake of the fall of communism in 1991.

Both the government and the central bank have been pushing commercial lenders to come to the party, citing the BNB’s cuts to its rates and the relatively solid position of most private banks.

According to BNB governor Ivan Iskrov, the country’s banking system retained high capital adequacy levels and was stable. This stability helped them post combined profits of more than $465m for the first nine months of the year, Iskrov said in early November.

Bulgaria’s banks have worked to boost capital adequacy levels, offering higher interest rates to depositors to attract more funds and shore up their own position, paying out as much as 10% on deposit accounts.

In mid November, the finance minister, Simeon Djankov, called on the country’s banks to reduce their interest rates by 3% or more on deposit accounts to give spending and investing greater appeal, while also saying the banks should step up loan activity.

While keen to see an increase in lending, Violina Marinova, the chairperson of the Association of Banks in Bulgaria (ABB) and the chief executive director of DSK Bank, recently said that a reduction of interest rates is not just reliant on the banks themselves and their good will but on the wider economic climate.

Once the economy began to pick up and run smoothly, companies will increase production and hire more staff, Marinova said in an interview with local press in mid-November. This in turn would result in the need for more finance for their activities and would spark competition among banks, thus pushing down interest rates, she said.

The economic spring may not bloom any time soon though, with the government predicting that the economy will contract further in 2010. Addressing the parliament in mid-November during the debate over next year’s budget, Prime Minister Boyko Borisov said the economy would fall back by 2% in 2010, before returning to positive growth in 2011.

One of the requirements for a turnaround was a stable banking system, which the prime minister said would help “create the most adequate conditions for economic recovery”.

While many banks have built up their capital levels, there are still causes for caution. One of these is the rising number of non-performing loans (NPLs) on banks’ books, with the BNB predicting that bad loans will hit 16.5% of the total by the end of 2009.

Though other studies do not put the ratio of non-performing loans as highly as the BNB report, suggesting that the figure will be around 10% next year, even this level is a concern. On November 27, credit ratings agency Moody’s issued a review of four Bulgarian banks, First Investment Bank AD, DSK Bank, Raiffeisenbank (Bulgaria) EAD and MKB Unionbank AD. All four were given a negative outlook, while the agency also downgraded FIB’s financial strength rating and its long-term local and foreign currency deposit ratings and DSK Bank’s local currency deposit ratings.

Moody’s said the ratings action reflected the vulnerability of the bank’s earnings and capital position to increased credit losses arising from the deepening recession in Bulgaria. In particular, the agency cited higher corporate defaults as a matter of concern.

“The corporate sector’s financial performance in the country has weakened significantly, mostly due to lower demand for Bulgaria’s exports from its main export partners and from the declining foreign direct investment,” the agency said in a statement.

It also warned that, although the banking sector remained profitable, was strongly capitalised and had good liquidity levels, the recession was resulting in increased credit losses in the system, with the rates of NPLs more than doubling since the end of 2008.

According to Elena Panayiotou, lead analyst at Moody’s for the Bulgarian banking sector, the latest assessment reflected the potential for weakened activity in the coming year as much as the present situation.

“Given that asset quality metrics lag behind macroeconomic indicators by several months, it is crucial that the banks’ current ratings incorporate Moody’s expectations of their future losses,” Panayiotou said.

In some ways, there appears to be something of a standoff between the government and the banks, with the former needing the lenders to free up liquidity to help kick start the economy, while the banks are waiting for the economy to gain momentum before increasing loan activity.

With Borisov’s government limited in the steps it can take to prime the economic pump, given the fixed exchange-rate regime and focus on fiscal policy, despite plans to issue $920m worth of euro-denominated bonds next year, it may be up to Bulgaria’s banks to blink first.

Business expectations clearly spell another tough year lying ahead for Bulgarian companies, Roland Berger Strategy Consultants said.

Despite first improvements, small growth rates in 2010 will not compensate for the high declines of 2009, the international consulting company said in a survey entitled The Road to Recovery in Central and Eastern Europe (CEE).

