Baltic macro outlook - Q1 15 - Danske Bank · Romania 585 Macedonia 524 Ukraine 204 Average gross...

Baltic macro outlook – Q1 15 Rokas Grajauskas Baltic Analyst Danske Bank A/S Lithuania branch +370 674 03350 [email protected]

20 March 2015

Investment Research – General Market Conditions

www.danskebank.com/CI Important disclosures and certifications are contained from page 28 of this presentation

2

Key messages

Baltic economies are showing signs of resilience and f lexibility – despite the turbulent external environment, economic growth remains fairly robust, at 2-3% y/y.

Private consumption was the main driver of growth in 2014, especially in the last quarter, as real disposable incomes rose on the back of falling energy prices.

Domestic demand to remain the key growth driver in 2015, although there are significant downside risks to investment growth in Latvia and Lithuania.

The biggest external shock is the contraction in demand in Russia, which severely affects Baltic export volumes.

Unemployment keeps falling in all three Baltic states, although in 2014 Lithuania was the only country with significant gains in employment.

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Baltic growth in the regional context

Source: European Commission, Danske Bank Markets estimates

Note: CEE – countries of Central Eastern Europe (Poland, Czech Republic, Hungary, Slovakia, Bulgaria and Romania)

The key factor inhibiting economic growth in the Baltic region has been external shocks (contraction in demand in Finland, Russia and the CIS, as well as increased geopolitical tensions). We expect growth in all three Baltic economies to pick up in 2016 and exceed the CEE average.

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GDP growth rates of selected countries/regions

2014 2015E 2016E

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Economic convergence with the “old” EU members continues


Note: Adjusted for differences in price level

Over the last 10 years, Lithuania’s GDP has grown the fastest GDP growth rate among the Baltics. This trend became even more pronounced after the 2008/2009 crisis.

Given the declining populations of the Baltic states, per capita GDP growth is faster than the aggregate GDP growth.

From 2014-2016E, we expect average per capita real GDP growth to be 4.3% in Estonia, 5.3% in Latvia and 5.4% in Lithuania.

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Real GDP per capita as percent of EU-15 average

Estonia Latvia Lithuania

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Lithuania the first to reach its pre-crisis GDP level


In 2014 Lithuania was the first of the Baltics to reach its pre-crisis GDP level. We expect Latvia and Estonia to reach pre-crisis levels in 2016 only.

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E

Index of real GDP growth (2005=100)


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Real wage growth accelerates

Source: National statistical offices, Danske Bank Markets

As economies and business profits grow, so do wages. Real net wage growth in 2014 was 4.7% in Estonia, 8% in Latvia, and 4.6% in Lithuania.

An important reason driving up wages is the imbalance between the demand and supply of qualified labour.

Rising wages in the public sector directly contribute to average wage growth. In 2014 wages in the public sector grew by 5.5% in Estonia, 8% in Latvia, and 4.5% in Lithuania.

Minimum wages also rose in 2014: in Estonia from €320 to €355, in Latvia from €285 to €320, and in Lithuania from €290 to €300.

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Real net wage growth (%, y/y)


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Estonia boasts highest wages in CEE

Source: Eurostat, Macrobond Financial

Average gross salaries in Estonia are 1.32 times higher than in Latvia and 1.45 times higher than in Lithuania.

Estonia also has the lowest ratio between productivity and gross wages, i.e. Estonian workers receive the highest share of added value in the economy in the CEE region.

Wage growth potential is highest in Lithuania of the Baltics in the long run. But real wage growth in 2015 should be similar in all three Baltic states (our estimate is that wages will grow 4-5% in all three countries).

EU-15 3662

Estonia 1,038

Czech Rep. 997

Poland 938

Slovakia 837

Hungary 829

Latvia 786

Lithuania 715

Russia 596

Romania 585

Macedonia 524

Ukraine 204

Average gross salary in Q4 14 (EUR)

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EU-15 CEE Estonia Latvia Lithuania

Ratio between productivity per worker and

average gross wage

Source: Eurostat, Macrobond Financial

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Inflation at record lows

Source: Eurostat, Danske Bank Markets

Deflationary periods are not common in the Baltic region. Since the 1990s inflation in Estonia and Latvia was more negative only during the 2008-2009 crisis, while in Lithuania it was more negative only in 2003.

