Baltic States implemented harsh austerity policies during the post-crisis period and now can boast having one of the lowest public deficit and debt levels in the EU. Interestingly enough, Baltic States are among the only 6 EU countries satisfying all Maastricht Criteria (together with Luxembourg, Denmark and Slovakia).
Zygimantas Mauricas, Nordea chief economist in Baltics says, that Baltic States did a remarkable improvement in its competitiveness as evidenced in its high rankings in Global Competitiveness, Ease of Doing Business or Economic Freedom indices. In general, Baltics are well prepared to withstand any external or internal shock, which is in sharp contrast to pre-crisis period in 2005-2008.
Somehow GDP forecasts are below potential growth, because an ongoing uncertainty of external environment does not promise an easy stroll in a park for Baltic economies.
GDP growth in all three Baltic States fell below Eurozone average in 2016 Q3. Zygimantas Mauricas, Nordea chief economist in Baltics says, that low growth environment will require taking active and targeted policy measures to minimize potential damage on long-term economic development and enhance competitiveness to ensure continued economic convergence. Over the last decade economic convergence was remarkable with GDP per capita (in PPS) in the Baltics moving from 54% of EU average in 2005 to 72% in 2015. However, at this level the speed of convergence tends to slow down as benefits from low-hanging fruits is mostly exhausted.
„Having no macroeconomic imbalances Baltic economies are well positioned for solid and sustainable growth, but the growth path is littered with hurdles. Negative spill-overs from Russian economic crisis, Chinese financial turmoil and Brexit prevent Baltic economies from utilising their full growth potential. If sustained, this may inhibit an ongoing convergence with the West and have negative longer-term social and economic consequences“, - states Zygimantas Mauricas.
Gints Belevics, Nordea chief economist in Latvia states that inflation comeback puts an end to household income growth bonanza, but may revive dormant housing market . Inflation growth will be supported by strong domestic inflationary pressures and fading deflationary effects from imported energy prices. Nominal wage growth is forecast to slow down to 4% to become more aligned with productivity growth, while inflation will accelerate to 2%-3%, driven by a sustained increase in service prices and fading deflationary effects from energy imports. Hence, real wage growth will decelerate from an observed 5-6% to a mere 1-2% over the next two years. It is expected Consumer prices to rise from 0.0% in 2016 to 2.4% and 3.0% in 2017 and 2018 respectively.
Investments were primarily dragged down by fall in construction activity as a result of lower inflows of EU funds, which are of temporary nature and is forecasted to rebound in 2017. Investments in transport equipment are already recovering after drop in 2014-2015 following Russian embargo and economic crisis. The key for future competitiveness and economic stability is investments in machinery, which is still at moderate levels.
Tõnu Palm, Nordea chief economist in Estonia states, that cyclical recovery in Estonian industry will be supported by export demand and rising prices. Estonian industry is heavily dependent on ongoing recovery in the Euro are and Nordic demand, since more than 70% of manufacturing goes for exports, with the Nordics share standing as high as 40% of overall industrial exports. Today, more than half of the branches are expanding with more sectors to deliver revenue growth next year supported by fairly steady performance by the Euro area economy. Moreover, the China stimulus and Trump reflation trades have added to commodity prices, which will feed into export prices. The recovery will be challenged by growing political uncertainty as the elections cycle approaches in Europe.
Overall, the economy will gradually regain momentum as domestic demand will be supported by exports. It is too early to conclude to which extent will the fiscal policy of the new government (inaugurated 23 Nov) stimulate investments. As a positive for investment climate, the dividend rate will be sharply cut from 20% to competitive 14% level. Growth will continue to be driven by private consumption with continues rose on wages. Yet for long-term growth boosting productivity is essential.
Lithuania successfully overcame external economic hurdles but failed to create a modern welfare state. The newly elected government aims to create one and stem emigration. However, this is no easy task, given the weak growth environment, and strong political will be needed to implement major structural reforms.In the post-crisis period, Lithuania succeeded in balancing its public finances and regaining its competitiveness. This paved the way for a robust export-led recovery and adoption of the euro in 2015. However, Lithuania failed to create a modern welfare state. High income inequality, a sizeable shadow economy, widespread tax evasion, low social security spending and vast regional differences preclude many citizens from benefiting from the economic recovery. Negative side effects include emigration and social exclusion, which may endanger the long-term economic development.
With the external environment remaining hostile (Brexit, Russia) and globalisation going out of fashion, Lithuania can no longer rely exclusively on the export-led recovery. “Cleaning your own backyard” becomes increasingly important. The overwhelming victory of the “Lithuanian Peas-ant and Greens Union” in the October parliamentary elections reflects the prevailing dissatisfaction with the “unwelfare” state. Yet the path towards a welfare state will be one with hurdles. Our baseline scenario assumes only gradual pro-gress with moderate growth of 2-3% both in 2017 and 2018, driven primarily by the ongoing cyclical recovery in private consumption fuelled by rapid wage increases. Investment will pick-up due to a more active government investment programme and continued attraction of foreign direct investment, while export growth will remain moderate.