The survey was conducted this summer among over 380 senior company executives to find out their expectations about the current financial crisis and its consequences for the region. It covered 11 countries in CEE: Bulgaria, Romania, Croatia, Serbia, Slovenia, Slovakia, the Czech Republic, Hungary, Poland, Russia and Ukraine. Austria was used as the benchmark Western European economy.

Bulgarian companies need to focus on adapting their structures and implementing strategic measures, standing still is the most dangerous option, the survey indicated.

Construction, textile and engineering have been hit hardest by the economic downturn in Bulgaria since the beginning of the crisis in the last quarter of 2008. In Romania, real estate transactions halved over the same period, and investment plans were frozen. Most affected industries in Croatia were tourism, wood processing and food production.

The construction sector in CEE is careful but more optimistic than in March, when Roland Berger Strategy Consultants conducted its previous survey of entrepreneurs’ expectations. Accordingly, half of the  companies surveyed in the summer expect a recovery already in June next year. Financing difficulties, however, remain.

Since the previous survey the optimistic expectations for the economy in CEE have slightly increased, but uncertainty is significantly high at 50% of those polled.

A vast majority of Bulgarian managers (70%) believe an upturn would take place rather later and expect recovery in their industry output and company sales no earlier than the fourth quarter of 2010. Just like in March 2009, Bulgarian companies still have to fight declining sales, worse payment behavior and financing difficulties.

The survey reveals a consensus among the polled company executives on the timeline of the economic recovery with the peak at the end of 2010.

Bulgaria was no exception to the overall improving expectations in CEE, the survey showed. The general assessment of the current economic situation in Bulgaria has not changed significantly since March. In comparison with the overall CEE attitude, Bulgarian managers are still rather pessimistic and uncertain on the economic outlook.

Croatian managers remain the most pessimistic in CEE, while the too positive attitude of the Hungarian managers is more likely wishful thinking and less reflected in macroeconomic results.

The ranking of the popularity of actions of the Bulgarian companies in reaction to the crisis showed no change compared to the results in March 2009. The main focus is still on operative measures, implementation of strategic measures is still low but has developed already, Roland Berger Strategy Consultants said. With the exception of tightened cash management, all measures gained in popularity since the previous study.

Increased customer bankruptcies are still one of the major sector-specific problems in the banking and insurance industry. Interestingly, price pressure is experienced again as less important.

Declining sales is doubtless the most important issue on the management agenda in the retail sector. However, 70% of the companies hope already for some growth.

The mood in the energy and utilities sector is now neutral: “Let’s wait and see”. Even hiring was stopped at only 50% of the companies surveyed in the summer.

The IT/media/telecom industry is among the most pessimistic sectors. Accordingly, a real recovery from the crisis is expected later than in other industries. Over half of the companies in this sector continue their investments.

Due to increasing demand and better prices for commodities there is more optimism in the metals ans mining sector now. High share of lower sourcing costs seems to be a sector-specific effect of the crisis.

In the spring of 2009, the services sector was the only industry demonstrating some hope. This positive attitude was further strengthened until September.

Until 2007, CEE countries enjoyed remarkable GDP growth rates and have been the main growth spot of Europe. The region, however, was not immune to the crisis. Until March 2009, the stock market indices declined by up to 70%, most national currencies lost up to 30% of their value against the euro and GDP growth forecasts turned negative.

In September 2009, however, the indices were already in upswing, although still not reaching their former highs.

Among the stock indices in the CEE region, the Bulgarian blue-chip SOFIX index is still the worst performer, having recovered to just 38% of its former market capitalization, while the Hungarian BUX is soaring, Roland Berger Strategy Consultants said. The Romanian and Croatian blue-chip benchmarks, the BET and the CROBEX, regained 69% and 59%, respectively.

As for GDP growth, 2009 was a tough year for all countries. The situation worldwide was so turbulent that forecasts have been revised several times. Despite the first slightly positive projections for 2010, a real recovery is forecast in CEE only onwards 2011.