As long as deflation is perceived as a temporary phenomenon, it encourages consumption and investment. Inflation is expected to pick up in all three Baltic states in the second half of 2015.

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Annual inflation rate in the Baltics


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Inflation in Estonia turned negative in December (-0.2%) and bottomed in January (-0.6%) increasing slightly in February (-0.3%).

The slump in prices was caused primarily by deflation in energy products, which has averaged -4.5% since the beginning of last year.

We forecast inflation to turn positive in the course of the next few months and average 0.6% in 2015.

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Annual inflation rate - Estonia

Core inflation Food prices Energy prices Headline inflation

Falling energy prices behind the recent deflationary trend

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Latvia has so far experienced the shallowest deflation among the Baltics, caused by the smallest fall in energy prices (average energy deflation averaging 2.1% during the last 14 months).

Inflation in January was -0.3% but f lattened out completely in February. We expect average inflation to be 0.8% in 2015.

Latvia barely avoids deflation in January

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Annual inflation rate - Latvia


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Lithuania has so far experienced the deepest deflation among the Baltics – after turning negative in December (-0.1%), inflation continued to move deeper into negative territory in January (-1.4%) and February (-1.5%).

The primary factor has been the steep fall in prices of energy products (averaging -5.6% since January 2014 and reaching -15.1% in January and February 2015). Prices have been falling in all energy categories but most strongly in gas and heating (-17.6% and -9.3% respectively in February 2015).

As in the other Baltic neighbours, we expect inflation to move into positive territory by mid-2015 and average 0.2% in 2015.

Deepest deflation – in Lithuania

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Annual inflation rate - Lithuania


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Price trend is very different in the housing market

Demand for residential real estate has been on the rise lately on the back of rising wages and better availability of mortgages, causing house price growth to accelerate. The average annual growth in house

prices in Q1-Q3 14 was 14.4% in Estonia, 9.2% in Latvia, and 6.5% in Lithuania.

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Annual real growth in house prices

Latvia Lithuania Estonia


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Yet house prices are still below the 2006 level

Although house prices in the Baltic states recovered from the post-crisis slump in 2009-2010, in real (deflated) terms they are roughly at their 2004-2005 level.

In March 2015 Estonia introduced caps on loan-to-value and debt-to-income ratios (85% and 50% respectively) as well as a cap on maximum loan duration (30 years). These measures are expected to cool demand for housing, although similar limitations in Latvia and Lithuania have had little effect on house prices.

Residential real estate is most expensive in Estonia. The difference in house prices from the other Baltic states is greater than that of the general price level.

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Real house price index (Q1 06=100)

Eurozone Latvia

Lithuania Estonia

Ireland Spain

By class:

Index of average prices

(Estonia = 100)

General price level

index Economy Middle Luxury Average

Estonia 1,500 2,000 3,500 2,333 100 100

Latvia 1,250 1,600 3,000 1,950 84 90

Lithuania 1,100 1,525 2,400 1,675 72 82

Source: Ober-Haus Baltic Market Report 2014

Note: General price level as measured by the European Commission’s Purchasing Power Standard


Prices of residential real estate (EUR)

14

GDP growth in Estonia due to private consumption


Note*: Consumption – private consumption, investment – gross fixed capital formation, exports and

imports comprise goods and services.

Note**: Due to deflation in exported and imported goods in 2014 and 2015, deflated growth in exports

and imports is greater than growth measured at current prices.

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Growth of main GDP components - Estonia

2014 2015E 2016E

Economic growth in 2014 was solely due to private consumption, which was fuelled by lower prices and rising real wages.

Amid the climate of geopolitical uncertainty, investment turned negative in the second half of 2014.

Falling exports to Russia will be the key factor inhibiting stronger export growth.

Imports are set to accelerate as a result of robust growth in domestic demand.

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Slack in investment in Latvia is expected to fade

Domestic demand in Latvia remained subdued throughout 2014 but deteriorated in the second half of the year.

Geopolitical uncertainty affected both consumption and investment growth:

• In 2014 Latvians saved more heavily than their Baltic neighbours. Bank deposits in Latvia grew by 12.4% in 2014 (8.1% in Estonia and 7.2% in Lithuania).

