Baltic Rim Outlook: Record-strong growth

Despite the strong advances in recent years, the potential is far from exhausted yet. "We believe that the Baltic countries and Poland will continue growing faster than the EU on average in the coming years as well. Above-average growth in the Baltic Rim is also supported by the bright prospects in Russia, which has benefited a lot from the booming oil and gas prices," says Senior Analyst Mika Erkkilä, Nordea's economist responsible for the Baltic countries and Russia.

According to Nordea analysts, inflation in Lithuania in 2007 and 2008 will be on its way up and will respectively grow to 4 and 4.3 per cent. The lending boom, which follows trends in the real economy, has peaked. This is related to the housing market; price stabilisation in the residential property market has halved credit growth from its peak. Consequently, Lithuania is in the phase of the economic cycle typically characterised by accelerating inflation and growing imbalances – although the imbalances have not developed as far as in Latvia and Estonia. 

Overheating risks in Latvia have increased as economic imbalances have aggravated. Double-digit growth has come at the expense of stubbornly high inflation, a very high current account deficit and growing indebtedness. Inflation has increased to the extent that the country has seen its EMU plans delayed. "There have been fears about a possible devaluation. Despite the risks, we think that ultimately the authorities will manage to steer the economy into calmer waters and avoid a hard landing of the Latvian economy," Mika Erkkilä points out. 

It should be noted that both Estonia and Lithuania use pure currency board systems, where the monetary base is always covered by currency reserves. This system offers good protection against devaluation pressures, but the consequence in case of a substantial outflow of foreign currency will be sharply rising interest rates.

Estonia will probably escape a hard landing, as the economy is heading towards a cyclical slowdown. Credit growth has probably peaked and the real estate market is also likely to cool down. At the moment it seems that the risks of a hard landing have diminished. Although Lithuania has also experienced historically high growth rates, the country has not experienced the same lending and real estate boom, and indebtedness is also lower.  

Russia is now slowly but steadily regaining her status as a major power that has a say in the world affairs. In the run up to the election cycle, Russia has benefited from the high world market prices for its main exports, oil and other raw materials. The purchasing power of households, whose savings were largely wiped out after the rouble crisis in 1998, is increasing fast again.  "The economy is more resilient to a possible oil price decline now," says Mika Erkkilä. "However, this is not to say that there aren't risks, either. There are concerns around the political development and the investment climate." The Polish economy is also performing strongly, although hardly as fast as in 2006. High growth and a tighter labour market should mean gradually higher interest rates, as the central bank is expected to act in order to avoid inflation accelerating too much.