GDP in Bulgaria is expected to go down by another 2.5% in 2010 after a projected 6.5% decline in 2009, Roland Berger Strategy Consultants said. The survey predicts the Bulgarian economy will grow by 2.0% in 2011 and by 4.0% in 2012.

The survey also forecasts a divide between the companies in CEE in the next 12 months. Those who have implemented relevant strategic measures should quickly start looking forward – market consolidation, mergers and acquisitions, sales initiatives, penetration of new markets. Those still timid about adapting to the crisis will need significant restructuring, or will be restructured by someone else.

“In my view … it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s.”

* Compared with the average quarterly value of GDP in 2007-08, the first two quarters of 2009 are down in nominal terms to the tune of 15.9%, 15.4% and 10.5% in Lithuania, Estonia, and Latvia respectively.

* The average quarterly current account deficit of the Baltics from Q3 2008 to Q2 2009 was mill 500 Euros. This amount to just 18% of the average quarterly current account deficit two years prior to the crisis. Consequently, the Baltics have delevered to the tune of 80% over the course of less than 1 year.

* In the two first quarters of 2009 (relative to Q1-2006 to Q4-2008), imports have contracted 16%, 33% and 11.5% more than exports in Lithuania, Latvia and Estonia respectively.

* In Euro terms, the Baltics have lost external financing to the tune of bn 1.87 Euros in the first half of 2009 compared to the peak of the boom which amounts to 12.6% of the entire region’s GDP in the same period.

The quote above from Fed chairman Bernanke is ripped from the introduction of a recent conference paper drafted by international economics icons Kenneth Rogoff and Maurice Obstfeld who suggest that the financial and economic crisis that is currently making its presence felt across the global economy, at least in part, has something to do with the notion of global current account imbalances. Now, and in all modesty, this is something I have argued extensively at this space and in this way I welcome the likes of Messieurs Rogoff and Obstfeld in the fold. I tend to go, of course, for the big prize in my stubborn persistence on the link between global ageing, global imbalances and thus by way of deduction the economic crisis as we have come to know it.

Now, I am not going to treat this link here but merely point to the rather obvious question at this point in time, in the form of whether in fact the crisis itself has been a catalyst of re-balancing? At a first glance this would clearly seem to be the case. In a crisis driven decisively by a violent process of deleveraging, those economies who had hitherto relied on borrowing have now been forced to scale back (and essentially correct either through a debasement of their currency, internal price correction, or a combination of these two) and the nations that had delivered the funding have likewise been forced to accept that their external surpluses have shrunk in a comparative manner.

So far so good then, but what happens when we have to get the patient out of intensive ward; who will run the deficits and surpluses and what size will the imbalances, if any, be. This is a difficult question to answer, but it appears that with the US economy now being effectively forced to correct its external imbalance (be it with Europe, China, Japan et al kicking and screaming or not), we have a situation with a lot of would be exporters and very little importers.

If this is the general set piece, it was with some interest that I read this VOX.eu piece by Mr. Richard Baldwin and Ms Daria Taglioni which dryly submits the thesis that although it may appear that rebalancing is occurring, this is only as a byproduct of the crisis. From ther horse’s own mouth;

Global imbalances are shrinking at a fabulous rate. This column argues that these improvements are mostly illusory – the transitory side-effect of the greatest trade collapse the world has ever seen. A global recovery will almost surely return the US, Germany, China and others to their old paths.

Not exactly the prospect we were all hoping for, but in the main I agree with this point except of course the small and important qualifier that the US economy will have to deleverage and reduce the external (and indeed internal) borrowing. Whether Germany, Japan, China will also need to export … well, this is ultimately a question of finding a customer.

Rebalancing the Baltics?