• Following the escalation of geopolitical tensions in mid-2014, investment growth turned negative in Q3 14.

Low domestic demand kept import growth in check in 2014.

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Growth of main GDP components - Latvia

2014 2015E 2016E






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More balanced domestic demand growth in Lithuania

Despite the geopolitical uncertainty, both consumption and investment growth among the Baltics was strongest in Lithuania.

Investment growth is being fuelled by record high capacity utilisation rates. But geopolitics slowed down investment growth in the second half of the year (from 11.1% in H1 14 to 4.6% in H2 014).

Declining industrial confidence, which has fallen since October from -3.4 to -10.8 in February, is a worrying sign in terms of investment growth outlook.

Retail sales were weak in January 2015 (up 1.7%), largely due to the uncertainty related to the introduction of the euro.

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Growth of main GDP components - Lithuania

2014 2015E 2016E






17

Contributions to growth - Estonia


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Contributions to Estonian GDP growth (%)

Output gap Domestic demand Exports Imports GDP growth

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Contributions to growth - Latvia


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Contributions to growth - Lithuania


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Contributions to Lithuanian GDP growth (%)


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Exports to Russia in freefall


Russian imports declined by 40% y/y in January. Baltic exports to Russia in January shrank (y/y) by 57% in Estonia, 32% in Latvia and

38% in Lithuania.

This comes on top of the 15.4% contraction in Estonian exports and 4.9% contraction in Latvian exports to Russia in 2014.

Lithuania managed to increase its exports to Russia in 2014 by 4.4% largely due to stronger re-exports of investment goods.

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Exports to Russia (EURm)

Estonia (lhs) Latvia (lhs) Lithuania (rhs)

Export growth to Russia, 2014

Estonia: –15.4%

Latvia: –4.9%

Lithuania: +4.4%

Fall in January ‘15 (% y/y)

Estonia: –57.4%

Latvia: –31.9%

Lithuania: –38.0%

Our forecast for export growth to Russia in 2015:

Estonia: –31%

Latvia: –21%

Lithuania: –25%

21

Effect of Russian food sanctions (Lithuania)

Following the imposition of the food sanctions on Russia on 7 August, Lithuanian exports of the banned products into other markets increased.

Although Russia accounted for 45% of all exports of the banned products prior to the embargo, in September-December 2014 the fall in total exports of the embargo products was just 27%.

Exports increased to Belarus, the US, Saudi Arabia, Germany, Uzbekistan but decreased to Poland and Latvia.

The increase in exports to other countries clawed back 26% of the exports lost to Russia.

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Global exports of the embargo products, Lithuania

(EURm)

Other countries Russia Belarus

Source: Statistics Lithuania, Danske Bank Markets

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Effect of Russian food sanctions (Latvia and Estonia)

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Latvia (EURm)


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Global exports of the embargo products,

Estonia (EURm)


Source: Statistics Estonia, Statistics Latvia, Danske Bank Markets

In September-December Estonian exports of the embargo products declined by 14% (vs 16% share of Russia in the export structure of the banned products). In Latvia the decline was 31% (vs 11% share of Russia).

The increase in exports to other countries clawed back 9% of the exports Estonia lost to Russia (for a ‘rate of compensation’ of 9%). In Latvia however, exports to other countries declined by more than the losses (the rate of compensation therefore being negative at -115%.)

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Transport revenues decline

Transport services account for a large share of total exports of goods and services. The share is 10.8% in Estonia, 12.8% in Latvia, and 12.5% in Lithuania.

Slowing export volumes and Russian food sanctions affected revenues of the transport companies as well. Although on an annual basis contraction in income of the transport sector was avoided, annual income growth slowed down considerably, especially in Lithuania (from 12.4% in 2013 to 4.6% in 2014).

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14

Q3

2

01

4Q

4

Annual change in revenue of transport companies (deflated)



24

Exports to continue growing despite Russia

While exports of goods and services in 2014 expanded by 2.0% in Estonia, 1.4% in Latvia and 3.1% in Lithuania, losses in some of the main export markets continued to be a drag. The biggest losses for Estonia were in the Russian and Finnish markets (down by 15% and 7% respectively), for Latvia in the Estonian and Russian markets (down 6% and 5%), while Lithuania suffered heavily from the decline in refined oil products (down by 24%).