The obvious question to arise at this point is obviously what all this has to do with the Baltics? Well, in a direct sense not a whole lot since as the Economist so famously put it, the Baltics remain piqsqueaks and whether we observe current account positions, of either negative or positive pedigree, at some 20% of GDP it won’t do much to affect the global imbalances. However, in the light of the idea of rebalancing on the back of the economic crisis and whether this is sustainable let alone feasible, the Baltics become very interesting not least since they have chosen (or have been led into) a process of rebalancing through internal price deflation (devaluation) as their currencies, for now, remain fixed to the Euro. In that vein, I thought it interesting to have a look at how the Baltics have faired so far with a specific focus on the external balance.

Beginning however with a general view of the correction so far the picture is definitely one of a hard landing on the back of the economic crisis.

Most of the readers of this space will be well acquainted with travails of the Baltic economies (and in particular, the near collapse observed in Latvia earlier this year). In all three Baltic economies the Euro value of their GDP peaked in 2007-08 and has since fallen back dramatically. Compared with the average quarterly value of GDP in 2007-08, the first two quarters of 2009 are down in nominal terms to the tune of 15.9%, 15.4% and 10.5% in Lithuania, Estonia, and Latvia respectively. The Baltic economies have lost bn. 2.2 Euros worth of GDP in 2009 from the GDP output observed in 2007-08 which amounts to a loss of some 21% of the average value of the quarterly GDP output for all Baltic economies combined from 1999 to 2009. In short; these economies have taken some blow to the kidneys and even if we can safely say that the levels of nominal GDP observed in 2007-08 were unsustainable the way down is still rough, very rough.

On the price front the correction has indeed begun and the graph above actually underestimates the current bout of price deflation as it smoothes away, as it were, the fact all three Baltic economies are in deflation on a m-o-m basis. Only Estonia registers deflation on my representation with Latvia basically hovering at the 0% line and Lithuania still producing inflation rates at some 2%.

Moving on to the external balance it is worthwhile splitting up the analysis by having a look at first the import/exports picture and then grinding down to the income level and finish off with a look at the financial accounts and thus the inflows used to finance the deficit (or how the surplus is invested abroad).

This is perhaps the best picture of the Baltic correction there is and nicely illustrates the point emphasised by Baldwin and Taglioni that the correction of imbalances, at this point in time, has been very much forced upon the deficit economies. Consider consequently the average quarterly current account deficit of the Baltics from Q3 2008 to Q2 2009 at mill 500 Euros; i.e. at the point when the crisis made its mark decisively.This amount to just 18% (!) of the average quarterly current account deficit two years prior to the crisis. This means that the Baltics have delevered to the tune of 80% relative to the level of the current account deficit observed up to the crisis. Again and with the benefit of hindsight, we know that these levels were unsustainable, but please do remember that it was only back in the H02 2008 that we were discussion whether the Baltics were going to have a hard or a soft landing. It is remarkable to note the example of Latvia here which has gone from a current account deficit of -17.6% of GDP in the period 2007-08 to a current account surplus of 14% of GDP (mill 681.3 Euros) in Q2 2009 due mainly to the fact that imports and GDP have plunged.

This point in particular is important to emphasize since the extent to which we are able to talk to about a sustainable (or benign if you will) process of rebalancing rather than one entirely driven by a sharp correction in internal demand and thus imports. The intuition tells us that Baltics are currently subject to the latter form of rebalancing and thus it remains to be seen whether there is a virtuous circle of increasing competitiveness and rising export shares (and values) on the back of the current vicious circle. But just how vicious is the current circle then?

The graph to the right attempts to answer this question as it plots the equally weighted average of the evolution of exports and imports in the Baltics. The time series corresponds to the value of exports and imports in million of Euros of the three Baltic economies and is indexed with the average quarterly value between Q1-1999 and Q2-2009 of imports and exports as 100.

The graph easily shows how imports have contracted much more than exports and it is consequently here that we must look for the driver of rebalancing in the Baltics. If we take Q1-2006 to Q4-2008 as the peak of the boom (in terms of the external deficits), exports are down 10.8% in the first half of 2009 whereas imports are down a full 33.4% in the same period. This suggests that more than anything that rebalancing in the Baltics are currently driven by a sharp contraction of domestic demand. Splitting up the result on the three economies and looking exclusively at the second quarter of 2009, imports have contracted 16%, 33% and 11.5% more than exports in Lithuania, Latvia and Estonia respectively.

Another way to look at this is to approach the external deficit from the financing side and consequently have a look at the inflows used to finance the external deficits. In principle, you would normally and in the perfect world mainly look at portfolio and investment flows, but in the case of the Baltics we cannot neglect credit flows which, through all those Euro denominated loans supplied by Scandinavian banks, have been instrumental in driving the external deficits during the peak of the boom. If we begin with the inflows as a share of GDP we observe the drastic way in which the financing have been withdrawn in the context of the crisis.

Observe in particular the Latvian situation where an external surplus has been forced upon the economy, proxied here by “negative” inflows and thus outflows. In Lithuania, the total sum of important inflows had declined, as a share of GDP, to 60% in Q2-2009 relative to value recorded during the peak of the boom (Q1-2006 to Q4-2008). The corresponding figure for Estonia is 23% whereas for Estonia it has changed signs all together due to the fact that financing here has come to a complete standstill. In Euro terms, the Baltics have lost external financing to the tune of bn 1.87 Euros in the first half of 2009 compared to the peak of the boom which amounts to 12.6% of the entire region’s GDP in the same period.

As noted extensively above, this process is natural since we can say with some confidence that whatever the level (and flow) of incoming investment and credit during the peak years it was not sustainable. However, when it happens with such force in the context of the global financial crisis and, moreover, in relation to fixed exchange regimes and thus internal devaluation the obvious question that begs is what the risk is of pushing these economies into a hole from which they cannot emerge. One particularly important point here is what kind of general (and domestic!) credit and financing environment we will see as the external funding is ground down and thus, in some sense, what kind of domestic environment the Baltics will have to stage a recovery in.

This last point is perhaps the most important underlying theme to think about when assessing the situation in the Baltics. We could almost say that the extent and pace to which the Baltics’ growth path has crumbled is also the extent to which expectations of convergence, Euro membership, underlying growth potential etc have crumbled. Where we go from here is consequently anybody’s guess. A lot of unresolved question still clouds the horizon not least the continuing unravelling in Latvia where the IMF has so stuck with the country despite the increasing dire outlook as long as the currency peg remains. What I can tell you however is that the Baltics are going to rebalance, but the key is the extent to which it happens so as to allow the Baltic economies to enter a virtuous circle somewhere down the road.

So far, a preliminary assessment suggests that while the Baltics are indeed rebalancing, they are only doing so because internal demand has caved in. We are yet to see whether the dose of internal devaluation/deflation will bring back competitiveness in due time to turn a vicious cycle into a virtuous one.

New York-based Van Eck launched on Wednesday the Market Vectors Poland ETF (PLND), a fund that will track the 26-company Market Vectors Poland Index.

PLND will trade on the NYSE Arca Exchange and charge an expense ratio of 76 basis points. Unlike most single-country international ETFs, which tend to be dominated by holdings in multi-national mega-cap companies, PLND offers exposure to companies of all sizes: according to its fact sheet, 41% of the underlying index is composed of companies with a market capitalization greater than $5 billion, with almost 50% in mid-caps.
Investing In Poland

Poland is the world’s 18th largest economy by 2008 GDP, making it surprising that there hasn’t been a pure play ETF prior to PLND. The void is even more confusing considering that #43 (Chile – ECH), #44 (Vietnam – VNM), and #50 (Israel – EIS) on the list are the subjects of country-specific ETFs. Last month, we included a Poland ETF among our list of Ten ETFs That Don’t Exist, But Should, citing the European country as a “shining example of a country that successfully transitioned from a centrally-planned economy to a capitalist market-based economy, thanks in large part to aggressive policies implemented since the fall of communism.”