Despite the contraction in exports to Russia, overall exports are set to expand in 2015 in all three Baltic states: by 2.1% in Estonia, 2.8% in Latvia, and 0.6% in Lithuania. We expect export growth to pick up to 5-6% in 2016.

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

Real growth in exports of goods and services



25

Employment on the rise in Lithuania

Source: Eurostat, European Commission, OECD, Danske Bank Markets estimates

Note: NAIRU is the non-accelerating inflation rate of unemployment; it measures the natural

rate of unemployment, i.e. the unemployment rate at the point when an economy is in the

middle of its business cycle

5.8 4.3

5.8

13.8

17.8

15.4

13.4 11.8

10.7 9.6 9.2

-10

-5

0

5

10

15

20

-10

-5

0

5

10

15

20

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

E

20

16

E

Unemployment and output gap in Lithuania

Output gap Unemployment rate NAIRU

Despite the 1.2% decrease in population, the labour force in Lithuania in 2014 decreased by just 0.1%. Reductions in population were offset by higher employment and participation rates.

Employment expanded by 2.5% in 2014, reflecting the broader trends in business confidence and rising business profits.

A new labour law, the draft of which is to be presented to the Lithuanian parliament in May, promises to bring more flexibility to the labour market, potentially bringing unemployment down and further decreasing the NAIRU.

26

Stronger shrinkage of labour force in Latvia and Estonia

Source: Eurostat, European Commission, OECD, Danske Bank Markets

Note: NAIRU is the non-accelerating inflation rate of unemployment; it measures the natural rate of unemployment, i.e. unemployment rate at the point when

an economy is in the middle of its business cycle

7.0 6.1 7.7

17.5 19.5

16.2 15.0 11.9 10.8 10.2 9.9

-15

-10

-5

0

5

10

15

20

-15

-10

-5

0

5

10

15

20

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

E

20

16

E

Unemployment and output gap in Latvia


5.9 4.6 5.5

13.5

16.7

12.3 10.0

8.6 7.4 6.8 6.5

-10

-5

0

5

10

15

20

-10

-5

0

5

10

15

20

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

E

20

16

E

Unemployment and output gap in Estonia


Downward trends in unemployment in Estonia and Latvia in 2014 were primarily driven by shrinking labour forces (which shrank by 1.1% and 0.9% respectively).

Employment growth was virtually zero in both countries but the trend is set to reverse in Latvia in 2015 as businesses have kept new hiring on hold lately.

Employment is to continue declining in Estonia in 2015-2016 (by 0.2% on average). However, even stronger shrinkage in the labour force (1.1% on average) will continue driving down unemployment.

27

Economic forecasts for the Baltic states

Source: Danske Bank Markets estimates

Year GDP (% y/y) GDP deflator (%

y/y) CPI (% y/y)

Private

consumption (%

y/y)

Fixed

investments

(% y/y)

Unemployment

(%)

Current account

(% of GDP)

Estonia

2013 1.6 4.5 3.2 3.8 2.5 8.6 -1.4

2014 1.9 0.6 0.5 4.4 -1.0 7.4 -2.3

2015E 2.2 2.3 0.6 4.2 2.2 6.8 -2.5

2016E 2.7 2.7 1.7 4.0 3.5 6.5 -2.6

Latvia

2013 4.2 1.1 0.0 6.2 -4.2 1.9 -0.8

2014 2.5 2.6 0.7 3.2 1.2 10.8 -0.2

2015E 2.6 2.8 0.8 4.4 2.8 10.2 -1.6

2016E 3.1 3.0 1.9 4.2 5.6 9.9 -1.9

Lithuania

2013 3.3 1.6 1.2 4.2 7.0 11.8 1.6

2014 2.9 3.4 0.3 5.0 7.0 10.7 -0.5

2015E 2.5 2.9 0.2 4.1 5.8 9.6 -0.9

2016E 3.1 3.1 1.6 4.3 6.4 9.2 -0.7

28

Disclosures

This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’). The author of this research report is Rokas Grajauskas.

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Each research analyst responsible for the content of this research report certifies that the views expressed in this research report accurately reflect the research analyst’s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report.

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Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request.

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29

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