While Poland’s economy certainly faces some hurdles. Its adoption of the euro has been shelved due to a failure to meet entry requirements set forth by the EU, and a once ambitious government has seen several initiatives sputter. Poland’s public debt could breach the threshold set by Polish law by exceeding 55% of GDP next year. Prime Minister Donald Tusk is now focusing on more manageable domestic agenda items, such as improving transportation infrastructure, increasing internet access, and gearing up for the 2012 European soccer championship.

Despite these obstacles, there are some reasons to be bullish on Poland. “Poland is the largest and fastest growing economy in Central and Eastern Europe,” said Jan van Eck, principal of Van Eck Global. “Poland’s economy has recently surpassed Belgium and Sweden and is one of the only economies in the CCE region to show positive growth this year.”

Poland’s local economy accounts for approximately 70% of GDP, allowing the country to come through the recent recession unscathed, at least relative to more export-dependent countries. Poland also has one of the lowest corporate tax rates in Europe and and a young, educated workforce, making the country an ideal location for multi-national firms looking to expand their reach into Europe.
Country-Specific ETFs

Van Eck has become the leading issuer of country-specific emerging market ETFs, as PLND joins several other Van Eck ETFs targeting emerging and frontier economies. The Russia ETF (RSX), Africa ETF (AFK), Indonesia (IDX), and Vietnam (VNM) have all seen some success, accumulating more than $1.5 billion in AUM in aggregate. While all of these countries are included in more broad-based emerging markets ETFs, their allocations in these funds are generally limited.

For more on the Poland ETF and the economy of Poland, see Van Eck’s The Investment Case For Poland (pdf).

The pharmaceutical market in Central and Eastern Europe is dominated by generic drugs. This subdivision was worth €17.2bn in 2008 and is expected to develop by around 14% per annum between 2009 and 2011.

The growth rate of the innovative drug market, which was worth €12.4bn in 2008, will be slower, according to the latest report from PMR, a research and consulting company, entitled “Generic and innovative drugs market in Central and Eastern Europe 2009. Comparative analysis, reimbursement policies and development forecasts for 2009-2011″.

Generics to account for 60% of the market in 2009

According to PMR estimates, the generic drug market (including non-branded generics, traditional products and other products which have never enjoyed patent protection) in Central and Eastern Europe  was worth €17.2bn in 2008, in contrast to a market value figure of €12.4bn for innovative drugs. Generic drugs therefore accounted for around 58% of the pharmaceutical market in the region in terms of value (taking into account both pharmacy and hospital sales).

The CAGR for generics will reach as much as 14% between 2009 and 2011, whereas that of innovative drugs will be much lower. “As a result, the share of generic drugs will constantly increase and in 2009 generics will account for around 60% of the pharmaceutical market in Central and Eastern Europe”, according to Agnieszka Stawarska, Pharmaceutical Market Analyst at PMR and a co-author of the report.

Although the innovative drug market in Central and Eastern Europe will develop at a slower rate than that of generic drugs between 2009 and 2011, the growth rate of original medicines for the whole region will be positive. It has, for the time being, been compromised by the cost-containment policies of the CEE countries, which have been stepped up during the global financial crisis. However, in the medium term PMR expects an improvement in health awareness and the modernisation of healthcare systems, including the development of private health insurance and the establishment of health insurance and drug reimbursement systems, similar to those in European countries, in Russia and Ukraine, to be drivers of the innovative drug market in the CEE countries. An additional driver will be the aging of the population in the region.

Local companies are generic-oriented…

There are few innovative pharmaceutical companies of local origin in Central and Eastern Europe. Most companies based in the region are generic drug manufacturers. “The largest players of this kind include Gedeon Richer, Krka, Egis and Zentiva. These companies have a presence in most CEE countries and they are well-established there” Monika Stefanczyk, Head Pharmaceutical Market Analyst at PMR and a co-author of the report, explains. For such companies, the region of Central and Eastern Europe is usually the main area of their activities.

The second group of companies consists of global generic players. Their presence differs from one CEE country to the next. For example, Dr. Reddy’s, an Indian generic manufacturer, concentrates on Russia, which is one of the company’s key markets worldwide. Actavis, an Iceland-based manufacturer, is at its strongest in Bulgaria and Russia. Ranbaxy’s key markets in the region are Romania and the CIS countries (Russia and Ukraine in particular). Stada has a strong presence in Russia, particularly after the acquisition of two Russian companies (Nizhpharm and Makiz-Pharma); and at the beginning of 2009 the company entered Poland and Bulgaria by establishing subsidiaries there.

A number of consolidation processes recently took place in the generic arena, which were of great importance for Central and Eastern Europe. For example, Teva gained a strong presence in the region through the acquisition of Barr in July 2008, which included one of the largest local generic drug producers ? the Croatian company Pliva. In June 2008, Mylan, a US generic manufacturer, acquired the CEE generics businesses of Merck KGaA, the prominent German drug manufacturer. The deal includes Merck’s operations in Poland, Hungary, Slovakia, Slovenia and the Czech Republic. In March 2009 Zentiva, one of the leading generic players in the region, was bought by Sanofi-Aventis. In May 2009 Novartis acquired the generic cancer drug production division of the Austria-based EBEWE Pharma.

…whereas innovation is the domain of global concerns

The innovative drug market in the region is dominated by multinational pharmaceutical concerns. Such companies have representative offices in most of the Central and Eastern European countries, but, as they are active all over the world, the region is not, in most cases, their main market. However, innovative drug producers often choose Central and Eastern Europe as a place in which to locate clinical trials, because of the low costs, high population and limited access to innovative therapies in such countries.
Today innovative companies face a crisis associated with the loss of patent rights pertaining to their most important products, which is expected to affect their sales performance in Central and Eastern Europe also, as many players of domestic origin may launch the generic equivalents of their drugs on the market.

Van Eck, a leading company for providing ETF investors with access to new investment categories, has done it again.

Today’s launch of Market Vectors Poland ETF (PLND) is the first pure-play single-country ETF focusing on Poland for US investors. PLND trades on the NYSE and expenses are capped at 0.76%

I asked Tomasz Janeczko, a business owner and global investor located in Poland, for his views of this new offering. He replied:

“The new Market Vectors ETF is very interesting and welcome development. Until now, investors preferring index-based trading approach to Poland could only trade futures based on popular Warsaw Stock Exchange indices like WIG20, but it was rather difficult for foreigners.

“PLND makes it a lot easier to get exposure to the economy of the 9th largest country in Europe. The Warsaw Stock Exchange in its current form started its operation in 1991 and currently has 377 companies listed. I am looking forward to see how this ETF will work in practice considering sometimes limited liquidity of certain stocks traded on WSE. I guess the fund will need to use futures traded on WSE that have better liquidity to address such shortcomings and to deliver the expected 95% correlation between fund’s performance and the index.

“Some may consider it a drawback that PLND tracks the proprietary Market Vectors Poland Index rather than the most popular (and known) Warsaw Stock Exchange WIG20 index, even though both indices have very similar constituents.

“Regarding risks, everything spelled out in the prospectus is certainly true, but I would not worry too much about the statement regarding local securities laws and shareholder rights because Poland is a part of European Union and E.U. law has precedence over national law now. This provides a rather strong guarantee that there will not be any ‘unpredictable’ changes in laws, at least not ones that E.U. does not accept.”

As of November 24, 2009 the fund held 25 stocks, with the largest being Pko Bank Polski Sa 9.3%, Bank Pekao Sa 9.07%, KGHM Polska Miedz SA 8.2%, Telekomunikacja Polska Sa 6.2%, and Polski Koncern Naftowy Orlen 5.8%.

The sector breakdown is Financials 40.2%, Energy 13.6%, Industrials 11.0%, Consumer Staples 8.6%, Materials 7.8%, Telecommunications 6.8%, Consumer Discretionary 6.7%, Technology 4.1%, and Health Care 1.2%.